Are bond funds bad for a retirement portfolio?

[pb4uski]

I have not looked at their yields in awhile, but that is something I would consider as we could ladder those.

As you may know, structurally they have many similarities with brokered CDs exFDIC insurance coverage. Yields are similar to brokered CDs. I think of them as simply owning a participation certificate in a pool of individual corporate bonds. Based on closing prices the 2020 Bulletshare and 2020 iBond are yielding about 2.34% compared to 2.25% for a 5 year brokered CD.

BSCK - Exchange Traded Funds | Guggenheim Investments - Investment Management for Financial Professionals
iBonds® Mar 2020 Corporate ETF | IBDC

 

[nun]

Part of my thinking in asking this question is the dogma that people entering retirement should be a bit more "conservative" and that usually involves increasing the bond allocation. But with rates at rock bottom the value of bond funds will eventually go down and if people are retiring and taking income from them they are dooming themselves to bad sequence of returns at the beginning of retirement. So would a CD ladder or really short duration Treasury bonds be better for those about to retire?

 

[statsman]

Part of my thinking in asking this question is the dogma that people entering retirement should be a bit more "conservative" and that usually involves increasing the bond allocation. But with rates at rock bottom the value of bond funds will eventually go down and if people are retiring and taking income from them they are dooming themselves to bad sequence of returns at the beginning of retirement. So would a CD ladder or really short duration bonds be better for those about to retire?

Would there be a difference between a portfolio requiring part of the principal to be cashed out from the beginning of retirement vs a portfolio which only requires the dividends/interest/capital gains and none of the principal (at least until the RMD(s) kick in)? Or should an investor always chase total return and generally ignore income vs expenses?

 

[audreyh1]

Part of my thinking in asking this question is the dogma that people entering retirement should be a bit more "conservative" and that usually involves increasing the bond allocation. But with rates at rock bottom the value of bond funds will eventually go down and if people are retiring and taking income from them they are dooming themselves to bad sequence of returns at the beginning of retirement. So would a CD ladder or really short duration Treasury bonds be better for those about to retire?

Sequence of returns is on the entire portfolio, not just the bond portion. Equities, when clobbered, tend to suffer far more than bonds do in the face of modest rate rises.

CDs can be good value. Nothing wrong with having them as part of a fixed income allocation, especially if you find the rare deal that out yields high quality intermediate bond funds. Personally, I think CDs give better value than some short term bond funds at the moment. But if all hell breaks loose, those bond funds can appreciate, helping the portfolio overall.

So I remain diversified in my fixed income asset allocation.

It's also foolish to assume that short-term bond funds will outperform intermediate or long term funds if the Fed raises rates. A study of history will show times where long-term interest rates have dropped when the Fed raised short-term rates. So you simply can't assume the interest rates will rise the same amount across the board.

Again, remaining diversified is a good strategy. It's very tricky (IMO impossible) to time interest rates, the rate curve, inflation, credit crises or squeezes, etc.

 

[Lsbcal]

Part of my thinking in asking this question is the dogma that people entering retirement should be a bit more "conservative" and that usually involves increasing the bond allocation. But with rates at rock bottom the value of bond funds will eventually go down and if people are retiring and taking income from them they are dooming themselves to bad sequence of returns at the beginning of retirement. So would a CD ladder or really short duration Treasury bonds be better for those about to retire?

After a lot of data crunching I cannot find a really good way to manage the duration in a market timed sort of way. The market knows an awfully lot already about rate guesses going forward.

The yield curve slope is somewhat above average right now suggesting a premium for taking "term risk". I could mention the numbers if someone is interested. It could be that shorter duration will do somewhat better then longer duration (maybe 2 years versus 5 years). But I have no idea if that would happen. I'd like to see the reasoning that favors short duration over intermediate. One would have to say why term risk will not be rewarded going forward and why the bond market has not factored this in.

I don't have CD's but they could be a good idea. I'm not sure why this time is any different then others to choose CD's over bond funds.

 

[Lsbcal]

Sequence of returns is on the entire portfolio, not just the bond portion. Equities, when clobbered, tend to suffer far more than bonds do in the face of modest rate rises.
...

