Intermediate Term Bonds

[TromboneAl]

Most of the bond part of my portfolio is in Intermediate Term bonds, namely 39% VG Intermed-term bond index, 9% CA IT Tax Exempt, and 52% GNMA.

Is that stupid, given the current flat yield curve?

 

[cute fuzzy bunny]

I dont think theres enough reward to holding almost ANY bonds right now, given that cash is paying better and it'll be maybe six to nine months before the fed quits raising the rates...

Its not stupid, but with 5-5.75% cd's and 4% money markets out there...

 

[lazyday]

I'm struggling with bonds myself, a bit. Until sometime last year, I never owned any. (Except a little as a checking account some time ago)

I don't like intermediate or long term, as I don't feel compensated for extra risk, with flat yield curve. And, yields seem low to me, so don't want to be too long term if they might go back up.

In taxable, I agree that 4% FDIC money market or an FDIC/credit union eq. CD on good terms can be sensible.
Another option is 4 week, 3 month, and especially 6 month treasuries from treasury direct, which can be linked to a bank account. Better rate than money market.
Or, Vanguard's short term treasury fund, which has a relatively high ER or their TIPS fund, which has a longer duration than I like.

In a traditional IRA, ideally, I'd like to own short term TIPS (5 years maturity or less) but with my broker, that's not practical. Now I own short term treasury SHY, but the dividends are a nuisance. So, I'm thinking about one of the vanguard funds above, for the next bond purchase.

 

[LOL!]

Yes. I noticed the other day that the Dodge & Cox Balanced fund which is 60/40 equities/fixed is about 15% cash. The Pimco Total Return fund is 53% cash.

If these funds which are supposed to be holding bonds are holding cash, then I think I would want to hold cash, too.

 

[TromboneAl]

I guess my question really is, should I transfer the intermed-term bond fund money to the short-term bond fund? That's what I'm leaning towards now. Almost all of this money is in IRA-type accounts.

 

[danm]

I dont think theres enough reward to holding almost ANY bonds right now, given that cash is paying better and it'll be maybe six to nine months before the fed quits raising the rates...

Its not stupid, but with 5-5.75% cd's and 4% money markets out there...

Past performance is no guarantee of future results.

 

[mb]

Al,

Do you know of a good short term alternative (CA tax exempt) to the CA IT Tax Exempt Fund?

MB

 

[Roger_R]

I guess if you're a buy and hold sort it might not be such a bad deal. I bought equal amounts of VG short term and intermediate term bond index funds about a year and a half ago. This was when many weres predicting that rising interest rates would hit longer term bond funds pertty good. The intermediate value with reinvested dividends is a couple of per cent higher than the short term. Unfortunately they both have sort of sucked. Mine are a much smaller percent of my portfolio and I'm planning on hanging onto them just incase rates may drop some time soon. I know it isn't the likely thing, but also know that predicting interest rates is not a science.

 

[JPatrick]

A decent case can be made that as soon as the Fed finishes overkilling on the upside a drop in rates could follow fairly soon.

 

[lazyday]

I guess my question really is, should I transfer the intermed-term bond fund money to the short-term bond fund? That's what I'm leaning towards now. Almost all of this money is in IRA-type accounts.

If it were me, I would switch to short term.
Nobody really knows if rates will go up, down, or stay same. So, a move to short term might look stupid in the future, as rates could go down. But, short seems like the best risk to me.
I think W Bernstein reccs short term in Four Pillars. Long term has been more correlated with stocks, and more risky than short term.

Swenson's book Unconventional Success has convinced me that treasuries and TIPS are the way to go, with bonds. If much of your portfolio is stocks, that's where he'd say to take the risk, and get high return. The bonds are good for safety. Corporates and asset backed, have risks you might not be fully compensated for.

If you can buy at auction for free or cheap in the IRA, you could buy 6 month treasuries, at about 4.5%. Or, in April?, maybe a 5 yr TIPS. Or, for simplicity, VG short term treasury, or if you don't agree with Swenson, one of the other short term funds.

