Bonds vs. Inflation

[Mysto]

I want to increase my bond allocation. Most of my FI is currently in Prime MM. However the last time I had major allocations in bond funds was in the early 80's ( I discovered that it was possible to lose money in bonds - something I didn't know before)

My question is how are the rest of you investing in bonds and how are you protecting against the almost inevitable inflation that is coming?

[LOL!]

I try to keep my maturities short and thus I have chosen bond funds with shorter durations. I am using the Vanguard short-term investment grade fund (VFSUX) and the Vanguard GNMA fund (VFIIX) for some of my holdings. I also use the Vanguard TIPS fund (VIPSX) when the blue line goes above 2.5% (blue line is found here: St. Louis Fed: Series: DFII10, 10-Year Treasury Inflation-Indexed Security, Constant Maturity . Since the blue line is in the sell range, I have sold my VIPSX and replaced with VFIIX. I also have some stable value fund shares in my 401(k) with a yield of about 4%.

There are outstanding bond fund discussions at Bogleheads :: View Forum - Investing - Help with Personal Investments and its sibling forums. In particular there is a currently active thread on the GNMA fund with lots of pros and cons: http://www.bogleheads.org/forum/viewtopic.php?t=37057

[socca]

The nice thing about staying short is that as long as we have mild deflation you can collect a nice big real yield. Furthermore, if inflation/hyperinflation does appear your short bonds and/or bond funds won't be hammered nearly as badly as the intermediate or long term bonds. This is why my short-term bond funds have performed extremely well during this economic 'crisis' - many other investors are aware of this investment strategy and have placed their investment bets accordingly.

My favorite short/intermediate bond funds are Vanguard's municipal money market, short-term, limited-term, and intermediate-term bond funds. Whether these are good investments at this exact point in time depends on an economic forecast that I'm unwilling to make; however, they may be worth further investigation for your portfolio. Good luck!

[freebird5825]

I take a simple approach - the yield I get from my bond funds needs to be close to or maybe even match the current inflation rate, and hopefully with a relatively stable NAV. What a dreamer!
I'm a TE muni fanatic. I really like the free and clear dividend yields I get from VWAHX and VNYTX. I view the 30 day dividends as a "match" to my monthly DCA. I invest my bond portion this way to annual cover property taxes. I haven't had to tap them for taxes yet.
Yet.
Long term plans for these funds is to be an income generator when I start drawing on my portfolio.
I do my non-muni bond investing through a few balanced funds (VBINX, DODIX) and have recently responded to the "psssst Welleesley" siren.
Current target AA is 40/60 for 2009 going forward, with a maximum drift of 10% allowed to 50/50 worst case. Ongoing DCA will be redirected to rebalance as market conditions shift.

[Rambler]

I'm floating around 50/45/5 and planning to keep it pretty close to that. Monthly investments are going to equities and bonds every other month. My bonds are mostly long munis with coupons yielding in total about 5.7% of the bond portion of my AA. That is equivalent to about a 10.4% pre-tax yield for now as I am still w*rking. Current estimates put me at being able to live on less than the bond interest, reinvesting the rest, as well as reinvesting the dividends from the equity side. Much of the equity divvies will go into more long munis to add enough cash flow to cover for inflation. Of course in 10% inflation came along, I would have a problem...but if equities inflate at the same time I would just re-balance into more bonds. If not, I would add the divvies to my cash flow for expenses as necessary. We're talking about a very long timeframe here though. So, provided I continue to w*rk as long as megacr@ p is telling me it wants me to work (3 1/2 years), or as long as it takes to get me to the above mentioned position of being able to live off the bond interest alone while reinvesting the leftovers and the divvies (about 1.5-2 years) then I think I'll be OK.

All of this said, as of 2 years ago I was hoping to pull the plug next month. That's not happening for a variety of reasons (including the market, but also including not having my replacement ready, and other reasons). I also note that if push came to shove, I am FI enough to go today, if that became necessary. I'd like a little more cushion though.

R

[audreyh1]

I also stay with short-term bond funds. It's tough though - every interest rate increase cycle seems to act different. In the most recent one, the short-term bond funds were creamed while the intermediate bond funds reacted little to increasing interest rates - the opposite of what is usually expected. You never know.

Sometimes during an interest rate increase cycle I hold some of my cash or a portion of my bond allocation in a bank-loan fund like FFRHX. This is a risky bond fund that does well during rising interest rate cycles if the economy is doing well, but can do very poorly if the economy falters and awful during any credit crunch/crisis. So this would be a short term timing thing.

