Rebalancing into Bonds advice needed

[ratface]

Having been very much of a chicken for the last five years I have held a cash position. I think most would agree that this is too conservative and advise some balance between equities. So I am embarking on a long term plan to rebalance. As I stated on the thread that Dex started on riding the market up I am now in an 83/17 position, cash to equities. I would like to add some bonds but don't know how. What I mean is, do you DCA as you do with equities or do you get in all at once at your target percentage. Or is there a preferred set of circumstances at any given time within the market that you wait for? That leads to, Do you market time bond entry positions?

[freebird5825]

If you are a total beginner with bonds, stick with low cost mutual funds -bond only funds or use a balanced mutual fund.
I personally own EE and I bonds, 2 muni bond funds, and I get exposure to corporate bonds through 2 balanced mutual funds.
I don't mind paying VG and Dodge & Cox to figure out the best bonds to have in the muni and corporate arenas. Way over my head...

[ratface]

Hi Freebird, Dodge and Cox is exactly where I would be going. I suppose I should put a small percentage in and then take it from there.

[DblDoc]

As timing the bond market is as challenging as the stock market I would DCA in just as you are for stocks. If you want to learn more I would recommend: Amazon.com: The Only Guide to a Winning Bond Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today: Larry E. Swedroe, Joseph H. Hempen: Books, or post over at Bogleheads: Bogleheads Investing Advice and Info

DD

[kumquat]

I'm sure I'll be crucified for this, but I don't see any difference between a bond (that you will hold to maturity) and a CD. Both offer a fixed rate of interest. Yes a bond may increase/decrease in value with interest rates but if you hold until maturity the relative rate of interest is the only deciding factor. A CD can be an insured deposit.

I have no bonds, mostly because I don't understand them. Right now, I have no bonds or CD's because a high rate savings account is close to the 2-year bond rate.

I have no intention of buying government bonds in the near future since I think that if we have a recovery bond prices can only fall as interest rates increase.

I am interested in corporate bonds now since some have a high interest rate and (possibly) a low probability of default. Speculation money, however. It could all go bye-bye.

If I was 83/17 cash/equities, I'd re-balance into equities. Unfortunately, I'm closer to 17/83, even after the meltdown. The 'best' ratio depends on age, risk tolerance and if retired, SWR. YMMV. Enjoy.

[dshibb]

Answer these questions and you'll see my point.

If you buy a bond today and the interest rate rises, is your bond worth more or less?
What does inflation due to interest rates?
Does a federal government printing money like crazy cause inflation?

Go with TIPS(Treasury Inflation Protected Securities) instead, ratface. You get your coupon fixed interest rate, but you also get the inflation rate added to your principal. IE 2.5% coupon rate + 7.5% inflation = 10% interest. You get a bond paying 6% and it is negative 1.5% in real interest. Your bond will be worthless in an increasing interest rate environment. TIPS will be worth more in an inflation environment because the coupon rate for NEW TIPS goes down in an inflationary environment. The 10 year TIPS auction is in April, and the 20 year is in June.

Also the bond interest is subject to interest income. So is the coupon rate for TIPS, but the added inflation protection is capital gains--lower tax rate.

[MasterBlaster]

Quote:

Originally Posted by kumquat I'm sure I'll be crucified for this, but I don't see any difference between a bond (that you will hold to maturity) and a CD.

They do have similarities...

The short answer though is that Bonds have greater risk.

With a CD your principle is guaranteed up to $250k, not so with a bond. If you want to cash out today the bond principle will vary whereas the CD principle will be there (less some early withdrawal interest penalties). Some bonds with good interest rates are callable (so you get cashed out early) not so with CD's.

There are all kinds of bonds, with all kinds of risk profiles and all kinds of quirks. many bonds are sold with large hidden markups that come out of your principle should you cash out early.


Per holding a bond to maturity...