 

[cute fuzzy bunny]

Past performance is no guarantee of future results.

Good point Danm.

So in an environment where we've had a long term recent bull market for bonds, supplanted by rates that have dropped almost severely and steadily for 20+ years (excepting the late 99 'lets see if we can defeat the irrational exhuberance trend and destroy the economy in the process bit and the latent run from 'free money' to a nearly neutral market'), where do you see the upside breakout in intermediate to long term bonds? Please help me with any insight you have. I dont see the upside here, what do you see that I dont?

To be fair, when I was a single ER living off my stash and looking long term, I had a bucket of short term bonds and a very good sized bucket of the short end of intermediate in wellesley and wellington. Now that i'm emboldened by my wifes income stream and what looks like unfavorable bond and favorable equity situations, i'm not real big on run of the mill bonds.

 

[brewer12345]

A decent case can be made that as soon as the Fed finishes overkilling on the upside a drop in rates could follow fairly soon.

I'm kind of swinging that way myself. Frankly, nobody knows which way LT rates are going in the next few years, so you have to either allocate or make a guess.

Al, what's the duration on these funds? 3? 4? 5? More? I would just suggest that you match your duration to your risk tolerance. Personally, I am comfy with 3 to 4 durations. Much more than that starts to look iffy soince we aren't getting paid for going out long.

A GNMA duration is just a guess, so we can leave that one out for now.

 

[unclemick]

Duration 4.7 years on VG Intermediate Term Treasuries.

A DCA strategy long enough to follow the interest cycle could be crafted. But the last one lasted twenty years or so with intermediate bumps. So - do you feel lucky/smart?

Nerves of steel? - Zero's and Strips - are always good for those posessing 'investment brilliance'.

Me - my salad days are over - I hesitate to recall the last time I owned a wad of VG Intermediate - late 80's early 90's.

Also owned a large chunk of er ah psst - Wellesley - they picked bonds much better than I.

heh heh heh

 

[danm]

Bill Gross of PIMCO fame believes that the recent bear market in (short term) bonds is over, you can find the commentary on their site. El-Edrian also on that site, has a good commentary about the 'secular turn' we are going through, a time of high uncertainty as the developed nations age and the developing (China and India) take over for us. Economist Gary Shilling believes we are on the final leg of the transition to deflation of excess, and that there is still a nice 35% capital gain to be had with long term bonds. And that housing (mostly) will wreck the stock market, and bring them back in line with historical norms. You have to subscribe to his newsletter ($275) to get his full story.

Even Bernstein makes the not so subtle point in Four Pillars that stocks now have a high risk premium. This was a few years ago, they have a darned high risk premium today as dot.com era speculation never really died. There's still time however. Shilling believes stock owners are headed for the puke point, where they disgorge their last stock and refuse to ingest another. I'm seeing warning signs all over. Even a trade mag for my business (chip high tech) is warning about 2006.

Heck, regardless of the exact future, bonds are a bargain.

Good point Danm.

So in an environment where we've had a long term recent bull market for bonds, supplanted by rates that have dropped almost severely and steadily for 20+ years (excepting the late 99 'lets see if we can defeat the irrational exhuberance trend and destroy the economy in the process bit and the latent run from 'free money' to a nearly neutral market'), where do you see the upside breakout in intermediate to long term bonds?  Please help me with any insight you have.   I dont see the upside here, what do you see that I dont?

To be fair, when I was a single ER living off my stash and looking long term, I had a bucket of short term bonds and a very good sized bucket of the short end of intermediate in wellesley and wellington.  Now that i'm emboldened by my wifes income stream and what looks like unfavorable  bond and favorable equity situations, i'm not real big on run of the mill bonds.

 

[TromboneAl]

The aveage duration for the interm-term is 5.8 years, compared with 2.4 years for the short-term index bond fund.

I wouldn't make the decision based on where I think interest rates are going.

But my feeling is that the yield of 4.79% for the intermediate term is not worth the added risk compared with the 4.49% yield for the short-term index fund.

 

[brewer12345]

The aveage duration for the interm-term is 5.8 years, compared with 2.4 years for the short-term index bond fund.