Very important points. Bonds rarely get clobbered compared to equities. Bonds are there for capital preservation i.e. safety. It's nice to also get some real return but that is a secondary issue I think.

In one of the worst periods for equities, the early 1930's, corporate bonds did get clobbered. Capital preservation was really a troubling issue then. For this reason, I'm looking very carefully at how to move my bond funds to the same duration Treasury funds should the yield curve flatten. If one waits until the daily papers are screaming recession it may be a bit late. This approach has worked out since 1987 which is as far back as my fund data goes. I realize this is (gentle) market timing and not to most people's taste. It is very unlikely we will see another 1930's again but not impossible.

 

[Fermion]

There *are* a lot of corporations financing purchases, buybacks and even dividends with very low yield bonds...

 

[FUEGO]

I've made a decision to mostly skip bonds in my retirement portfolio. I have about 1% of my assets in ISM, a bond that matures in Jan 2018 and will meet most of our spending needs for 2018. I also keep 2-4% in cash that pays 1% at my credit union. So 3-5% fixed income, with 95-97% being equities.

I'm not concerned about volatility year to year as much I am the multi-decade impact of investing in near-zero return assets. If bonds ever start paying a decent real return, I'll consider jumping back into them.

In the mean time, I would rather keep my limited cash in very short duration assets (zero duration in the case of money market).

 

[W2R]

As always, I think that Audreyh1 has such a clear understanding of her investments and why one might want to have or not have certain investments, bond funds in this case.

I don't worry about bond funds keeping up with inflation. That job is assigned to my equity allocation.

+1 That has been my viewpoint on inflation as well. If my equity funds did not have that long term role in my portfolio, I might cut way back on them because they can be so volatile.

My bond funds are:
Wellesley VWIAX
TSP "G Fund"
Total Bond Market index VBTLX.

Spreading my bond allocation between these three funds seems to work well for me so far.

I have a total yield mentality and I am not strictly a dividend investor. That said, I find that spending from my portfolio has been covered by dividends from my entire portfolio (not just from my bond funds). Yield from my bond funds has been adequate for this in my case. I would go nuts at every market swing if I had 100% equities like I did during the accumulation phase. Now my AA is 45:55 (equities:fixed, with the latter including 5.5% cash) and I don't worry so much.

 

[nun]

Very important points. Bonds rarely get clobbered compared to equities. Bonds are there for capital preservation i.e. safety. It's nice to also get some real return but that is a secondary issue I think.

But are intermediate bond funds safe and a good place for capital preservation? If there's a good chance that you will lose money in them, should they be used for capital preservation?

Of course you'd hope that if bonds are down you can take income from equities instead, but my question is whether it's a good idea to increase the percentage of bonds as you prepare for retirement with bond rate where they are right now, that's been the conventional wisdom, but does it still hold. Should people be holding more equites and CDs rather than going into retirement with bond funds that are almost certain to lose value in the next decade.

I'm definitely not a fan or market timing, but AA should change as your financial needs change. I'm a year into retirement and looking at my asset allocation and I've decided to move out of intermediate bond index funds as I don't think they'll do the job of capital preservation over the next 10 years unless I reinvest all the interest.

 

[Lsbcal]

But are intermediate bond funds safe and a good place for capital preservation? If there's a good chance that you will lose money in them, should they be used for capital preservation?

I don't invest in bond funds where there is a "good chance" of loosing a significant amount of money. Is that what you meant or were you referring to some modest loss of principle as rates rise over a short period?

One should be judging a fund over it's full duration e.g. 5 years for a 5 year duration fund. But there is always a chance of a once is a century occurrence like in the early 1930's. That is why I mentioned my Treasury option which is market timing to a very limited extent.

Of course, not all the intermediate bond funds are the same. Here are some credit qualities from M* for a few funds:
VFIUX, Intermediate Treasury = AAA
VBTLX, Total Bond Market = AA
VFIDX, Intermediate Investment Grade = A
DODIX, Dodge & Cox Income = BBB

 

[audreyh1]

I don't invest in bond funds where there is a "good chance" of loosing a significant amount of money. Is that what you meant or were you referring to some modest loss of principle as rates rise over a short period?

