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Bond Fund Allocations instead of an annuity
Old 02-27-2016, 05:45 AM   #1
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Bond Fund Allocations instead of an annuity

As I look at my nestegg, by my calculations, if I were 50% allocated in Vanguard's Bond funds: 1/3 of that in each of the Short term, Intermediate Term, and Long Term ( SEC yields of 1.27,2.75, and 4.19 respectively, for an overall yield of 2,74), that yield added to my SS would essentially provide the "floor" I need to survive.

the other 50% I was thinking of putting into the Vanguard Total Market Fund (VTSAX). That will provide the "gravy".

All of these funds are in IRAs. I have a chunk of after tax money, about 10% of my total holdings, that I'm not figuring into these calculations. That is my "if I goofed this all up and I need cash" money.

I'm 62, DW is 58. An overall 3.2% of my IRA pot combined with SS will give me my "gravy" retirement.

Any reasons not to fund my "floor" this way, as opposed to an annuity?
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Old 02-27-2016, 06:47 AM   #2
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Aren't you concerned about being equally weighted in a long term bond fund given today's rate environment? I guess if the dividends are all you are looking for this might be OK, but you could easily become dismayed as rates climb and the NAV takes a big hit. I think the sweet spot for bonds might be a duration 4-5 years, not sure how that works out with your particular selections.
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Old 02-27-2016, 07:02 AM   #3
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Yes, that is a concern. My thinking is that being also allocated in the short and intermediate terms, I have some money available to buy more Long Term if rates go up, and increase my yield.

Keeping in mind here that I'm not looking at this as a strategy to necessarily optimize my bond returns over 30 years, but as an alternative to an annuity for my "floor"... it seems to me if I annuitize right now I'm locked into the current rate environment, and consequently, annuities are expensive for what you get.
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Old 02-27-2016, 07:23 AM   #4
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People try to time interest rates and the recent track record on that hasn't been good! Broad diversification is a good strategy for handling uncertainty with rates. No one knows when rates will change, and if so which segment of the curve will be hit the hardest. Having an allocation and rebalancing is a logical approach.

When you have an allocation for diversification, turning around and kicking out certain assets because you think they might do worse in the near future totally defeats the purpose of diversification.

What matters is whether a certain asset class helps the diversification of the total portfolio over the long run.

I avoid long bonds myself, simply because models I studied 15 years ago showed that over the long run the risk/reward in terms of inflation/interest rate risk doesn't pay off, i.e. it doesn't improve the efficient frontier curve of the total portfolio.
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Old 02-27-2016, 07:36 AM   #5
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Check out this from the bogleheads forum.

https://www.bogleheads.org/forum/vie...?f=10&t=185601
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Old 02-27-2016, 08:02 AM   #6
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Interesting idea, but I would go with the investment grade corporate bond versions of the short and intermediate term funds rather than the regular bond funds (which include a lot of government bonds) and forget the long term version. While it is true that you get more credit risk with corporates, the risk is diversified and you get paid for it.

For example, for the intermediate term Admiral bond funds, the regular fund yields 2.38% and the corporate version yields 3.58%, 1.20% more and the durations are similar (6.5 vs 6.4). Similar story for the short term bond, 1.25% vs 2.29%, a 1.04% difference and the same 2.7 duration.

Due to interest rate risk, I have been investing in target maturity bond funds which are like buying a participation in a pool of corporate bonds that mature in a stated year. For example, the Guggenheim Bulletshares 2024 Corporate Bond ETF yields 3.51% based on its closing price and has a duration of 6.9 and the 2023 version has a 3.32% yield and a 6.4 duration. A portfolio of these with different maturity years would do the trick as well.
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Old 02-27-2016, 08:38 AM   #7
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Vanguard Balanced Index Fund is a simple 60/40 fund that seems to have qualities you are looking for. You could supplement it with enough Total Bond Index to reach your 50/50 AA and be done with a 2 fund portfolio. Granted, current yield would be about 2.20% though.
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Old 02-27-2016, 08:47 AM   #8
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Or just buy equal amounts of Wellesley and Wellington since they are 40/60 and 65/35, respectively or the Target Retirement 2020 Fund which is 50/50.

