Portfolio Without Bonds OK?

[sunsnow]

I have an investment allocation strategy that is a little weird, or at least one that I have not seen discussed. This may indicate that I am confused in my approach, so I thought I would post it and invite comments. Here's what it looks like:

65% stocks
35% ladder of long term CD's purchased at issuing banks

When I see suggested allocations, they always have a bond component, but our portfolio has no bonds or bond funds.

The reason for this is that I don't understand why anyone would want to own an individual bond, when their interest rates are no better than CD interest rates, yet bonds carry considerably more default risk. Also, with most bank CDs, you can cancel early with a small penalty if interest rates should shoot up at some point. Thus, there is less risk from inflation than with a corporate bond or even most governmental bonds. Since I don't understand why it would make sense to own a corporate bond, I am leery of investing in them or in funds that own them. I realize there is the possibility of making money as interest rates sink, but there's the symmetrical risk of losing money as interest rates rise.

Anyway, I'd be grateful to know what other folks think about this.

Thanks!

 

[REWahoo]

Nothing wrong with CD's instead of bonds if that's your preference.

 

[braumeister]

Sounds like you're thinking of portfolio allocation in terms of stocks and bonds.

Actually, many think of it in terms of equities (generally meaning stocks or stock funds) and "fixed income" (generally meaning bonds, CDs, or what have you.

You're fine.

 

[Dash man]

I don't have any bonds in my portfolio either. I keep 45% of my liquid AA in some form of cash at this point. Bonds are more likely to decrease in value within a few years because interest rates have little room to drop but significant room to rise. A 2% rise in interest rates would result in an approximate 15% drop in the value of a bond. Bond funds would drop too rapidly for an average investor to respond. An individual bond holder would at least have the option to hold on to the bond to maturity, but as you said, with a CD you can close it with only the cost of the penalty and reinvest at a higher interest rate.
Many people in this forum stick firmly to their AA thinking that getting out of bonds is attempting to time the market. I typically don't believe in market timing, but I depart from that at this particular time regarding bonds, believing we are in a debt bubble. We may not see the bubble burst for several years, but I also don't see the advantage to staying in bonds over the safety of CDs. If there is another market crash, the stock market is more likely to recover more quickly than the bond market IMHO.

 

[pb4uski]

+1 with REWahoo and braumeister though I would not agree with OP's assertion that bond interest rates are no better than bank CD rates.

Bond yields are considerably better than CD rates, albeit with some credit risk and interest rate risk if not held to maturity.

See https://personal.vanguard.com/us/funds/bonds/bonddesk

A five year upper-medium grade bond yields ~3% compared to ~2% for a 5 year broker-CD (and bank CD rates are normally lower).

 

[Hermit]

I would like to move a least some money from a bond fund to CDs, but my 401k does not offer that option. If an opportunity comes along for relatively high rates on CDs (like PENFED in Dec & Jan) I will find some money to move.

 

[pb4uski]

I would like to move a least some money from a bond fund to CDs, but my 401k does not offer that option. If an opportunity comes along for relatively high rates on CDs (like PENFED in Dec & Jan) I will find some money to move.

Does your 401k offer a stable value fund?

 

[Dash man]

The best CD rate I was able to find this week was with GE Capital Retail Bank at 2.25% APY for 5 years. Not as good as the recent PenFed offering, but I had to put money from another maturing CD somewhere.

 

[seraphim]

"The reason for this is that I don't understand why anyone would want to own an individual bond, when their interest rates are no better than CD interest rates, yet bonds carry considerably more default risk."

You're thinking short term. Think dollar cost averaging: buying bonds when price is low and selling when high. You can't do that with a CD, as the value remains constant. Also, individual bond rates vary depending on the source. A company in need of cash may offer higher coupon rates if that's what it takes to raise the cash. As always, more risk leads to the potential of higher returns.

But others were correct: think fixed income rather than bonds. Right now, 3/4 of my fixed income allocation is in stable value accounts, earning the same interest rate as the 10 year treasury. It is liquid, and I can transfer the money out at anytime. The money will stay there until bond prices drop sufficiently to present a buying opportunity (2015?). There's no penalty or charge for me to transfer that money elsewhere.