One should be judging a fund over it's full duration e.g. 5 years for a 5 year duration fund. But there is always a chance of a once is a century occurrence like in the early 1930's. That is why I mentioned my Treasury option which is market timing to a very limited extent.

Of course, not all the intermediate bond funds are the same. Here are some credit qualities from M* for a few funds:
VFIUX, Intermediate Treasury = AAA
VBTLX, Total Bond Market = AA
VFIDX, Intermediate Investment Grade = A
DODIX, Dodge & Cox Income = BBB

I noticed this slight downward creep in DODIX credit quality. M* has finally updated their average credit quality statistic to reflect this - BBB. It used to be A.

Gundlach has been warning loudly about credit quality coming to bit investors holding high yield bonds in 2015. Of course, DODIX has limited exposure to high yield issues, but it's still around 10%.

DODIX is my main core bond holding. I'm planning to move about 20% of it to a higher credit quality bond fund - probably FSITX, which has a much higher average credit quality of AA.

 

[statsman]

I noticed this slight downward creep in DODIX credit quality. M* has finally updated their average credit quality statistic to reflect this - BBB. It used to be A.

Gundlach has been warning loudly about credit quality coming to bit investors holding high yield bonds in 2015. Of course, DODIX has limited exposure to high yield issues, but it's still around 10%.

DODIX is my main core bond holding. I'm planning to move about 20% of it to a higher credit quality bond fund - probably FBIDX, which has a much higher average credit quality of AA.

Similar situation for us, although we're still in the process of settling on an AA to put into place by retirement next year. Unfortunately, my wife's 401(k) only has DODIX and Vanguard GNMA (VFIJX) as available bond funds, and that account is 48% of our tax deferred total. Since we're currently 53% bonds and 47% cash (no equities), this is a double whammy.

I still see a lot of articles where DODIX is one of the recommended fixed income funds to hold. But I wonder how much of that is based on past performances of the fund.

 

[Senator]

I just met with a Financial Adviser this week. According to him, there has never been a 15 year period where bonds have out performed stocks. I have not had a chance to verify this statement, but it makes sense. If you have a long time to live, and do not need the money right away, less bonds is better - if you can take the volatility.

Whether I use a FA or not is still a question. The only reason why I would is to diversify a portion (25%) of my portfolio. And still get an opinion or sounding board when I need it.

Going forward, interest rates are headed up, maybe only one time, maybe more. Current bond prices will go down. Funds and ETFs will switch to higher yielding bonds, but it will impact performance.

You do not buy bonds for appreciation, you buy them for stability and income. According to the fool.com, here is an asset recommendation, FWIT. I have a tendency to agree.

• Rule 1: If you need the money in the next year, it should be in cash.
• Rule 2: If you need the money in the next one to five (or even seven) years, choose safe, income-producing investments such as Treasuries, certificates of deposit (CDs), or bonds.
• Rule 3: Any money you don't need for more than five to seven years is a candidate for the stock market.
• Rule 4: Always own stocks.

My retirement allocation strategy is this. As I sell my rentals, I will be buying bond ETFs or similar. I view them as my bond allocation now, and will continue to view them as such as I sell.

 

[pb4uski]

Not a bad asset allocation recommendation, however I have added a twist to it. I hold my Rule 2 money in tax-deferred accounts (PenFed CDs in my case) rather than in taxable accounts. I hold domestic and international equities in my taxable account for tax efficiency. With this twist I get great tax efficiency but still get the stability of CDs with respect to my overall portfolio.

When I need that year 2-7 money, I simply sell stocks in my taxable accounts and get tax preferenced long term capital gains and rebalance as needed in my tax deferred accounts.

 

[Mr._Graybeard]

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.

People often regard the oil price shock as the primary cause of inflation during that period. But it was also a time when a lot of baby boomers entered the accumulation period of their lives and drove up demand for a lot of goods and services.

