Thinking of moving from bonds to CDs

[Gumby]

Its debatable whether preferreds are safer than junk, IMO. A junk bond and a preferred default: which one gets a higher recovery?

"Oooh, Oooh, Mr. Kotter, I know.

Yes, Horschak.

In bankruptcy, the bond is always senior to the preferred stock."

 

[rjohnla]

"I'm thinking of using 5-year CDs instead of bond funds for my domestic fixed income allocation and using the new VG international bond fund for my international fixed income allocation. I don't anticipate touching these funds at all in the next 10 years.

I see that 5 year CD rates are in the 1.50-1.75% range. I'm thinking that the credit and interest rate risk associated with VFIDX isn't worth and extra .61%-.36%. Thoughts?

Also, does anyone know whether I can buy/hold these non-Vanguard CDs in my Vanguard IRA or would I need to create an IRA with each financial institution that I am buying a CD from and rollover money from my Vanguard IRA to the new IRA accounts?"

The technical pattern for 10 yr. T-Bonds is not clear, the market will decide. As you know if IR go up the VFIDX will go down and visa versa. So, if it were me, I'd step aside from investing and go to savings - principle returned with interest - no potential loss of principle like in fund. If it were me I'd also check Weiss Bank reports to ensure the CD's are issued from an A rated bank (custodial risk goes down, re., they are all just numbers. What would you feel more comfortable with $100 in your pocket or $100 IOU in your pocket?) Does the .61-.36 account for mgt. fees?

As far as I know can not put a Bank C in Vanguard IRA fund, don't believe it exists and there is no benefit to Vanguard. p.s. I'm in Vanguard Admiral T-Bill fund - at this time the winner will be who loses the least.

 

[Katsmeow]

If you have one of these funds available to you, I would jump on it as a stand-in for bond exposure.

What about expenses? That is I do have a fund like this available in my 401k. Right now, all of our bond exposure is in DH's IRA at vanguard (total bond, short-term investment grade, high-yield corporate fund and Wellesley). We also have a little bit (less than 10% of portfolio) in the prime money market fund.

My 401k is at Fidelity and I currently have everything in the Dreyfus S&P 500 index found which has an expense ratio of .51%.

I do have available the Fidelity Advisor Stable Value Portfolio Class II fund. The expense ratio is .94%. One year performance of the fund is 1.13%.

 

[brewer12345]

What about expenses? That is I do have a fund like this available in my 401k. Right now, all of our bond exposure is in DH's IRA at vanguard (total bond, short-term investment grade, high-yield corporate fund and Wellesley). We also have a little bit (less than 10% of portfolio) in the prime money market fund.

My 401k is at Fidelity and I currently have everything in the Dreyfus S&P 500 index found which has an expense ratio of .51%.

I do have available the Fidelity Advisor Stable Value Portfolio Class II fund. The expense ratio is .94%. One year performance of the fund is 1.13%.

For a stable value fund, all ou have to do is look at the current yield. Is it more attractive than money markets and 1 year CDs? Then it is a no brainer.

 

[rbmrtn]

One of the reasons I kept my 401k at megacorp when I left was the access to a stable value fund. It's been rolling along, earns as much as available bond funds with less risk.

 

[foxfirev5]

I've been putting new money into my 401k SV fund, Fidelity MP II,for awhile. However I notice the yield is considerably lower than most posted here (1.35%). It lists a duration of 2.6 ( not sure how that's calculated for a SV fund) and expenses of .2%. My HR dept claims that this SV option minimizes risk and while they could go with higher yielding options there is a significant increase in risk. Not all SV funds are as safe as they are made out to be. I don't know, but I guess I won't concern myself with it since I don't have an other choice.
While not impressive I'm keeping about half of my 401k fixed income in this SV and the other half split between VG Total Bond Instl. and Pimco Total Return Instl.
I don't think there's much else I can do at this point. I look at the monthly dividends from each and have decided the total difference from high to low is less than a quarter of what I contribute from each paycheck.
I guess I'll have to let my 45% equity allocation do the heavy lifting.

