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What to do with bonds (funds) now?
Old 01-25-2012, 01:39 PM   #1
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What to do with bonds (funds) now?

I've been thinking over the last couple of months about making a change. I mulled over posting my question on here yesterday while driving and decided to do so this morning. Now the Fed announcement on interest rates makes it even more timely.

A couple of years ago I started shifting a significant amount into bonds. This was lifestyle timing not market timing. We got serious about setting an ER date in 2017 and I figured it was a good idea to switch to a ~30% bond allocation. This was partly for safety and partly so that we'd have an income portfolio in place when 2017 comes around. I started the shift in small steps and we are currently at about 20% bonds. The money is mostly in relatively near duration funds. The longest term are GNMA funds at about 6 years.

This is specifically in reference to taxable money. I was willing to pay the extra tax on the income from the bonds as the price of beginning to make the move gradually. Our tax deferred money is roughly 30% bonds already.

Lately though I have been rethinking this decision for a couple of reasons. One big change is that my wife has a government pension she'll start getting in late 2014 and, because of a service purchase opportunity that came as a surprise in 2011, will be considerably more than we expected. I can look at this pension as a "phantom portfolio" in government bonds. That would eliminate most of the need to have a 30% bond allocation in our taxable portfolio because her pension will already cover more than half of our income needs. In a rough way it would mean we have a 50% bond allocation as is.

My thinking a couple of days ago was to stop the bond allocation where it is and possibly even take some profits. I was thinking of cutting back to about 10% bonds. That idea was driven partly from the realization that we probably don't need so much because of the pension and partly because I expect(ed) rates to start creeping back to normal relatively soon as the economy recovers.

But now, the Fed announces this morning that rates are staying low for a while. Bonds are rallying as are stocks. I'm torn between following through with my previous plan to cut back the allocation a little and take advantage of the rally or stay put since rates are probably not going to rise as soon as I had thought.

Any comments on how I should think about this?
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Old 01-25-2012, 01:45 PM   #2
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I would do a revision of your long term financial plan, including asset allocation. Once I was absolutely sure, I'd write it down, and consider it to be written in stone.

Then, I'd gradually move into that asset allocation. As you can tell from my comments, I do not think much of my own few attempts at market timing.
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Old 01-25-2012, 01:48 PM   #3
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Lately though I have been rethinking this decision for a couple of reasons. One big change is that my wife has a government pension she'll start getting in late 2014 and, because of a service purchase opportunity that came as a surprise in 2011, will be considerably more than we expected. I can look at this pension as a "phantom portfolio" in government bonds. That would eliminate most of the need to have a 30% bond allocation in our taxable portfolio because her pension will already cover more than half of our income needs. In a rough way it would mean we have a 50% bond allocation as is.

My thinking a couple of days ago was to stop the bond allocation where it is and possibly even take some profits. I was thinking of cutting back to about 10% bonds.
You could do that. But speaking of late 2014 here, today the Fed announced it plans to continue the War on Savers zero fed funds rate target until at least late 2014. So I don't think bond funds are going to be at much risk of significant price declines but to rate hikes in that timeframe.
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Old 01-25-2012, 01:54 PM   #4
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Any comments on how I should think about this?
I won't tell you how I think you should think, only what I think.

No way am I going to play Russian Roulette and try to time either the bond or stock markets. I'm sticking with my AA and will rebalance if the need should arise - even if that means buying more bonds.
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Old 01-25-2012, 01:55 PM   #5
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You could do that. But speaking of late 2014 here, today the Fed announced it plans to continue the War on Savers zero fed funds rate target until at least late 2014. So I don't think bond funds are going to be at much risk of significant price declines but to rate hikes in that timeframe.
That was my point - that today's news might be an opportunity because of the rally but also lowers the risk of price decline over the next few years.
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Old 01-25-2012, 01:58 PM   #6
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That was my point - that today's news might be an opportunity because of the rally but also lowers the risk of price decline over the next few years.
Yep -- I was looking at more or less the same thing but from the other direction. Simply put, I don't think the urgency to take profits will be there for a while, but if you find better things to do with the money *now*, so be it.