I remember demographers in the 1990s pointing to 2005 as a likely point for a stock market crash because boomers were ending their accumulation phase. Sure enough, it happened (a little late, but nearly on time). It's interesting to consider how the shadow boomers (millennials) will drive demand in the economy, and whether they'll have a similar impact on the economy as a whole.

 

[pb4uski]

....I remember demographers in the 1990s pointing to 2005 as a likely point for a stock market crash because boomers were ending their accumulation phase. Sure enough, it happened (a little late, but nearly on time). ...

I recall seeing that graphic of the stock market compared to births lagged by a certain number of years and thought it was interesting but not compelling.

Are you referring to the decline during 2008-2009? If so, that was due to entirely different reasons. If it was for the reasons you suggest in your post then the recovery rally would not have occurred.

 

[mathjak107]

bonds have to be watched now .
yeah , they ain't stocks if they fall which they already have but they are a weight if stocks returns are weak .

a 1 year cd has surpassed most total bond funds this year by almost double. ,

the last 3 years have not been much better for bond funds .

there may be a very near time ,cash and equity's may be better performing .

in my opinion things going forward will have to be more dynamic as far as allocations go . a bond allocation may need a lot more diversification and higher yield since a total bond fund is missing way to many aspects of the bond market and is very very heavy in treasury's and gov't bonds

 

[Mr._Graybeard]

I recall seeing that graphic of the stock market compared to births lagged by a certain number of years and thought it was interesting but not compelling.

Are you referring to the decline during 2008-2009? If so, that was due to entirely different reasons. If it was for the reasons you suggest in your post then the recovery rally would not have occurred.

A lot of things can contribute to a perfect storm. I'm not saying generational demographics were the trigger to the 2008 crisis, but ... say the demand for mcmansions goes into decline as a certain generation ages out of them. Money available for mortgages builds, making riskier mortgages more attractive to yield-hungry investors.

I don't want to hijack this thread too much, so I'll leave it there.

 

[audreyh1]

Similar situation for us, although we're still in the process of settling on an AA to put into place by retirement next year. Unfortunately, my wife's 401(k) only has DODIX and Vanguard GNMA (VFIJX) as available bond funds, and that account is 48% of our tax deferred total. Since we're currently 53% bonds and 47% cash (no equities), this is a double whammy.

I still see a lot of articles where DODIX is one of the recommended fixed income funds to hold. But I wonder how much of that is based on past performances of the fund.

I think it is still highly regarded, and it will probably continue to be a great bond fund. I just notice they've decided to take more risk. I am just managing the credit quality of my bond allocation, and boosting it a bit, at the expense of sacrificing a little yield. I'll still be keeping 80% of my current position in DODIX.

 

[audreyh1]

I just met with a Financial Adviser this week. According to him, there has never been a 15 year period where bonds have out performed stocks. I have not had a chance to verify this statement, but it makes sense. If you have a long time to live, and do not need the money right away, less bonds is better - if you can take the volatility.

Going forward, interest rates are headed up, maybe only one time, maybe more. Current bond prices will go down. Funds and ETFs will switch to higher yielding bonds, but it will impact performance.

You do not buy bonds for appreciation, you buy them for stability and income.

I don't think things will work out as cut and dried as you spell out. The December rate rise is highly anticipated, and should be mostly factored in to current bond prices. Short term rates raised a small amount may not cause long rates to go up at all - that depends on the longer term outlook. If the economy falters or looks weak next year, any high quality bond fund NAV loss this Dec will be quickly reversed. Lower quality bond funds may get hit due to credit fears.

 

[Lsbcal]

I noticed this slight downward creep in DODIX credit quality. M* has finally updated their average credit quality statistic to reflect this - BBB. It used to be A.

Gundlach has been warning loudly about credit quality coming to bit investors holding high yield bonds in 2015. Of course, DODIX has limited exposure to high yield issues, but it's still around 10%.

DODIX is my main core bond holding. I'm planning to move about 20% of it to a higher credit quality bond fund - probably FSITX, which has a much higher average credit quality of AA.

Credit quality seems to be much in the financial news in recent months. As usual the bond market fully reflects this news. This Fed chart shows the credit quality spread: https://research.stlouisfed.org/fred2/series/BAA10Y

I am guessing that the under performance of DODIX in the last year or so was due to credit spreads widening. I too have DODIX as my largest intermediate term bond fund.

