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Bond Questions
Old 01-05-2010, 07:55 AM   #1
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Bond Questions

It seems a general rule of thumb for retirement is to have about a 40/60 split between stocks and bonds. In this economy, is having 60+% of your retirement savings in Bonds, in my case, Vanguard Total Bond Index a good idea? And, if the Fed raises the interest rate to 4 or 5% in the coming months, how would you expect Bonds (VG) to react?
Thanks for any insight.
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Old 01-05-2010, 08:08 AM   #2
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Most of the work I've seen done on "safe withdrawal rates" in retirement assume somewhere between a 40/60 and 60/40 allocation.

Keep in mind that the Fed can really only directly impact short term interest rates; the longer term rates are still set by the market and its outlook on the economy and inflation. It's possible for short rates to rise and longer term rates to not move much, and if that happens not much happens to the NAV of bond funds with intermediate to long maturity. However, if short term rates rose sharply and longer term rates stayed flat, we could see an inverted yield curve which has been a fairly reliable indicator of recession (in which case, long investment grade bonds *usually* perform better).

On the other hand, if long rates *did* rise a lot as in the late 1970s and early 1980s, the longer the maturity, the worse the haircut.

In any event, VBMFX is a perfectly fine "core" bond fund holding. I'd probably want some of my 60% bond allocation in TIPS, though, given the importance of inflation protection as a retiree (especially without a COLA'd pension).
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Old 01-05-2010, 09:49 AM   #3
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Yes, bonds and bond funds react to prevailing interest rates. As interest rates go up, bond fund NAVs go down. The formula is relatively simple: For every 1% rise in interest rates, the NAV will go down by 1% * duration_of_funds_in_years. You can look up the duration.

Since rates are now about 0%, if rates go to 4%, then the NAV of VBMFX will drop by 4 * 4.27% = about 17%.

Another rule-of-thumb, is that it will take duration_years after an interest rate hike for the fund to break even if there are no further interest rate changes. That is, the dividends and internal replacement of bonds in the fund will eventually get you back to even. So if there are series of interest rate hikes, then it will take a while.

This is a reason why folks tend to like shorter duration bond funds when interest rates are rising. It becomes a game of chicken: Do I blink and go to short-term bond fund now with its lower interest rate? Or do I go long with the higher yield because the Fed is not going to raise rates for awhile with unemployment high and the economy struggling?
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Old 01-05-2010, 12:05 PM   #4
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Originally Posted by ljhilljr View Post
It seems a general rule of thumb for retirement is to have about a 40/60 split between stocks and bonds. In this economy, is having 60+% of your retirement savings in Bonds, in my case, Vanguard Total Bond Index a good idea? And, if the Fed raises the interest rate to 4 or 5% in the coming months, how would you expect Bonds (VG) to react?
Thanks for any insight.
I have some concerns about bonds right now. Also, it always seems like the types of bonds that are smart to have, are expensive to buy because of supply and demand. I think that "LOL!" and others have addressed what we might expect with a rise in interest rates.

I don't feel at all secure with my bond allocation.

About 1/3 of my bond holdings are part of my big chunk of Wellesley (VWIAX). This is an actively managed fund, so there I am at the mercy of Wellington Management and I hope these demigods of Wellesley, such as they may be, continue to make wise decisions.

Another 1/3 of my bond holdings are in the TSP "G Fund", which is a treasury fund available only to military and civil service (as part of our benefits) and is guaranteed not to decrease in share price. However, for the first time in the decades since inception it has not kept up with inflation in the past year or two.

The last 1/3 of my bond holdings is split between a big chunk of VBMFX Total Bond Index, a somewhat smaller chunk of VFSTX Short Term Investment Grade, and cash. If I invest more of that cash in bonds, I would probably choose VBMFX. But would that be smart? I am not sure. If the dividends hold up, then sure, but who knows if that will be the case. In the (very probable IMO) event that we have some inflation coming up, I will be in trouble unless my equities compensate, because I don't have TIPS or other inflation protection in my fixed income allocation. I am not sure they are a good buy right now.

