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Are bond funds bad for a retirement portfolio?
Old 10-31-2015, 07:37 AM   #1
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Are bond funds bad for a retirement portfolio?

It looks as if bond funds will have poor returns for a while. As many retirement portfolios have intermediate bond index funds as core assets are people going into retirement that plan to take income from those funds stepping right into a sequence of returns problem? Are there any better fixed income solutions?
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Old 10-31-2015, 08:06 AM   #2
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As long as interest rates are held artificially low, it makes sense to be overweight stocks and very light on bonds.

Since inflation is very near zero, it doesn't hurt to hold cash right now. Very short term investments such as CDs, special bank offers, brokerage transfer bonus.

You can get a safe, no interest rate risk, 3 to 3.5% return on $300k+ with a little legwork.

We plan on being 60% stocks 30% bonds 10% cash but right now we are 65% stocks 5% bonds 30% cash. Soon as the 10 year is paying above 3% I am going to be pro bonds. Until then the stock market is going to continue to climb.
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Old 10-31-2015, 08:10 AM   #3
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Fixed income also reduces volatility, which can be a retirement plan killer for individuals with little annuity income. When considering moves into higher yielding options we need to be sure we can take the added volatility.
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Old 10-31-2015, 08:15 AM   #4
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This is part of the general problem of low expected returns. Some partial solutions:

(1) CD ladder
(2) shorten duration of your bond funds
(3) take more risk (= higher expected returns) elsewhere in your portfolio and use a total return approach
(4) accept lower return and live with a lower swr
(5) some combination of above


Regarding #2 my short term Corp bond fund has nearly the same yield as my total bond fund but with half the duration.


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Old 10-31-2015, 08:21 AM   #5
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They probably are since we are 0/45/10/45 (0% stocks, 45% bonds, 10% TIPs, 45% cash) heading into retirement the middle of next year. We had planned on most of the cash being invested by retirement, but no absolute plan is in place. Risk aversion has its price. The above worked very well from 2008 through 2012 plus 2014, but not so for 2013 and 2015 so far.
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Old 10-31-2015, 08:25 AM   #6
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Our retirement portfolio has a mix of bond funds: short term investment grade, Wellesley-managed intermediate term, interenational total bond, intermediate term corp, and high yield. The weighted average duration is only 4.5 years.
Although the price return of the shares will decline with increased rates, the interest return will continue. Since I have a long term objective and plan to only take interest, and, don't plan to sell shares I'm not worried.
Schwab has an article, from which I quote: "We see limited value and higher risks in long-term funds today compared to intermediate-term funds. The benefits of a slightly higher rate aren’t well-balanced with the increased interest-rate risk, in our view, for funds with average maturities much greater than 10 years. An exception might be if you’re focused on income and income alone and won't need to sell, or if you believe that interest rates will fall. While we believe rates could stay lower longer than many investors expect, they will rise eventually."
Should You Worry About Bond Funds If Interest Rates Rise?
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Are bond funds bad for a retirement portfolio?
Old 10-31-2015, 08:26 AM   #7
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Are bond funds bad for a retirement portfolio?

To me anyways it depends on what the investor really wants out of the term bonds... Some can be thinking one thing but really wanting something else. In other words wanting "income" but actually more concerned with a ballast against stock market corrections.
I wouldn't say my way of investing for income is "better", but provides significantly higher income. That being investing in "baby bonds" (exchange traded debt) or preferred stocks. These are basically income producing vehicles.
I would much rather receive an almost guaranteed 6%-7% dividends (my opinion only based on historical record of my issues) than a low paying bond fund. Many people confuse these with "high risk junk bonds", but that is not correct. Those are only a subset of the entire gamete that I do not buy.
I invest in high quality utility preferred stock. These are cumulative, and must be paid out before common dividends can be paid. For example, just yesterday I bought me some more CNTHP. It is a 1968 preferred 6.56%, $50 par, $51.44 callable issue. Bought at $52.20 for a present yield of 6.28%. Bought less than a dividend above call price, so no risk of principle loss. It is a Connecticut Light and Power issue that has not missed a dividend in its 47 years. It has been callable for 30 years so obviously little desire for company to call it.
If interest rates rise will price of issue fall? Maybe, maybe not. Who knows...I do know I wont lose any sleep over getting my 6.28% every 3 months. But I do like to back check. In 2006 when Fed Funds were 4% and 10 year was almost 4.5%, this issue was selling around $51. Hardly a major capital loss when its kicking out 82 cents every 3 months. Most of my issues are like the example cited above.
I love the yield and safety of these types of issues. These are my "bonds". However, the piper must be paid on everything. Drawbacks include, call risk and having to reinvest and these type are rather illiquid. Meaning you have to be patient in buying them and do not use them as trading vehicles.



