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Fear of bonds
Old 03-30-2014, 06:19 PM   #1
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Fear of bonds

I am noticing in the threads about bonds a bit of fear given the low rate environment and likelihood of rising rates in the near future.

I am curious how folks are approaching bonds. They are obviously an important part of AA and FI. If you are in bonds, are you in bond funds or ind bonds, tax-free or not and what duration(s)?

And, how are you feeling about Wellesley and Wellington (VG Funds) which are so popular here, yet have significant bond exposure?

Thanks!
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Old 03-30-2014, 06:34 PM   #2
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My AA was about 50/50 a few years back, 60/40 recently and I will let it go to maybe 70/30. Our Roths are the VG 60/40 balanced fund. Still need some fixed income somewhere in the AA so I have some ibonds, cash in the credit union, some money in my stable value type fund (TSP G fund) and my wife does hold VG Wellesley and Star funds in her IRA. They have managed bonds better than I have. So far I have been 'wrong' on bonds for a while now but I would not add to generic bond funds right now.
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Old 03-30-2014, 06:34 PM   #3
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I share your concern, but at the same time I wonder if there is a whole lot of group-think going on.

Nonetheless, I got out of bond funds in 2013. My domestic investment grade fixed income is a combination of PenFed 3% CD, VG MM fund, and smaller portions of Merger Fund (as a fixed income alternative/substitute) and the iShares 2020 Corporate Term ETF. The VG MM fund is temporary and am transitioning into the 2020 iShares ETF gradually when the price is around NAV (not much lately). I currently prefer the target date maturity bond funds to traditional bond funds.

I also have some Guggenheim 2017 and 2018 High Yield Corporate Bond ETFs for my high yield allocation and the Vanguard International Bond Index and Emerging Markets Government Bond Index funds for my international bonds allocation.

I don't use balanced funds in the interest of tax efficiency, so I can't address your Wellesley and Wellington question.
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Old 03-30-2014, 07:17 PM   #4
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I am curious how folks are approaching bonds.
I am concerned about the impact of rising rates. My bond allocation has always been low, but a few years ago I reduced it further, slightly increased what I have in cash, and reduced the duration of those bonds that remain. The only mid-to-long bonds that remain in our portfolio constitute less than 1% or our portfolio, they are in a small Wellesly holding.

One viewpoint: Current short-term bond rates aren't much different from the dividend rates of value stocks. Barring a real problem, those dividend payments are about as dependable as the bond fund dividends. Are the stocks "riskier"? They have higher volatility, but if held for 10-15 years and considering other "risks" (inflation, etc) and their greater potential for appreciation over that time, I think it's possible to make a case for reducing bonds and holding the stocks instead.

We should ask: what is the purpose of having bonds in my portfolio? At the current rates and risks, what type, if any, bonds can do that?
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Old 03-30-2014, 07:24 PM   #5
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I have some bond exposure, but about 2/3 of my 35% allocation to fixed income is in the form of cash, CDs, I bonds, stable value and non-USD bonds.
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Old 03-30-2014, 08:16 PM   #6
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What we choose to fear changes as the market changes. Many people feared equities after the 2008 crash. Now the media hypes us to fear the "bond bubble".

If you have a bond fund with a five year duration, yes it will lose 5% of the NAV if interest rates rise 1%. But the current Federal funds rate is .25%. The government has been forcing the rate to this unrealistically low rate for a long time now to stimulate the economy. The fed knows that as rates rise, it will have a significant impact on the economy. That is why the bond tapering they began earlier this year is being done so gradually.

So now we fear that we may lose 10% in NAV if rates rise 2%. But for rates to rise from .25% to 2.25%, we would be talking about a rate increase of 400% (I may not have done that math on the increase right, but I know it's close).

Why would the government taper bonds so gradually, and then shock the economy by incurring a 400% increase in the lending rates? And should we really be more concerned about this happening than a major correction in a very frothy equities market?