I'm also planning on spreading the risks around by holding more equal parts of DODIX, VFIDX, and BOND. But I might hold off for awhile because much of the credit spread widening has already taken place. Will it get worse? I don't know but I really don't think it probably that a big credit spread move such as 2008 will occur for the near future.

I also plan on going to intermediate Treasuries should the yield curve flatten too much.

 

[audreyh1]

Credit quality seems to be much in the financial news in recent months. As usual the bond market fully reflects this news. This Fed chart shows the credit quality spread: https://research.stlouisfed.org/fred2/series/BAA10Y

I am guessing that the under performance of DODIX in the last year or so was due to credit spreads widening. I too have DODIX as my largest intermediate term bond fund.

I'm also planning on spreading the risks around by holding more equal parts of DODIX, VFIDX, and BOND. But I might hold off for awhile because much of the credit spread widening has already taken place. Will it get worse? I don't know but I really don't think it probably that a big credit spread move such as 2008 will occur for the near future.

I also plan on going to intermediate Treasuries should the yield curve flatten too much.

I think the performance of DODIX was quite good the last couple of years. They held up very well in 2013 compared to their peers - that's when the "Taper Tantrum" occurred mid year with a sharp, temporary rise in interest rates. They did very well overall in 2014 when many intermediate bond funds recovered as interest rates dropped again. This year they seem to be running a little weaker, and I think it may very well be due to taking on a bit more credit risk which from what I have read was a change they made this year.

One of the posters over on Morningstar made this observation about DODIX this year:

I have to add some warnings about Dodge and Cox (DODIX). All Ms. Dziubinski has to say is correct, if you are using your rear view window to drive by.

In January, 2015 DODIX changed from being a Core type fund to a Core "Plus". The fund struck from the prospectus the requirement that 65% of its bonds be rated A or above. It added permission for itself to buy up to 20% of BB or B. M* dropped the portfolio's average credit rating from A to BBB.

By Sept. 30, 2015 (03 QTR 15), DODIX had lost money for the trailing: 1 day, 1 week, 4 weeks, 12 weeks, 6 months, and 1 year. It's Percentile Ranking in Category flailed around between 80th and 90th. They are bright boys and girls. I'm sure they have a good excuse or two.

This fund should have been re-rated as Neutral or Bronze until they proved they had learned how to be a "Plus" fund. But not on our dime. We moved to Fidelity Total Bond, where they already know how to do this sort of thing.

I don't require my entire bond allocation to be high-quality/safe, but I like a good chunk of it to be, as I am looking more for portfolio stabilization and bonds behaving well during credit crises and equity crashes. I avoid funds such as high yield bond funds, that tend to be highly correlated to equities.

BTW - yes, that credit spread graph is a classic one, and a pretty good predictor of recessions. It's back in the danger zone, although it has backed away a couple of times since 2009. There is a lot of oil related debt that has to be dealt with still - probably the main reason for the rise in 2015.

 

[Mulligan]

I don't think things will work out as cut and dried as you spell out. The December rate rise is highly anticipated, and should be mostly factored in to current bond prices. Short term rates raised a small amount may not cause long rates to go up at all - that depends on the longer term outlook. If the economy falters or looks weak next year, any high quality bond fund NAV loss this Dec will be quickly reversed. Lower quality bond funds may get hit due to credit fears.

We may invest differently, but our thoughts are the same. I own no bonds and treat all my preferred stocks as my bonds. Two years ago, the non utility preferreds took a bit of a dive when the first sniff of a rate hike was coming (taper tantrum). It hasn't happened this time yet. Market this time thinks raising short term rates is a "win-win" situation for preferreds. They know short term rates cant be raised much, and if it does it will just further protect the long end anyways.
I don't feel too worried anyways as most of mine are "yield trapped" (meaning past call, so they cant rise in value for fear of a call).They were issued around 6.5% when 10 year was 4% plus. They have little room to move downward since they are already still near 6.5% and have solid investment grade ratings.


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