I wouldn't make the decision based on where I think interest rates are going. 

But my feeling is that the yield of 4.79% for the intermediate term is not worth the added risk compared with the 4.49% yield for the short-term index fund.

Sounds like the decision is pretty obvious, then.

 

[cute fuzzy bunny]

Bill Gross of PIMCO fame believes that the recent bear market in (short term) bonds is over, you can find the commentary on their site. El-Edrian also on that site, has a good commentary about the 'secular turn' we are going through, a time of high uncertainty as the developed nations age and the developing (China and India) take over for us. Economist Gary Shilling believes we are on the final leg of the transition to deflation of excess, and that there is still a nice 35% capital gain to be had with long term bonds. And that housing (mostly) will wreck the stock market, and bring them back in line with historical norms. You have to subscribe to his newsletter ($275) to get his full story.

Even Bernstein makes the not so subtle point in Four Pillars that stocks now have a high risk premium. This was a few years ago, they have a darned high risk premium today as dot.com era speculation never really died. There's still time however. Shilling believes stock owners are headed for the puke point, where they disgorge their last stock and refuse to ingest another. I'm seeing warning signs all over. Even a trade mag for my business (chip high tech) is warning about 2006.

Heck, regardless of the exact future, bonds are a bargain.

I will point out that Bill, while being an exceptional bond fund money manager, has made a number of observations and predictions that turned out to be wrong. Really, really wrong sometimes. Nords likes to bring up his "Dow 5000" prediction. I guess if we wait long enough, it might happen. Same with Shilling.

Bernstein did note the high risk paid when owning equities; I dont remember him saying you shouldnt include them in the portfolio or that you should own a humongous percentage of bonds in the average portfolio.

As far as valuations go, I guess we'd have to agree on what constitutes a 'valuation' first. It sure appears to me that the wind went out of the internet/tech stocks. The six figures in capital losses that I'll be writing off for the 6th straight year gives me a good reminder of that every February. By many measures, stocks are fairly valued. By some, quite undervalued. The only widely viewed measure that says equities are overpriced that I can find is morningstars current market value graph, which says that the broader market is about 7% overvalued.

I guess to each their own. I'm not feeling like i'm buying big bargains in equities even with all the good news, but I cant see a strategy in clearing maybe a percentage point over inflation and buying a bunch of equally good questions in bonds.

I guess if you go googly moogly every time the market moves a few hundred points in a day, equities arent for you. Doesnt really bother me.

 

[justin]

Al,

I'm with you re: favoring short-term bonds at this point. I think Bernstein favors short term bonds too, in general. Not sure if he talked about it in 4 pillars, but in The Intelligent Asset Allocator, he discusses the small increase in average incremental returns by increasing your bond duration (which increases the volatility significantly). As you have noted, going from short term to intermediate term bonds at VG will increase the yield by 30 basis points, however your duration increases a great deal and volatility will increase significantly. From a risk-reward perspective, it seems silly accept a 30 bp increase in yield in exchange for the risk of losing 3+% of principal per year due to interest rate fluctuations.

If it were me, I'd switch to short term, assuming the move won't cost you too much in terms of taxes due to capital gains. Maybe if the spread between short and intermediate started creeping up, I'd bite on the longer duration bonds. A 75 or 100 basis point spread would certainly pique my interests for at least part of a bond portfolio.

 

[TromboneAl]

Thanks for being a sounding board, guys. I transferred the intermed bonds to the short term bond index fund today.

 

[lswswein]

http://www.dfaus.com/strategies/fixed/

You guys might find the discussion on Maturity interesting. The DFA guys don't go longer than 5yrs.

-h

 

[Sarah in SC]

And I just wanted to say thanks for being the sort of place that has discussions about duration of bonds since minutes ago I made a B (yay!) on the Investments class of my CFP course from the College for Financial Planning and had to calculate the @#$% duration for a number of questions. You guys rock!
Sarah

 

[lazyday]

So, what's the duration of a 5 year TIPS, at about 2%?

(really)