 

[Cat-tirement]

Partially correct. I have been following this business for years in a professional capacity. Basically the stable value manager buys a pool of short to medium term (usually not more than 5 years maturity) bonds of very high credit quality (routinely AA average quality). They then contract with several banks and insurers to extend a guarantee to always keep the value at par. They usually pay the guarantors a pittance (at the absolute height of the market disaster guarantors were getting paid maybe .25% a year for these guarantees). If you have one of these funds available to you, I would jump on it as a stand-in for bond exposure.

This discussion of using a stable value fund to replace some bond fund inspired me to go look at mine. I have a stable value fund in my 401k that has total expenses of 0.28%, effective duration of 2.71 years, and a blended yield of 2.52%, which seems to put me in the middle of what others have listed here. I currently have about 3% of our combined retirement portfolio in it. Sounds like maybe I ought to move some of my longer to mid term bond money into this instead.

 

[steelyman]

I looked up the numbers for the Invesco fund, and they listed the current yield at 2.3%, also a "crediting rate" of 2.19%. I'm guessing the latter reflects what the investor is getting.

Those are as of 3/31/2013.

The characteristics brewer mentioned are there (duration, quality/rating).

I'm glad we have it - the Fidelity offerings in the tax-deferred plan did not include stable value. I've been slowly selling a stock fund as the market has risen and exchanging the proceeds into stable value.

I don't think of any of the 457 stuff as "retirement", but there if/when needed; you don't have to meet an age requirement, you only have to leave your employer - got that covered

 

[brewer12345]

Ignore the stated duration of whatever stable value fund you might have access - it is meaningless. You can withdraw at par any time you like regardless of what rates have done: market value losses are someone else's problem.

 

[veremchuka]

My stable value doesn't mention duration maybe cuz it is not a bond fund per se. The er is 26 bp.

 

[Htown Harry]

This blog has a couple of recent posts relevant to the CD vs. bond fund comparison

Diversify Bond Funds with CDs

CD vs Bond Fund: A Case Study

Over the full course of 7 years until the CD matures, assuming the bond fund’s returns in the next 3 years match its yield today, here’s what the returns would look like: [bond fund estimated avg. rate: 4.15%, 2009 CD actual rate: 4.5%]

 

[timo2]

I'm not opposed to taking on a little more risk, but preferred stock is a potential time bomb as bonds. Maybe a small portion here, but you are taking on a lot more risk.

Danger: Unexploded Bomb In Your Preferred Stock Portfolio - Seeking Alpha

This part of the 'danger' article made me laugh in amazement. The author must have a Psychic on staff: ".... and keep a close eye out for unexpected events could suddenly explode onto investment markets with the most unpleasant of consequences for their long range financial plan."

 

[tuixiu]

I'm glad I saw this thread, was just about to do my rebalance and I've been fretting over the prospect of exchanging into my total bond index fund when it seems almost certain to underperform in the near future.

I checked and found my wife's 457 does offer a stable value fund option at 2.6% so I'm not only rebalancing into that for bond allocation but making the necessary exchanges to park most of the remaining bond allocation there too.

Cheers brewer, I owe you a beer. Feel much better about this stuff now.

 

[pb4uski]

I guess that retaining access to a stable value fund might be one reason not to do a 401k>IRA rollover after retiring. Too late for me.

I still have one DC account with my former employer. It seems that they at one time had a stable value fund but no longer offer that option so I'm out of luck there.

I'm still pondering what to do. CDs are a hassle since this is in my IRA which is all at VG right now and to get the best CD rates I would have to create a couple IRA accounts at different banks.

I will look into Vanguard's international bond fund when it becomes available even though it still has some interest rate risk. Also considering Bulletshares as an alternative to CDs - I realize the value will fluctuate with interest rates but when the bonds mature I would get the par and the interest rates are better than broker CDs and I'm willing to accept the credit risk so in a way it would function similar to a CD if held to maturity (which would be my intent).

Also considering paying off my mortgage with some of my bond allocation (indirectly) where I would pay off my mortgage but increase my AA from 60/40 to 70/30. Even though I have a sweet rate now (3.4%) I'm thinking that I will "earn" 3.4% risk free and if I don't have a mortgage I can accept the additional risk of a higher equity allocation. Thoughts?