Overall, I don't have a good answer to the question of where to put your fixed income money other than to pay attention to what other people (not me) say in this thread, and then diversify within the possibilities that sound prudent.
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Old 01-05-2010, 12:55 PM   #5
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W2R, I am a bit concerned about bonds as well. I have pumped up the G Fund to 40% of my TSP and eliminated the B Fund (which may not have done all that much for me in the short run). Then DW has bonds in her VG Wellesley and Star funds and we have a small position in GIM (foreign bonds) in my IRA. Thats about it, more in cash in the credit union. Oh, our Roth is in VG Asset Allocation (VAAPX) which sometimes and currently holds some bonds. We have a small amount in ibonds but I expect to cash them out this year to help with younger sons college expenses. Iknow I'm 'supposed' to hold a higher % of bonds but don't know which ones and where to hold them. I expect bonds to take a beating sometime but 'the market can remain irrational longer than I can remain solvent' so we'll see what happens.
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Old 01-05-2010, 02:40 PM   #6
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I'm in the same boat. Our AA is currently heavy in equities and we should rebalance. But the current NAV and yield of our bond funds is not very attractive, so I'm procrastinating. Now I feel like a "dirty rotten market timer" for not sticking with our target AA. At times like this, I wish our funds were in something like Wellesley and then I wouldn't have to worry about it.
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Old 01-05-2010, 05:47 PM   #7
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I'm in the same boat. Our AA is currently heavy in equities and we should rebalance. But the current NAV and yield of our bond funds is not very attractive, so I'm procrastinating. Now I feel like a "dirty rotten market timer" for not sticking with our target AA. At times like this, I wish our funds were in something like Wellesley and then I wouldn't have to worry about it.
Is there room in the lifeboat for one more?
I have handful of individual corporates in my IRAs they are intermediate term and the companies (with the possible exception of Sallie Mae) don't look like they are going to default so I'm planning on holding to maturity.

The same thing is true for me few remaining Muni bonds. Approximately 1/2 of my bond are in Vanguard bonds funds. They use to be entirely in Vanguard GNMA (listening to Bob Brinker tout the fund all of these years had an impact). In Nov 2008 I moved 1/2 the GNMA in the Vanguard Hi Yield. My timing was almost perfect and now I have a nice paper gain.

However, I am loath to sell the High Yield fund, because quite frankly I need the income. I am also reluctant to sell dividend paying stocks because the dividend yields are roughly the same as the bonds funds (and get better tax treatment). My basic retirement strategy is to have sufficient income via bonds, CDs, and dividends to fund my retirement spending. One of the ironies is last years rallies was terrific for restoring my net worth. However, between the huge drop in interest rates, massive dividend cuts by banks, REITs, and one MLP, and the paltry dividend increase in my other stocks, my income took a big hit.

So I am also procrastinating, I don't think stocks are a bargain, I think bonds are over priced compared to the interest rate risk, and I don't see how I can fund a retirement with 3% CD yields....

psst Wellesley is sounding better and better.
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Old 01-05-2010, 09:17 PM   #8
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Thanks everyone....so I now have a really stupid question, why would one want to own bonds at all? What good are they really. The VG FP that I talked to several months ago said that even though the bond price might go down, the bond income might go up at that same time. I just don't know if holding bonds is worth the trouble.....
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Old 01-05-2010, 11:50 PM   #9
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Thanks everyone....so I now have a really stupid question, why would one want to own bonds at all? What good are they really. The VG FP that I talked to several months ago said that even though the bond price might go down, the bond income might go up at that same time. I just don't know if holding bonds is worth the trouble.....
The conventional answer (which I think is still true) is that holding bonds along with stocks in a portfolio reduces the overall volatility (aka riskiness) of your portfolio significantly while only having a minor impact on the overall return.

The last decade is a perfect example of this the Vanguard Total Bond Index fund a perfectly respectable average annual return of 6.06%/year while the total stock index fund suffered a loss of -.27%/year. Somebody with a 50/50 portfolio would have average 2.9% which would have beaten (barely) inflation.