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Old 10-31-2015, 08:35 AM   #8
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....Risk aversion has its price. The above worked very well from 2008 through 2012 plus 2014, but not so for 2013 and 2015 so far.

How true. For 2008 to date stocks have returned 7.1% and bonds 4.3% so a 60/40 portfolio would have yielded about 6%.

Let's say a more conservative portfolio yielded 3.5% for the same time period.

Over the 7.8 years (2008 to now) the 60/40 portfolio would be worth 20% more.... that's a lot of bling.... so the price of risk aversion is quite steep.
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Old 10-31-2015, 08:36 AM   #9
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....You can get a safe, no interest rate risk, 3 to 3.5% return on $300k+ with a little legwork....
Where?
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Old 10-31-2015, 08:50 AM   #10
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Where?
Ok, a lot of leg work.

I have been reading the churn sites and bonus offer sites. Some people actually do a lot better than 3% but from what I see you can manage 3% without too much money movement.
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Old 10-31-2015, 09:47 AM   #11
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It looks as if bond funds will have poor returns for a while. As many retirement portfolios have intermediate bond index funds as core assets are people going into retirement that plan to take income from those funds stepping right into a sequence of returns problem? Are there any better fixed income solutions?
I'm not at all sure about the premise here. I did some historical analysis to calm my own fears -- and I'm definitely not fearless about money.

The current 5 year Treasury yields 1.5%. Looking back, from April 1954 to December 1965, the 5 year Treasury rose 3% (from a start of 1.9% it went up to 4.9%). During that time the real return was 0.9%. But that was only calculated return (income + cap gains) and neglects any roll return which many bond funds capture. It also does not include credit risk return which more general intermediate bond funds provide.

Also the shorter period April 1954 to April 1959 saw the 5 year Treasury rise at a faster rate of 1.9% up to 4.1% and that calculated return was -0.5% real. Again this ignores roll return and does not include any return due to taking on some credit risk such as a more general purpose bond fund provides (such as Total Bond Market).

My own guess, initially we go up but at a slower rate then even the 1950's. I think it is wrong to assume intermediate bond funds will do poorly over the next 5 to 10 years. Yes, there could be a few months of angst, but overall this may turn out better then some fear.

When I have mentioned this history stuff there seems to be little to no response. But I hope some see it as relevant.
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Old 10-31-2015, 10:00 AM   #12
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Originally Posted by Lsbcal View Post
I'm not at all sure about the premise here. I did some historical analysis to calm my own fears -- and I'm definitely not fearless about money.

The current 5 year Treasury yields 1.5%. Looking back, from April 1954 to December 1965, the 5 year Treasury rose 3% (from a start of 1.9% it went up to 4.9%). During that time the real return was 0.9%. But that was only calculated return (income + cap gains) and neglects any roll return which many bond funds capture. It also does not include credit risk return which more general intermediate bond funds provide.

Also the shorter period April 1954 to April 1959 saw the 5 year Treasury rise at a faster rate of 1.9% up to 4.1% and that calculated return was -0.5% real. Again this ignores roll return and does not include any return due to taking on some credit risk such as a more general purpose bond fund provides (such as Total Bond Market).

My own guess, initially we go up but at a slower rate then even the 1950's. I think it is wrong to assume intermediate bond funds will do poorly over the next 5 to 10 years. Yes, there could be a few months of angst, but overall this may turn out better then some fear.