But the main way I handle inflation risks over the long run is to own equity funds in my portfolio. These are what truly protect a portfolio against inflation. Over time, if equities increase, you will be rebalancing and buying more bond funds even if interest rates are rising, you come out ahead.

Audrey

[dshibb]

There are only two ways. One is to do short durations, the other is to go for medium to high risk(not quite junk) bonds. What you would hope is that you could get a bond that is has such an overpriced default rate that it does well even in high inflation times. The first strategy isn't a good one, the second is a mediocre one.

Oh and there is TIPS, too(one of my favorite moves, but you don't want to wait any longer on these).

Maybe you should find something else besides bonds.

[socca]

Quote:

Originally Posted by audreyh1 But the main way I handle inflation risks over the long run is to own equity funds in my portfolio. These are what truly protect a portfolio against inflation.

This is true if and only if a large number of possible events negatively impacting equity ownership do not occur. It is worthwhile for equity investors to be aware of all of these possible negative events and factor them into their overall risk calculation, rather than just rely on the overly simple asset allocation mental model.

Of course, there are a large number of possible events negatively impacting bond ownership as well. So, there are no easy answers (unless you're a broker selling dubious investments to passive and trusting clients on commission, in which case the answer is obvious: buy, buy, buy ).

[dshibb]

Sorry is*** a good one, typo. For some reason it wont let me edit my previous post.

[MichaelB]

I think we are seeing the top in bond prices and they will soon begin a long slow journey downwards. If so, bond funds would see a progressive decline in price and increase in yield – a real killer in a taxable portfolio. I am reducing a bit my fixed income allocation and have moved most (90%) of it into individual bonds laddered to meet my projected budget needs, and plan to continue this indefinitely. The rest is short term corporate.

[dshibb]

I wouldn't do that, but to each is own. You need something that moves with inflation.

[brewer12345]

Personally, I rather doubt that inflation will come anywhere near the 13.XX% YTM I locked in today buying investment grade bonds that mature in 2016.

[dshibb]

Really?




And listen to the Anna Schwartz interview on this forum(she's in my top 2 living), its the best interview with her I've seen.

[Notmuchlonger]

Quote:

Originally Posted by dshibb Really? And listen to the Anna Schwartz interview on this forum(she's in my top 2 living), its the best interview with her I've seen.

For us small folk. What did you just post mean. Or just me because Im not so smart...

Thanks

[dshibb]

Here is 07 and 09 annual change graph.







I'll tell you right now, this is the scariest graph I've ever seen in my life.

[dshibb]

"For us small folk. What did you just post mean. Or just me because Im not so smart...

Thanks "
I'm picking up on a quite a bit of sarcasm. If I'm wrong in that assertion let me know.

[freebird5825]

Quote:

Originally Posted by Notmuchlonger For us small folk. What did you just post mean. Or just me because Im not so smart... Thanks

I think it means the exponential growth, as shown by the chart spike to the right, of the liquid money supply is a guarantee of inflation once it gains momentum in the public domain.
A Physics 100 short course for all the business and journalism majors on Wall St, if I may.
Velocity = distance / time and is a vector. It has magnitude and direction.
Momentum = mass x velocity.
I see "velocity" used in some of the articles about the liquid money supply.
I'm picturing $100 bills skewered on arrowheads with short lines, and $1000 bills skewered by much longer lines.
All that extra money is gonna have some serious mass and it will be moving.
Hence momentum is the correct term for lots of money moving around quickly.
OK, enough geek speak. Test is Thursday.

[dshibb]

In case you weren't being sarcastic, freebird summed it up pretty good. On top of that fed observers say that its going to be extremely hard for them to pull back on that. In the Schwartz interview, Anna talks about the Fed not having enough treasuries. Treasuries are traditionally the way that the Fed can engage in open market transactions to contract the money supply. They take the treasuries on their balance sheet and sell them to public. The money paid from the public to the fed contracts the money supply. That option is all but completely gone. Now they have toxic assets that no one wants, so it will be hard for them to sell those and contract the money supply.

They are either going to have to come up with some other way to contract the money supply or they are going to be limited to raising the fed rate by such an extreme amount that credit just becomes non-existent. And I would be very scared for any company that was beholden to the commercial paper industry. Every company in the country needs to start building cash reserves before that kind of pullback happens.

[Notmuchlonger]

No I wasn't being sarcastic.


Have a nice day.

[dshibb]

Sorry, it was the way that you worded it that led me to believe that. My apologies.

Essentially that graph meens that inflation is inevitable and it is going to be bad.