Now historically over long (20-30 year) period stocks out perform bonds. However, a lot can happen in life in a twenty or thirty year and it is nice to have some more stable than the highly volatile stock porfolio

During the worse period of 2008 it was comforting to know as long as Uncle Sam and various municipality didn't default I had several year of living expenses even if the market went to zero..
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Old 01-06-2010, 05:07 AM   #10
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...Now historically over long (20-30 year) period stocks out perform bonds. However, a lot can happen in life in a twenty or thirty year and it is nice to have some more stable than the highly volatile stock porfolio

During the worse period of 2008 it was comforting to know as long as Uncle Sam and various municipality didn't default I had several year of living expenses even if the market went to zero..
Hear hear!
As a FIREd person on a fixed pension/annuity income, and still accumulating at age 51, I have a decent stake in TE munis for a specific reason.
My thinking is...If I ever have a drastic increase in expenses beyond my fixed income, VWALX is there to tap into versus liquidating my equities. A few mouse clicks and I can redirect the dividends right into my bank account.
Two benefits - 1) less paperwork to track and 2) a redirect dividends to bank account action is not a taxable event.
The 30 day dividends I get from VWALX coupled with my ongoing monthly DCA to this fund are essentially a matching mechanism for me to build up a special case subset of my portfolio.
I own balanced mutual funds and individual US govt bonds, so I have lots of exposure to non-muni bonds.
My strategy with respect to VWALX will change of course when I enter the portfolio withdrawal stage of retirement.
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Old 01-06-2010, 07:24 AM   #11
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I'm in the boat with Yakers, IBWino, and clifp. I will probably make up my mind about two weeks too late
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Old 01-06-2010, 09:40 AM   #12
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It seems a general rule of thumb for retirement is to have about a 40/60 split between stocks and bonds. ....
A couple side notes on this discussion - while this seems to be a generally held premise, FIRECALC is not so definitive. I plugged in $1M portfolio, $35K WR (3.5%) and 35 year timeframe, which gives a 99% success rate. Now, hit the "investigate" tab, and we see that stock/bond ratios from 30/70 all the way to 100% stocks give similar success rates. You'd need to dig in a bit more to see how that affects volatility, but at least in terms of the 'end game', not as great a difference as most (including me) would expect. And the real danger (at least historically) was having > 70~75% in bonds.



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I'm in the same boat. Our AA is currently heavy in equities and we should rebalance. But the current NAV and yield of our bond funds is not very attractive, so I'm procrastinating. ...
Interesting point. I find that I used to look back at charts and say to myself - now THAT would have been an excellent time to make this-or-that move! But now, I've seen some times where it would seem to be a smart thing, but there are other variables i the mix that are not on that chart. You might want to make a note of this, so later on you don't say "Gee, what a dummy for missing that great opportunity!".

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Old 01-06-2010, 11:28 AM   #13
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Yes, bonds and bond funds react to prevailing interest rates. As interest rates go up, bond fund NAVs go down. The formula is relatively simple: For every 1% rise in interest rates, the NAV will go down by 1% * duration_of_funds_in_years. You can look up the duration.

Since rates are now about 0%, if rates go to 4%, then the NAV of VBMFX will drop by 4 * 4.27% = about 17%.

Another rule-of-thumb, is that it will take duration_years after an interest rate hike for the fund to break even if there are no further interest rate changes. That is, the dividends and internal replacement of bonds in the fund will eventually get you back to even. So if there are series of interest rate hikes, then it will take a while.

This is a reason why folks tend to like shorter duration bond funds when interest rates are rising. It becomes a game of chicken: Do I blink and go to short-term bond fund now with its lower interest rate? Or do I go long with the higher yield because the Fed is not going to raise rates for awhile with unemployment high and the economy struggling?
This is way too simplistic a view IMO and not nearly so easily predicted. Different points in the yield curve react differently to the Fed raising short-term interest rates. In past decade, the Fed raised short-term rates aggressively but intermediate and long-term rates went down slightly. Intermediate and long-term bond funds did nicely, short-term bonds were hurt. Folks who flocked to short-term bonds in anticipation of rising interest rates were the only ones really hurt.

Now why would the Fed raising interest rates cause intermediate and long-term interest rates to drop? Because under this scenario the Fed is viewed as being more aggressive at fighting long-term inflation.

You never quite know what is baked into the bond market and what is not. It's really difficult to game these things.

If you are holding bonds for the long-term as part of your AA and rebalancing these rate cycles average out over time.

Audrey
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