But I think the Fed action does buy time for you to DCA into something else with some of your bond allocation, or perhaps wait a bit and see if any better buying opportunities come in the next year or two.
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Old 01-25-2012, 02:07 PM   #7
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The problem with bonds, IMO and validated by my buddy is that if rates stay low through 2014 or longer, you get shafted cause who wants 2% or less - 10yr treasury. If rates rise, then who wants 2%. Heads I loose, tails I loose.

Problem 2 is I've normally been correct in my outlook, just never been able to time it right. Normally years away from the correct time. Easy to say inflation and rates will go up, just question is when (as you mention).

So my answer for me, not necessarily for others is to find another way to get what I want from bonds.

1) I've done some floating rate funds FFRHX - they give me a better return and plan is if rates go up the underlying instruments will pay more also.
2) I've moved some into large cap dividend stocks. This is all over the place, everyone talking about it so you have to be carefull. When the heard is doing the same thing can doom be far behind?
3) It was hard, but I left most of my bond funds alone, just shifted to get shorter duration.
Finally 4) I've purchased a forclosed home (again wrong timing, I bought it 3 years ago and dropped another 12% in value since then) and have had it rented out for the entire time. I have a property manager. Rentals have been discussed quite enough in other postings if you have questions about that. If I look at the price I bought the house for - $230,000 and rent of $1,450 and expenses of 30% I get a return of 5.29 plus tax gain if you make less than 100K or so and also potential for appreciation.

Just what is working so far for me. Gives diversity and also some fixed income.
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Old 01-25-2012, 02:21 PM   #8
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I just moved some money from bond funds to stock funds this week. Nothing to do with any expectations of market moves, simply as part of annual re-balancing to my long term AA.

If you re-evaluate your long term AA and decide to reduce your bond portion then fine, and you can do it in one shot, or DCA, I don't think there is a big urgency to make a snap decision.
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Old 01-25-2012, 02:39 PM   #9
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I'm not opposed to a little market timing if the opportunity presents itself. But more and more I do want to stick with an AA and not respond to news. But my basic question came about before today's announcement. The news might just influence my tactics rather than strategy.

I had picked a 30% bond allocation a few years ago based partly on information I found here and elsewhere regarding SWR and the need to keep a significant amount in equities even in retirement. That 30% would easily provide us enough income beginning in 2017 when combined with my wife's pension also beginning then. We'd be well under 59.5 so we'd live on the taxable account and pension for a few years until we start tapping the tax deferred money to supplement the pension.

The big change last year was that my wife had an opportunity to buy service credit in her pension that added about $15000 a year to her future earnings and moved her retirement date back 4 years. Now she can retire as early as late next year and draw the full pension but for personal reasons she will stick around until 2014/2015 and I'll stay working until 2017.

That change to her pension is the main reason for thinking about changing the AA to be a little less in bonds. The extra pension income means that our "phantom portfolio" of government bonds is larger and our need for income from the taxable portfolio is lower and hence it might make more sense to have a lower bond allocation.