Since it is all IRA money these may be an easier, simpler approach for you.
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Old 02-27-2016, 08:48 AM   #9
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Bond funds instead of an annuity is like apples instead of oranges. If you are just interested in yield why not look at dividend stocks as well? An annuity is an insurance product and might be a complement to a bond allocation rather than an alternative.
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Old 02-27-2016, 08:59 AM   #10
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Any reasons not to fund my "floor" this way, as opposed to an annuity?
The annuity might be better and if live a long time and also if you end up spending your bond principal in a rising interest environment.
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Old 02-27-2016, 01:33 PM   #11
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My view of having ST, IT, and LT bond funds for your FI portion just complicates a simple plan. Take a look @ VG Intermediate-Term Index Bond fund, perhaps it may fill the bill.
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Old 02-27-2016, 03:20 PM   #12
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Thanks for all of the input, everyone. I appreciate it.
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Old 02-27-2016, 03:26 PM   #13
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Don't forget that U.S. equities are currently yielding something around 2% and CD's are yielding more than short-term treasuries.

You can probably get your income "floor" without the need to venture out into LT bonds.

Also, that "floor" isn't really a floor. As low as yields are today, they can always go lower.
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Old 02-27-2016, 08:51 PM   #14
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HadEnuff, I think you have an excellent plan. It is well diversified, has plenty of stability, and enough stocks to help overcome inflation while giving enough dividends to survive comfortably.

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Old 02-27-2016, 11:04 PM   #15
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If the 2.74% is a nominal yield, and you're planning to spend all of it, then your "floor" will subside at the inflation rate. Not an attractive picture.

The equities aren't "gravy", they are just a hope-for inflation defense.
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Old 02-28-2016, 08:10 AM   #16
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The annuity might be better and if live a long time and also if you end up spending your bond principal in a rising interest environment.
This is why I want some Short Term, figuring that if inflation adjusts upward so will interest rates, and I can re-allocate into Intermediate and/or LT with higher yields..

Right now it seems to me investing in an annuity product is the essence of making a long term investment at historically low interest rates, in historically low interest rates. Unless I'm missing something, which is quite possible.

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....... As low as yields are today, they can always go lower.
and this is why I want some LT; if yields go down the LT will lock in relatively higher yields and higher share price...

No? Yes?
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Old 02-28-2016, 08:26 AM   #17
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Quote:
Originally Posted by HadEnuff View Post
This is why I want some Short Term, figuring that if inflation adjusts upward so will interest rates, and I can re-allocate into Intermediate and/or LT with higher yields..

Right now it seems to me investing in an annuity product is the essence of making a long term investment at historically low interest rates, in historically low interest rates. Unless I'm missing something, which is quite possible.



and this is why I want some LT; if yields go down the LT will lock in relatively higher yields and higher share price...

No? Yes?
Given the above perhaps you should consider a "barbell" approach that some people use given the rate environment. Rather than 33/34/33 ST/Int/LT they go 50/0/50. The weighted average yields and durations are about the same.

I'm aware of it but have not really considered it or explored the pros and cons but wanted to mention it. I'm sure others who are more knowledgeable about this strategy or are using it will weigh in.
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Old 02-28-2016, 09:08 AM   #18
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and this is why I want some LT; if yields go down the LT will lock in relatively higher yields and higher share price...

No? Yes?
Definitely true.
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Old 02-28-2016, 09:20 AM   #19
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I have about 40% LT bonds (BLV, 4.1%) and the rest of the bonds are midterm (BND, 2.5%). I am not just considering the bonds by themselves, but also as counterweights to stocks. They tend to move in opposite directions from stocks. Yes, I've heard about the great up and coming interest rise. My long term bonds are a touch more valuable today then when I bought them in September of 2014. I like the higher payments and expect that to be very stable.

Also, the great and up and coming interest rise is more of a myth than reality.

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Old 02-28-2016, 09:41 AM   #20
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Any reasons not to fund my "floor" this way, as opposed to an annuity?
Circling back to your headline question, I'd say "definitely maybe."

I know annuity is a bad word here. I know their shortcomings. And I don't currently actually own any, but I do think that I might some day.

Right now my financial plan has a huge amount of market risk in that I'm relying on stock and bond fund returns almost exclusively. If those returns fall short, so will my financial plan.

Because of that I'm always looking for ways to hedge my market risk. Unfortunately, the options are few. A portfolio of inflation indexed annuities can provide some diversification against lower than expected market returns.

Now that annuity portfolio is only as good as the credit risk of the providers, so one could argue that it doesn't improve the situation that much. But I think how much of an improvement depends on the nature of the retirement plan.

A plan with a very low withdrawal rate can be expected to survive most normal markets. The kind of returns that would endanger a 2% WR might also endanger the insurance industry. So adding annuities here might actually increase your risk.

But for people planning on +4% WRs and possibly underestimating life expectancy, an annuity portfolio could be a meaningfully upgrade. That's because it wouldn't take an insurance industry threatening market to sink a +4% retirement plan. Especially when we're looking at starting real yields on stocks and especially on bonds that are well below that required withdrawal rate.
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