And then sometimes I think that I am overthinking this since I have a long time horizon and that eventually the higher yields of the bond fund would offset the reduction in value caused by higher interest rates.

Luckily, I don't see rates rising right away so I have time to ponder more.

 

[pb4uski]

hAt this point I've backburnered the CD idea. I don't care for the hassle of setting up multiple IRAs at different banks to keep under the FDIC limit to get ~1.8% and the 1.2% brokerage CD available through Vanguard are not real appealing to me.

I think what I will do is swap out my Vanguard Intermediate-Term Investment Grade Fund for 75%/25% 2019/2020 Guggenheim Corporate Bond Bulletshares. I'll pay 0.14% more in fees (0.24% vs 0.10%) but that 75%/25% mix has roughly the same weighted average yield, duration and average maturity as what I have now (2.11%, 5.3 and 6.4 now vs 2.05%, 5.4 and 6.4 prospectively).

I'll also swap out my Vanguard High Yield Corporate Fund for 50%/50% 2017/2018 Guggenheim High Yield Corporate Bond Bulletshares. I'll pay 0.29% more in fees (0.42% vs 0.13%) but that mix has better weighted average yield, duration and average maturity as what I have now (4.23%, 4.3 and 5.4 now vs 4.92%, 3.3 and 4.8 prospectively).

I'm guessing that if the high yield bonds in the 2017/2018 portfolios are maturing in 2017/2018 then they were probably issued before the recent covenant weakening that Brewer seems to be concerned about in the high yield market. Make sense?

While it is hard to compare credit quality because the Vanguard funds quality distribution information is by Moody's ratings and the Guggenheim quality distribution information is by S&P ratings, I "think" the investment grade credit quality is fairly similar and the high-yield credit quality is slightly junkier (but I'm also getting paid an extra 69 bps for the higher credit risk).

I realize that I will still be exposed to interest rate risk from a fair value perspective (value will go down as interest rates increase) but I am thinking of these held to maturity bond portfolios as being more similar to CDs except with a tradeoff of higher yields for some incremental credit risk but with the benefit of good credit risk diversification.

My concern with the bond mutual funds is that if interest rates rise then I get hammered and it takes years for the values to recover whereas with these target date bond funds I would get my principal back in the maturity year and be able to reinvest at then current rates which would be higher.

I'd be interested in any thoughts pro or con. This is money that I don't anticipate tapping into for about 13 years when I turn 70. What I am trying to wrap my head around at the end of the day is if rates increase and I just keep rolling these target date funds over at then current rates like a CD, after 13 years will I be ahead or behind where I would be if I just stood pat with the bond funds.

 

[brewer12345]

I'm guessing that if the high yield bonds in the 2017/2018 portfolios are maturing in 2017/2018 then they were probably issued before the recent covenant weakening that Brewer seems to be concerned about in the high yield market. Make sense?

The problem is that high yield bonds are generally callable by the issuer at a set price, so when the credit markets get stupid the issuers call the older, more conservatively structured bonds and issue new crap.

 

[pb4uski]

The problem is that high yield bonds are generally callable by the issuer at a set price, so when the credit markets get stupid the issuers call the older, more conservatively structured bonds and issue new crap.

Got it. So presuming that the new crap has a different maturity, the Bulletshare fund would get called on the old bond, be unable to buy the new crap and the fund shareholders would get their principal back earlier than maturity and have to find a place to reinvest it but at least I would avoid owning the new crap.

I guess there is an outside chance that the maturity date is the same year and the fund buys into the new crap but it doesn't seem a high likelihood to me.

 

[brewer12345]

Got it. So presuming that the new crap has a different maturity, the Bulletshare fund would get called on the old bond, be unable to buy the new crap and the fund shareholders would get their principal back earlier than maturity and have to find a place to reinvest it but at least I would avoid owning the new crap.

I guess there is an outside chance that the maturity date is the same year and the fund buys into the new crap but it doesn't seem a high likelihood to me.

I don't know what they do if they can't find junk that will match the original maturities promised since I have not bothered to look at these types of funds. However, before you invest I would make sure you know what happens in that case.

Hahahaha, the new maturities on the crap are always farther out than the better quality stuff they replaced. That is the game in the high yield world.