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Do I need an FI component or will I-bonds suffice?
Old 10-20-2004, 01:40 PM   #1
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Do I need an FI component or will I-bonds suffice?

A few of the top yields on bankrate.com have 1 year CDs at 3% APR. The Vanguard short term taxable bond fund (VBISX) currently has a yield of 2.87%. Average duration is 2.5 years. Given the risk of increasing interest rates, why would I ever choose the bond fund over the FDIC insured CD? Is the reasoning that if the stock market tanks, capital will move to bonds, pushing bond prices up?

I should mention that I'm in my 20s, I'm thinking about adding 5-15% of FI to my portfolio.

I ask because I don't have a true FI component of my portfolio right now (I have I-bonds, but these don't fluctuate in value) and I'm wondering if I need to add some FI (in the form of a short or intermediate term bond fund) to balance out my equity exposure. Would one of these funds help protect me from a decline in the S&P500?

My apologies in advance if this is rehashing something that should be obvious. I appreciate any input.
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Re: Do I need an FI component or will I-bonds suff
Old 10-20-2004, 01:50 PM   #2
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Re: Do I need an FI component or will I-bonds suff

I did the same thing, yanking my money out of the vanguard short term corp and into 11 month 3% cd's.

ibonds and cash instruments dont have the same dynamics as bonds do, so they wont give you quite the same asset allocation 'balance' as bonds do. But they will keep some of your cash away from stock volatility.

Which isnt to say its a bad idea to stay away from bonds right now, given the potential for rising rates.
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Re: Do I need an FI component or will I-bonds suff
Old 10-20-2004, 01:53 PM   #3
 
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Re: Do I need an FI component or will I-bonds suff

Quote:
why would I ever choose the bond fund over the FDIC insured CD?
Liquidity. - The ability to yank your funds like TH did.
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Re: Do I need an FI component or will I-bonds suff
Old 10-20-2004, 02:18 PM   #4
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Re: Do I need an FI component or will I-bonds suff

Some old pharts like myself use the Short Term
Investment Grade fund as a money market
substitute to provide a monthly source of retirement
funds. We are betting that the total return will beat
a money market, even if rates rise. So far, so good
this year.

For the great unwashed, please note that rising
interest rates are not all bad for a bond fund. Sure,
a fund will take an immediate hit in proportion to
its "duration", but note that the "duration" of the
fund marks the point where the higher rate offsets
the initial hit.

Cheers,

Charlie

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Re: Do I need an FI component or will I-bonds suff
Old 10-20-2004, 02:20 PM   #5
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Re: Do I need an FI component or will I-bonds suff

Both offer liquidity if you need it. My 11 month cd's only require me to surrender 30 days of interest to liquidate, and I broke them down into 10k, 5k and 2.5k (the minimum) chunks so if doomsday does arrive and I have to dip into them, I only have to break a small one.

People wont automatically "run to bonds" if the stock market tanks, although thats a good bet. That wont automatically result in a big run up in bond NAV's though, although again thats a good bet.

It may also be a mistake to presume we're going to see continued rising rates...the economy looks like it may be dropping back into neutral and the ECRI leading economic indicators say we're going to start backsliding and re-enter a deflationary period starting later this year and persisting for at least 9 months...which means the fed might actually be forced to cut again to restimulate...or at least remain neutral in bias and quack a lot until things pick back up.
http://www.businesscycle.com/

In other words, nothing is any different...we really have no idea whats going to happen. So allocate your assets in line with the number of years until retirement, choose at least a stock/bond/cash allocation thats true to that, add some other classes (foreign, reit, etc) a la "the four pillars" if you want to get fancy, and let it ride.

In your situation, at your age, if you dont plan to retire for 20+ years, a 70/20/10 stock/bond/fixed income or thereabouts is probably ok.
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Re: Do I need an FI component or will I-bonds suff
Old 10-20-2004, 02:31 PM   #6
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Re: Do I need an FI component or will I-bonds suff

BTW, the main reason for using fixed income funds,
I-Bonds, etc is to reduce overall volatility of your
entire portfolio. Bernstein and Swedroe advocate
keeping the duration short ..... 1 to 2 years. The
fact is that bond values and stock prices are often
in synch. For example, when rates rise it tends to
depress both stocks and bonds.

I think it is great that you are using I-bonds for your
FI component. You can't loose money and you get
pretty good inflation protection.

Cheers,

Charlie
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