Also, in terms of liquidity, a bond can be resold, possibly at a higher value, possibly lower. Generally, people buy bonds to have a stable amount of income, or to offset volatility, which other other forms of fixed income don't do as well. Sell your CD early, and there's a fairly hefty penalty.

Nothing wrong with your CD plan. It's just not the only way of doing it, and there are pros and cons to both.

 

[Hermit]

Does your 401k offer a stable value fund?

Yes it does, but 1.08% for the last year is nothing to write home about.

 

[Tortoise]

I would like to move a least some money from a bond fund to CDs, but my 401k does not offer that option. If an opportunity comes along for relatively high rates on CDs (like PENFED in Dec & Jan) I will find some money to move.

Do you have equity investments in a taxable account? If that is the case, sell some of the taxable investments to purchase CDs. Then sell an equal value of bonds in your 401(k) and purchase equities (hopefully in the form of a low-cost passive index fund).

People need to view all of their accounts as one large portfolio.

 

[seraphim]

+1 for Tortoise's comment.

 

[sunsnow]

Sounds like CD's are an OK alternative to bonds. That's a relief

pbu4ski -- I agree that that with riskier bonds there is a premium, but when I've looked into the highest rated bonds, there is often no higher yield over the best CD's (maybe over the typical brokered CD's, but I don't buy brokered CD's because they are much worse than what is offered through the internet banks).

seraphim -- that stable value account sounds like an interesting idea, and is something I need to learn more about. thank you!

dash man -- That potential (and likely) drop in bond values has me concerned too. Interest rates can't get much lower than they are now, but they sure can get higher.

 

[samclem]

I don't see any problem with the OP's reasoning or approach. It would be smart to keep an eye on the Fed and interest rates over the next few years, and when interest rates increase to more historically normal levels it may make sense to re-allocate some money out of CDs to mid-term bonds.

Another idea worth considering: You could buy BulletShares bond ETFs. These ETFs hold a basket of corporate bonds (they come in conventional and high-yield --i.e. junk--versions). Each has a named target year when the ETF is shut down and you get your payout. If interest rates rise, the ETF is entirely unaffected. These can pay a bit more than CDs, it depends on the price at which you buy in: right now the weighted average yield to maturity on the 2017 Corporate Bulletshares ETF (ticker: BSCH) is 1.57% (about like CDs), if you went with the high-yield version (BSJH) the yield to maturity would be 4.82%. You'd need to subtract the expense ratio (.42%). Obviously, these aren't guaranteed (like a CD is), and they can have defaults, etc. But, they have a fixed maturity (like an individual bond, unlike regular bond funds) and they have a large number of holdings inside the ETF, so your "bet" is more diversified than if you bought an individual bond. They have target maturity dates available going all the way out to the year 2022 for Corporate (ticker BSCM), 2020 for High Yield (BSJK--weighted average yield to maturity: 5.44%)

Note: Some people would strongly resist the idea of carrying high-yield (risky, more subject to default) bonds in the fixed income portion of their portfolio, preferring to take these kind of risks only in the equity side of their holdings. I can see the logic in that. But, certain events (e.g. a big "correction" in stock prices not associated with a general slump in the economy) could leave high-yield bonds less affected than stock prices.

 

[pb4uski]

....pbu4ski -- I agree that that with riskier bonds there is a premium, but when I've looked into the highest rated bonds, there is often no higher yield over the best CD's (maybe over the typical brokered CD's, but I don't buy brokered CD's because they are much worse than what is offered through the internet banks). ....

Understood - I agree if your are comparing bank CDs to AAA bonds - yields are pretty similar. I happen to believe that the credit risk premium available from IG corporate bonds exceeds likely credit losses and that in the long run IG corporates will provide superior returns after credit losses.

 

[Hermit]

Do you have equity investments in a taxable account? If that is the case, sell some of the taxable investments to purchase CDs. Then sell an equal value of bonds in your 401(k) and purchase equities (hopefully in the form of a low-cost passive index fund).