I think it makes sense to take some precautions, but getting completely out of bonds, especially short or intermediate term, is a bit too aggressive for me. Municipal bonds offer a very attractive tax equivalent yield today. The Vanguard Long Term Tax Exempt pays a tax free yield of 3.10% and only has a 7 year duration. If you are in the 32% tax bracket, that's an equivalent yield of 4.56%. The best CD rate today is 2.25%, or less than half. When PenFed offered 3%, it was a bit more enticing. But with the spread we are seeing today between municipal bonds and the best CD rates, I don't think it makes sense to be completely out of bond funds.
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Old 03-30-2014, 08:31 PM   #7
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I have 35% of my portfolio in individual municipal bonds spread across credit ratings, states, sectors and varying in maturity between 2015 and 2029. At some point rates will rise and the value of these bonds will decrease during the period that I own them. However, I buy individual bonds because (borrowing a default) I will receive my full principal back at maturity or the call date--regardless of where rates go. I buy individual stocks and individual bonds for my own account.

We have all been waiting for a rise in interest rates for 4 years. Meanwhile I have been getting over 4.0% tax free (federal) on this portion of my portfolio. Certainly there is some risk (I bought California GOs in 2009 and Illinois GOs in 2010--but still not buying PR bonds) but I am personally comfortable with that risk. The tax free benefit of the munis is very important to me.

Don't know if I answered your question and I do not expect anyone can--other than to tell you that rates will most certainly rise........at some point. I have simply determined that a federal tax-free return of 4.0%+ is acceptable to me (even if rates do rise) for 35% of my portfolio. If the 10 year goes to 4.0% certain of my bonds will mature and I will replace them with others paying higher rates.

15 years from now, I know I will look back and determine that I did not own the highest paying instruments and that in hindsight perhaps I should have sold some bonds when the 10 year was in the low 2 range. However, for me a 4.0% federal tax free return is an acceptable return on 35% of my portfolio. I have accepted that I cannot time the bond market.
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Old 03-30-2014, 08:54 PM   #8
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I guess maybe the question I ask.....are the same people who quote Bogle and the "ignore what happens....stick to the plan" getting less exposed to bonds? And in which case.......how do you justify it? I have reduced bonds.....but I have never been a Boglehead do or die person. All those people who now reduce bonds.......market timers?
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Old 03-30-2014, 08:58 PM   #9
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I'm still in the accumulation phase of life but used to have a pretty conservative split with ~40% in bonds. I halted bond purchases about a year ago tho.

I don't think we're in a typical rebalancing period because the Fed has completely left the building in terms of normal behavior. Interest rates HAVE to go up (a lot) which means longer dated bonds HAVE to go down (a lot).

I just can't bring myself to put more assets in front of that inevitable trend.

I know, I know: you can't time the market. But we're in completely untested waters here. The Fed has essentially instituted price fixing on the most important security on the planet (federal debt). What happens when they stop? I'm not trying to time the car crash...but like driving on New Year's Eve, I am staying a good distance away from the drunks on the freeway.

We'll see if I'm happy with this choice or not...
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Old 03-30-2014, 09:02 PM   #10
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I guess maybe the question I ask.....are the same people who quote Bogle and the "ignore what happens....stick to the plan" getting less exposed to bonds? And in which case.......how do you justify it? I have reduced bonds.....but I have never been a Boglehead do or die person. All those people who now reduce bonds.......market timers?
Call me a porcupine if you like, just don't call me poor.

For me, this is just an issue of asymmetric risks vs. reward. I get equal or better yield by buying stuff other than bonds and generally avoid the potential capital losses of a rate spike. When rates settle at a higher level I will re-evaluate risk vs. reward.
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Old 03-30-2014, 09:05 PM   #11
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I'm still in the accumulation phase of life but used to have a pretty conservative split with ~40% in bonds. I halted bond purchases about a year ago tho.

I don't think we're in a typical rebalancing period because the Fed has completely left the building in terms of normal behavior. Interest rates HAVE to go up (a lot) which means longer dated bonds HAVE to go down (a lot).

I just can't bring myself to put more assets in front of that inevitable trend.

I know, I know: you can't time the market. But we're in completely untested waters here. The Fed has essentially instituted price fixing on the most important security on the planet (federal debt). What happens when they stop? I'm not trying to time the car crash...but like driving on New Year's Eve, I am staying a good distance away from the drunks on the freeway.

We'll see if I'm happy with this choice or not...
And as the argument went in the past.....you can't time(and yet we do)

This time it's different (and it was...)

Stick to your plan.....even if it's wrong....or....not so right.