The news, recent bond price increases, and my expectation of interest rates are just added factors that might influence how quickly I act to get to the AA I choose.
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Old 01-25-2012, 02:45 PM   #10
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I'm probably stupid, but I'm not worried about bonds tanking as long as the Fed holds interest rates down. In a sense, they've done us a favor (WRT bonds and loans only) in committing for so long. So I'll take whatever yields and stability they provide in the meantime, I have not changed my bond % allocation, though I have shortened duration. I'll be more worried once the Fed starts raising interest rates. Let me know if you think I'm not thinking what you think I should think...
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Old 01-25-2012, 02:51 PM   #11
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If you re-evaluate your long term AA and decide to reduce your bond portion then fine, and you can do it in one shot, or DCA, I don't think there is a big urgency to make a snap decision.
Yeah. that last part was what I was getting at. I see no sense of urgency. If you find a good opportunity elsewhere, take it -- but if nothing looks attractive to you right now at current prices, it's probably pretty safe to take your time on moving out of bonds.
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Old 01-25-2012, 02:58 PM   #12
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I'm probably stupid, but I'm not worried about bonds tanking as long as the Fed holds interest rates down. In a sense, they've done us a favor in committing for so long. So I'll take whatever yields and stability they provide in the meantime, I have not changed my bond % allocation, though I have shortened duration. I'll be more worried once the Fed starts raising interest rates. Let me know if you think I'm not thinking what you think I should think...
I know this is a discussion about a specific question and specific circumstances, so I'm kinda butting in here but...

1) I don't think your stupid
2) I would challange your comment about fed doing us a favor. They have held rates below what they would otherwise be if the market were left alone. There are risks involved in purchasing bonds right now (rates could rise and you could loose capital, your purchasing power is being degraded by not capturing interest above inflation) and bonds don't offer any return for the risk. Risk should pay you or why take it?
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Old 01-25-2012, 03:14 PM   #13
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One big change is that my wife has a government pension she'll start getting in late 2014 and, because of a service purchase opportunity that came as a surprise in 2011, will be considerably more than we expected. I can look at this pension as a "phantom portfolio" in government bonds. That would eliminate most of the need to have a 30% bond allocation in our taxable portfolio because her pension will already cover more than half of our income needs. In a rough way it would mean we have a 50% bond allocation as is.
Any comments on how I should think about this?
Which government-- federal? In other words, do you feel that they're going to be able to pay the pension and not jeopardize it for the rest of your life?

Maybe the question should be when you move some of your bond money into equities... perhaps large-cap dividend payers. You'd want to pick a new asset allocation and decide how much time you're going to spend getting there. Then you could either DCA in with new savings or sell off bonds when the stock market presents you with a buying opportunity.
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Old 01-25-2012, 03:17 PM   #14
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2) I would challange your comment about fed doing us a favor. They have held rates below what they would otherwise be if the market were left alone. There are risks involved in purchasing bonds right now (rates could rise and you could loose capital, your purchasing power is being degraded by not capturing interest above inflation) and bonds don't offer any return for the risk. Risk should pay you or why take it?
Awful for CD's, savings, etc. I meant they did us a favor only in terms of what's likely to happen WRT bonds, not much while interest rates are frozen low. Why would bond rates rise significantly while the Fed is holding interest down?
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Old 01-25-2012, 03:21 PM   #15
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Risk should pay you or why take it?
Yep. That's been my thinking and has countered my general strategy for wanting to have a decent income portfolio when I need it.

As far as the Fed doing favors, I think it is a mixed bag. Low rates are (at least theoretically) great for the housing market and for business investment. When the housing market (bubble) blew up it did a lot of damage to the economy. I think we need to fix/support that. And business growth will help the unemployment situation which is another serious problem.

But who wants to lend long term if they only get 3% or so? A 3% mortgage rate is only a favor if someone is willing to lend to you. Why would anyone (bank) tie money up for 30 years at these rates when they expect a return to normality around 5% at some point even if it's several years off. And what business wants to invest now when there is no demand and capacity utilization is very low. If you are meeting demand with current facilities operating at half capacity, why borrow money to expand? You'd need to be convinced that demand will grow steadily for some time before you'd even consider expanding even before you worry about borrowing costs.

I just don't believe that low rates are doing as much stimulating as the theorists predict. That makes me worry at least a little that the Fed might suddenly conclude their policy is failing and raise rates so that lending becomes profitable. It's not something I lose sleep over but it's definitely something I could see happening.
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Old 01-25-2012, 03:36 PM   #16
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I know this is a discussion about a specific question and specific circumstances, so I'm kinda butting in here but...