When I have mentioned this history stuff there seems to be little to no response. But I hope some see it as relevant.

I enjoy historical references and had looked at them quite a bit myself. I use it to judge certain scenarios on how the pricing of my preferreds will react to variable treasury and inflation rates since they traded throughout all those situations. It is my interpretation of it that I should probably question more than the history of it. I think some of us still are waiting/preparing for the "inevitable return" of the 70s and 80s since it was in our formative years. But after researching this, historically speaking those were considerable outlying years on the time continuum of our country.
There are many preferred stock issued in the 1940s and 50s that are still trading today with 4% par yields. And people desired them!


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Old 10-31-2015, 10:06 AM   #13
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Originally Posted by Lsbcal View Post
I'm not at all sure about the premise here. I did some historical analysis to calm my own fears -- and I'm definitely not fearless about money.

The current 5 year Treasury yields 1.5%. Looking back, from April 1954 to December 1965, the 5 year Treasury rose 3% (from a start of 1.9% it went up to 4.9%). During that time the real return was 0.9%. But that was only calculated return (income + cap gains) and neglects any roll return which many bond funds capture. It also does not include credit risk return which more general intermediate bond funds provide.

Also the shorter period April 1954 to April 1959 saw the 5 year Treasury rise at a faster rate of 1.9% up to 4.1% and that calculated return was -0.5% real. Again this ignores roll return and does not include any return due to taking on some credit risk such as a more general purpose bond fund provides (such as Total Bond Market).

My own guess, initially we go up but at a slower rate then even the 1950's. I think it is wrong to assume intermediate bond funds will do poorly over the next 5 to 10 years. Yes, there could be a few months of angst, but overall this may turn out better then some fear.

When I have mentioned this history stuff there seems to be little to no response. But I hope some see it as relevant.
I think it will work out fine. I think the rate will increase quite slowly, given the current state of the world economy. I would be surprised if we were at 1% at the end of 2016. I read somewhere the consensus is for 0.625% at the end of 2016.

And past history does matter because the period you refer to is very similar except we are going up from 0.125%. As rates go up, prices will go down but at the same time bonds will mature and the funds will get newer bonds at higher rates.

I do not know what roll returns means, could you explain please? Thanks.
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Old 10-31-2015, 10:59 AM   #14
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Here is one explanation from What Is Roll-Down Return? | Finance - Zacks
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Rolling Down The Curve

If you buy a longer-term bond and the yield curve has a normal slope, the market price of a bond naturally increases as the bond rolls down the yield curve. For example, say you buy a five-year bond, paying a 5 percent coupon with a 5 percent yield -- the bond is priced at face value. After two years, you own a three-year bond. If rates have not changed, the market yield on the now three-year bond should be lower, because it is a shorter-term bond. However, your bond pays a 5 percent interest rate, so the bond's market value must be higher. An investor buying the bond to now earn the 4 percent yield that three-year bonds are paying would pay 103.5 percent of the bond's face value. Your bond has gained value as it rolled down the yield curve.
My calculations above were from the Treasury constant maturity 5 year data. I'm not sure how I would calculate roll returns but when I do a calculation for Treasuries it is always lower then the comparable intermediate term Treasury fund due probably to roll returns. I think this may add another 0.5% or more to yearly returns. There was a discussion of this recently on Bogleheads.
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Old 10-31-2015, 11:55 AM   #15
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Ok, a lot of leg work.

I have been reading the churn sites and bonus offer sites. Some people actually do a lot better than 3% but from what I see you can manage 3% without too much money movement.
A lot of those are limited money deals. The recent CapOne had a $50K limit, for 3 months. If your portfolio is large, this offer was still worthwhile but not that significant overall. You'd have to keep finding a lot of those pretty constantly to get a 3% return on all your cash investments. Maybe they are out there and I'm just not looking hard enough. It's also more than just doing the paper work. You'd better do enough checking to make sure these are all legit and protected. One loss and you can wipe out all your gains and then some.
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Old 10-31-2015, 12:13 PM   #16
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I'm staying out of intermediate to long term bond funds for now. With interest rates so low the upside potential is small and the downside potential huge.
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Old 10-31-2015, 12:19 PM   #17
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I see bond funds as a nice stabilizing force within the overall retirement portfolio. They act to reduce volatility. I see them as one element of an overall balanced portfolio.