Wish I could see into the future........I'd be rich....
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Old 03-30-2014, 09:20 PM   #12
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And guess what the best performing YTD broad asset class is?
US Bonds: 1.8%
US stocks: 1%
Foreign stocks:0.1%

My approach to bonds is to own bond funds and TIAA traditional annuity paying on average 4.5%.
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Old 03-30-2014, 09:29 PM   #13
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And guess what the best performing YTD broad asset class is?
US Bonds: 1.8%
US stocks: 1%
Foreign stocks:0.1%

My approach to bonds is to own bond funds and TIAA traditional annuity paying on average 4.5%.
And yet....I ask again.....how many people have reduced their exposure to bonds? I sure have. Which breaks the Boglehead philosophy. There are rules that we want to follow....until we don't. And.....stating some evidence of three months of returns as something that's important......timing. And....following that way of thinking...could you please tell me which stock/fund is going to go up the most this year? I want to move back to the UK and I need more money.....so.....

Not being offensive/negative to your post ......just wondering how many people actually FOLLOW their plan.....rather than change it when things demand it(in my opinion). I change my plan when I think it needs to be changed. A lot of people state they don't.
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Old 03-30-2014, 09:42 PM   #14
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I follow my plan. I don't know what other people do.

If one is worried about bond funds, then one can shorten duration (I own lots of Vanguard short-term corporate bond index fund), use CDs and high yield savings (I do not have any of these), or use stable value fund and guaranteed funds like TIAA traditional annuity.

For the past several years 100% of my 401(k) contributions go into my US total bond index fund. Recently, I sold a REIT fund to buy a bond fund. If bonds tank, there is plenty of time for them to recover. And I am pretty sure my bond funds won't tank as much as my stock funds.

Anyways, that's the plan and I'm sticking to it. Furthermore, I post my trades in my newsletter thread.
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Old 03-30-2014, 10:28 PM   #15
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Assuming no default, any decrease in bond value will be fully recovered at maturity (regardless if it is a bond fund or individual bond). So if you have a long term plan or only use interest payments should be fine.

But I do not own too many bonds as stocks perform better long term.
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Old 03-30-2014, 10:49 PM   #16
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I still have the 40% fixed income that is my target. I have just restructured it so the interest rate risk is much lower. The yield is lower too, but I have made a conscious decision to live with a slightly lower yield in exchange for significantly lower interest rate risk.
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Old 03-31-2014, 06:45 AM   #17
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Originally Posted by Travelwanted View Post
I am noticing in the threads about bonds a bit of fear given the low rate environment and likelihood of rising rates in the near future.

I am curious how folks are approaching bonds. They are obviously an important part of AA and FI. If you are in bonds, are you in bond funds or ind bonds, tax-free or not and what duration(s)?

And, how are you feeling about Wellesley and Wellington (VG Funds) which are so popular here, yet have significant bond exposure?

Thanks!
The bond article this thread discusses sums up my position on the subject: Paul Merriman: Bonds - buy, sell, or hold?
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Old 03-31-2014, 07:20 AM   #18
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There are rules that we want to follow....until we don't.
I'm an adherent to the "Bogle Way", and most of my investments and rebablancing are passive. And I'll keep to that as long as we have an open market with prices set by the millions of traders and investors who make valuation decisions on their own. But I do believe that the Fed's actions have introduced a new factor into the "game", one that puts a finger on the scales to drive interest rates down and thereby put holders of long-term debt at risk. This wasn't generally the case when the historical data set was built, so that data may not be as useful when setting allocations in this environment. It's not huge, but it's different. When the government ends its cheap money policy, then I'll return to a slightly longer bond duration, and holding more of them.

Re: just holding long-bonds to maturity: Sure, but that means no rebalancing opportunities if stocks plunge. And it may mean getting today's terrible returns for a long time, maybe in the face of inflation that swamps them.
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Old 03-31-2014, 09:51 AM   #19
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Well, I'm lucky in that I can get to a stable value fund and the recent PenFed CD that are both yielding 3%. What type of bonds or bond funds can beat that right now with no interest rate risk.
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Old 03-31-2014, 10:05 AM   #20
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Bond yields have been manipulated down by the government (which means bonds are at all time high prices). Why would you want to buy something at an all time high price?

Muni bonds have the added bonus of default risk in addition to interest rate risk. The federal government can't default (without disaster) but a city certainly can. It is a small risk but significant compared to the measly reward you get.

Right now the only thing that makes sense other than cash are CDs, I-bonds, maybe EE bonds, and stocks.
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