People need to view all of their accounts as one large portfolio.

I didn't mean to hijack sunsnow's thread, but I am a perfect example of why you need to allocate your funds across taxable, tax deferred, and tax free as well as allocations between types of investments. All my investments are in tax deferred accounts. Mostly my 401k with about 10% in IRAs. That makes it hard to take advantage of opportunities like CDs when they come up. It also makes it hard (expensive) to move money from tax deferred to tax free (Roth) accounts. On top of that, I can't get below the 25% tax level so anything I move from tax deferred will mean high taxes.

 

[ERhoosier]

Nothing wrong with CD's instead of bonds if that's your preference.

+1

It's rather difficult for individual investor to get good deals on individual bonds these days, although you still need to shop for best rates on CD's too.

 

[pb4uski]

I didn't mean to hijack sunsnow's thread, but I am a perfect example of why you need to allocate your funds across taxable, tax deferred, and tax free as well as allocations between types of investments. All my investments are in tax deferred accounts. Mostly my 401k with about 10% in IRAs. That makes it hard to take advantage of opportunities like CDs when they come up. .....

Not necessarily. In December I transferred a big chunk from my Vanguard IRA to a new PenFed IRA and then invested the proceeds in the 5 year 3% CD they were offering at the time. A minor hassle but you could do the same with your IRA.

 

[Hermit]

Not necessarily. In December I transferred a big chunk from my Vanguard IRA to a new PenFed IRA and then invested the proceeds in the 5 year 3% CD they were offering at the time. A minor hassle but you could do the same with your IRA.

That's where I was planning to "find" the money. Half the IRA is in an inherited IRA from my LW's account and I don't want to mess with it, but I will do the other half. I got wrapped around the axle trying to get the money I have in stable value fund moved out of the 401k and ran out of time. The problem was how to treat post-tax dollars in the 401k. Didn't think about reallocating from the IRA until later.

 

[pb4uski]

IIRC you can roll post tax money in a 401k into a Roth (though there is a bit of tax risk as it isn't clear in the regs). I found out about it well after I had taken and spent the cash. YMMV.

 

[Hermit]

IIRC you can roll post tax money in a 401k into a Roth (though there is a bit of tax risk as it isn't clear in the regs). I found out about it well after I had taken and spent the cash. YMMV.

That is what I was trying to do. The first rep didn't know I could withdraw a requested amount up to 12 times a year. The second rep told me I could move all the post-tax out into a Roth. The third rep told me I couldn't do that. A supervisor figured it all out and said I would automatically get a tax-free check for the proportional tax-free amount based on the amount withdrawn. I can then put that money into a Roth on my own within a short time frame. Probably not enough money to attempt to track if it comes out in dribbs and drabbs. I'll probably just collect the cash and spend if foolishly.

 

[ripper1]

I think a lot of us were lucky to take advantage of the PenFed 5 year certificate yielding 3.04 in late 2013. I also was able to move a majority of my bond money into a stable value fund yielding 3.1.

 

[nun]

Does your 401k offer a stable value fund?

My 457 has a stable value fund returning 2.6 %.......fees are 0.4%. I still have bonds in Wellesley, but I moved my other bond money into the stable value fund to fund ER from 52.5 to 59.5

 

[ripper1]

My 457 has a stable value fund returning 2.6 %.......fees are 0.4%. I still have bonds in Wellesley, but I moved my other bond money into the stable value fund to fund ER from 52.5 to 59.5

Some of are lucky to have these stable value funds at this time. Mine also is from a 457.

 

[jazz4cash]

The best CD rate I was able to find this week was with GE Capital Retail Bank at 2.25% APY for 5 years. Not as good as the recent PenFed offering, but I had to put money from another maturing CD somewhere.

I found out (the hard way) that GE Capital Retail Bank offers IRA accounts, but GE Capital Bank does not. The CD rates are similar.

I also use a stable value fund/ bank CD combination in lieu of bonds for my fixed income allocation.