Also, lets say (just for fun) that due to heavy government spending that inflation and interest rates take off sky high. Your bond probably includes a modest interest rate that you will be stuck with. However with your CD you can cash out, take a small early withdrawal penalty, and then get another CD at the much higher prevailing rate. In that case you will get your nominal principle back from the bond plus the modest (below inflation) interest. With the CD, you could in theory track prevailing rates and come out significantly ahead of a bond holder.

In the case of falling interest rates the CD is locked in, your bond may be called.

[youbet]

Quote:

Originally Posted by dshibb Also the bond interest is subject to interest income. So is the coupon rate for TIPS, but the added inflation protection is capital gains--lower tax rate.

I think you better check your facts there.......

[LOL!]

Quote:

Originally Posted by dshibb ... Go with TIPS(Treasury Inflation Protected Securities) instead, ratface. You get your coupon fixed interest rate, but you also get the inflation rate added to your principal. IE 2.5% coupon rate + 7.5% inflation = 10% interest....

If the above were true, then that would be great. Sometimes you can purchase TIPS at a 2.5% rate, but not now. You have to time the purchase of your bonds to get that rate. See, e.g. the blue line:
St. Louis Fed: Series: DFII10, 10-Year Treasury Inflation-Indexed Security, Constant Maturity

The rate is around 1.4% nowadays plus inflation as told to you by the government.

You may be interested to read that other bonds do better than TIPS which is kind of blasphemous among TIPS proponents. Also there is talk that the next adjustment for I-bonds is going have them set to 0% real return. Go figure.

Bogleheads :: View topic - So much for CPI + 2.5%

I'm not saying the TIPS are bad. They are very useful to own from time to time. They are volatile and can be timed reasonably easily IMHO.

[ratface]

I'm somewhat constrained by the offerings of my 457b and TIPS are not an option. They do offer the Dodge/cox bond fund. My only other option is international equities?

[LOL!]

There is almost always the Roth IRA option. Some folks are not eligible for a Roth though. Sometimes a Roth is better if you are in a low tax bracket and have already captured all the match you are gonna get in your 457b/401k/403b.

And to answer the question, do you time bonds? My answer is yes. I buy TIPS when the blue line is above 2.5% or thereabouts and sell them when the blue line is below 1.5% or so.

[dshibb]

"I think you better check your facts there......."
Oops sorry. I double checked that with my tax guy this morning and he said that the inflation protection is taxed as interest. It was weird though because anytime you hear the words "added to principal" should give off the notion that it is subject to capital gain.

"The rate is around 1.4% nowadays plus inflation as told to you by the government."
I was just using the 2.5 as an example. The 10 year that was issued in mid January had 2.245. That appears to be roughly in line with your chart, and even if TIPS April auction are at 1.4, I'll still find that a good deal when an inflationary environment might actually lower new coupon rates to slightly negative. I would dump them though when they approach .5 because that's what some will get issued at in the next couple years.

Yeah of course regular bonds traditionally do outperform tips, but not when your projecting inflation. Especially when your projecting inflation in the teens, the 7.5 is a conservative estimate in my eyes. Inflationary environment = devalued bonds. Inflationary environment = appreciated TIPS--i.e. I can sell them for a profit on top of the the interest earned and inflation adjustments.

[dshibb]

Plus the April and June auctions are over sized auctions, so whatever rate they would normally give they are going to have to kick it up a few more notches.

[dshibb]

"My only other option is international equities?"
That's where I would put it then. I'm assuming your not close to retirement age. As our country devalues our currency the exchange rate differences will open up between us and other nations. So you get the growth in their markets as well as the exchange rate difference. Do your do diligence on international equities, though. Make sure that the fund invests in sound companies in emerging markets, there are a decent number that are going through cash like its going out of style right now(but that also is happening in the states as well).

[dshibb]

But LOL is right go Roth before you go for your 457b. If you are ineligible or already max it out, then yeah I would definitely, definitely pick an international equities fund over a bond fund in this market right now. Unless you are scared of risk so much right now that you would rather take a fixed negative 1 to 10 percent REAL return on the bond fund because as inflation rises your bonds continue to be worth less and less, and return negative to inflation.