My portfolio is designed for a longer time horizon, 30 years in retirement, and takes my risk tolerance and very long term goals into consideration. Your plans may be different from mine.

The portfolio design I have developed uses low cost index funds for stocks and low cost bond funds. The following breakdown of asset classes is used to guide the portfolio construction, as my target allocations:

• 55% stocks / 45% bonds and cash. This is close to an optimum compromise between volatility and growth over time.
• Stocks are divided to 70% US-based and 30% foreign to minimize volatility. See the Efficient Frontier diagram below.
• 80% of the US-based stocks are in the Total Stock Market fund, and 20% are placed in a Small-Cap Value fund, to try and take advantage of the Fama-French Three Factor Model.
• Bond funds are split roughly half in an Intermediate Term bond fund, half in a US Treasury Inflation Protected Securities (TIPS) fund, and a cash reserve. The TIPS find is exempt from state tax, and is held in a taxable account. The Intermediate Term bond fund is subject to state and federal taxes, and so is sheltered from taxes in an IRA account.
• If additional Intermediate Term bond funds are needed, and the IRA is full, put this allocation into a State Intermediate Term Tax-Exempt bond fund in a taxable account.
• About 5% of the portfolio should be in a cash reserve. This is drawn upon monthly over the course of a year to provide our monthly spending money and cover irregular annual expenses. Cash may be in a money market fund or for funds not needed for over a year, in a short term bond fund.

Attachment 22542

Given this portfolio design, and allowing for a shift in value before needing rebalancing of up to 25%, I have the following allocations worked out using low expense Vanguard funds. Holding limits as minimum to maximum values of the entire portfolio are in parenthesis.

• Cash - Vanguard Prime Money Market Account 5%
• Vanguard Intermediate Term Bond Fund (VBILX) 20% (15% - 25%)
• Vanguard Inflation-Protected Securities (VAIPX) 20% (15% - 25%)
• Vanguard Total Stock Market Fund (VTSAX) 30.8% (23.1% - 38.5%)
• Vanguard Small-Cap Value ETF (VBR) 7.7% (5.78% - 9.63%)
• Vanguard FTSE All-World Ex-US ETF (VEU) 16.5% (12.38% - 20.63%)

This was developed as part of my overall Investment Policy Statement.

I recommend that everyone investing for some future goals develop such a statement, and pull it out every time one is planning on making a significant change, just as a little reminder.
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Old 10-31-2015, 12:24 PM   #18
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A lot of those are limited money deals. The recent CapOne had a $50K limit, for 3 months. If your portfolio is large, this offer was still worthwhile but not that significant overall. You'd have to keep finding a lot of those pretty constantly to get a 3% return on all your cash investments. Maybe they are out there and I'm just not looking hard enough. It's also more than just doing the paper work. You'd better do enough checking to make sure these are all legit and protected. One loss and you can wipe out all your gains and then some.
That sounds like a lot of work. I'm retired and have better things to do.

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I'm staying out of intermediate to long term bond funds for now. With interest rates so low the upside potential is small and the downside potential huge.
Have you looked into the target maturity bond funds from Guggenheim (Bulletshares) and Blackrock (iBonds)? They are intermediate term but mitigate interest rate risk if held to maturity and diversify credit risk so there is less downside.
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Old 10-31-2015, 12:49 PM   #19
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You can get a safe, no interest rate risk, 3 to 3.5% return on $300k+ with a little legwork.
I realize only a certain group of people have access to TIAA-Traditional, but right now it has a minimum of 3% and a bonus of 1% so any money you put in is guaranteed to give you 4% and obviously your principal is protected.

If you are relying on bond interest for income and you don't reinvest it when interest rates go up you are definitely walking right into a sequence of return issue.
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Old 10-31-2015, 01:18 PM   #20
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Isn't the TIAA traditional rather illiquid (why does the ER.org editor think illiquid is misspelled)
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