1) I don't think your stupid
2) I would challange your comment about fed doing us a favor. They have held rates below what they would otherwise be if the market were left alone. There are risks involved in purchasing bonds right now (rates could rise and you could loose capital, your purchasing power is being degraded by not capturing interest above inflation) and bonds don't offer any return for the risk. Risk should pay you or why take it?
The risky bet is long term bonds. They returned 30 % last year. If you want interest rates to rise, all I have to do is put all my money in them. Based on my previous investment experience, I can gaurantee a bond bubble burst.
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Old 01-25-2012, 03:53 PM   #17
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I'm not opposed to a little market timing if the opportunity presents itself. But more and more I do want to stick with an AA and not respond to news. But my basic question came about before today's announcement. The news might just influence my tactics rather than strategy.

I had picked a 30% bond allocation a few years ago based partly on information I found here and elsewhere regarding SWR and the need to keep a significant amount in equities even in retirement. That 30% would easily provide us enough income beginning in 2017 when combined with my wife's pension also beginning then. We'd be well under 59.5 so we'd live on the taxable account and pension for a few years until we start tapping the tax deferred money to supplement the pension.

The big change last year was that my wife had an opportunity to buy service credit in her pension that added about $15000 a year to her future earnings and moved her retirement date back 4 years. Now she can retire as early as late next year and draw the full pension but for personal reasons she will stick around until 2014/2015 and I'll stay working until 2017.

That change to her pension is the main reason for thinking about changing the AA to be a little less in bonds. The extra pension income means that our "phantom portfolio" of government bonds is larger and our need for income from the taxable portfolio is lower and hence it might make more sense to have a lower bond allocation.

The news, recent bond price increases, and my expectation of interest rates are just added factors that might influence how quickly I act to get to the AA I choose.

I think that you are looking at this in a way that is confusing the question. You are asking something like 'should I lower my allocation to bonds'.... I would say no, not if 30% is what you wanted as an AA in bonds..

BUT, I think you need to look at your whole portfolio, which includes the PV of the annuity... As an example, say you have $500K now without the pension... and you allocate 30% to bonds... you have $150K in bonds... now you calculate the PV of your pension and it is another $500K... I would put this in your bond bucket and you now have $650K in bonds which is a 65% allocation to bonds... under this example, you could not even get to 30% bonds...

This is what happened to my sister.... her PV of her pension was SO big compared to what they had saved... I recommended a 100% allocation to stock for their savings (less their emergency bucket which I do not include in the total).... and they still were 80% bonds...
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Old 01-25-2012, 03:56 PM   #18
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Which government-- federal? In other words, do you feel that they're going to be able to pay the pension and not jeopardize it for the rest of your life?
Well that's another can of worms. State of Arizona. So far the pension fund is in decent shape. It was better a few years ago but still not as bad as many. The pension is a game changer of course but we have a backup plan even without it. But Arizona has long term demographics on its side so I think the risk of a pension problem is relatively low.

The opportunity we took advantage of was buying previously forfeited credit she had from a previous job long ago when she made (and hence paid into the system) very little. The cost was low - the extra $15000 income per year starting in 3 years cost her less than $45000! It was a no-brainer. That window though closed and people can no longer do the same thing. That's probably a good thing for the health of the system.
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Old 01-25-2012, 05:49 PM   #19
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I'm thinking the Fed took away some of the interest rate risk from bond funds for a year or two. We all worry about duration and rising rates but if the Fed is committed to keep rates low it reduces those risks.
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Old 01-26-2012, 02:59 PM   #20
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Would seem there may be a fair chance than your wife's pension has a provision for COLAs which makes it more attractive than many bond investments.
You can achieve a 30% fixed income AA for your entire portfolio with a higher than 30% allocation in your tax advantaged investments and a lower allocation in the taxable portion of you portfolio.
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