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When Bond Funds Make Sense
Old 02-16-2017, 10:13 AM   #1
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When Bond Funds Make Sense

Long time since I've been here but lately I've been slammed by my financial advisor for being invested almost entirely in bond funds..(Mostly intermediate investment grade)..I'm retired with capital preservation as my primary goal..I do not plan to ever sell shares but likely will one day begin drawing my dividends..I do not want to actively manage my account..I don't care what interest rates do short time and in fact nothing would please me more than for rates to go up..Again, I have no plans to ever sell shares..Advisors seem to ALWAYS steer me to equities which in my humble opinion are riskier than bonds..I don't need more money I just want to keep what I have..I understand inflation risk and have a lot of I Bonds that I am happy to have..I also believe that interest rates are more likely to track inflation than equities..So......what am I missing? Is my advisor right that I should sell my funds and buy his equities?
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Old 02-16-2017, 10:24 AM   #2
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I think he is more worried for you about the percentage of your asset allocation. If interest rates rise 1 percent over the next year or so, your portfolio is going to take a big hit and the recovery period for bonds is much longer. You better research and read up on bond fund investing.
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Old 02-16-2017, 10:33 AM   #3
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Everything I've read says that a 100% bond portfolio will not really keep up with inflation, so one has to have some equities. You could invest in TIPS though and we know how those things have done. TIPS still have interest-rate risk.
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Old 02-16-2017, 11:31 AM   #4
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I think he is more worried for you about the percentage of your asset allocation. If interest rates rise 1 percent over the next year or so, your portfolio is going to take a big hit and the recovery period for bonds is much longer. You better research and read up on bond fund investing.

I hope rates do go up..That means over time my dividends will go up..Why should I care what the share price is if I have no plans to sell..
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Old 02-16-2017, 11:33 AM   #5
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20% equities is considered a minimum, even for old farts. 100% bonds won't keep up with inflation.
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Old 02-16-2017, 11:38 AM   #6
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Everything I've read says that a 100% bond portfolio will not really keep up with inflation, so one has to have some equities. You could invest in TIPS though and we know how those things have done. TIPS still have interest-rate risk.

I think it is wrong to assume that equities perform significantly better than bonds when measured against inflation.There are a lot of variables the largest being the time period being measured..Also, past performance is no guarantee of future performance.. Regarding dollar value I just don't see how one could be under water holding a bond fund if it is held for a term length equal to the average maturity date of the bonds in the fund..

http://www.pankin.com/persp091.pdf

Also, I might be more of a mind to sell bonds and buy equities except I think the current valuations are way above historical averages..
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Old 02-16-2017, 11:50 AM   #7
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I think it is wrong to assume that equities perform significantly better than bonds when measured against inflation.
Then you've answered your own question - ignore what your FA is telling you and stick with bonds. Maybe you'll be fortunate in your remaining life span coinciding with a favorable period for bond performance.
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Old 02-16-2017, 12:53 PM   #8
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I hope rates do go up..That means over time my dividends will go up..Why should I care what the share price is if I have no plans to sell..
When interest rates go up, the payments from new bonds go up, but not on existing bonds. For the return on an existing bond to rise, since the bond payout is fixed, the value of the bond falls. You lose more on the drop in bond value than you make from the payment. The only way to get whole is to hold the bond to maturity, but with a fund you do not hold the actual bond, but share of a basket of many bonds.
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Old 02-16-2017, 02:19 PM   #9
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Want to save some money, or at least save some aggravation? Dump your FA. You obviously don't value his advice, so why pay for it (or pay for it with your time by talking/corresponding with him).

Over the long term, bonds have historically not done a good job of keeping up wit inflation (over some periods, some types of bonds have done okay). Historically, adding even 20-30% stock to your portfolio (and rebalancing every year or so) will do wonders for your return (improve it by about 2% per year) and will >decrease< the volatility of your portfolio. By adding 20-30% stocks, you'll be appreciably reducing risk (from inflation) while also decreasing the volatility of your portfolio. Look at the slope of the "efficient frontier" graph below. There's a lot of return for no/little increase in volatility for the first 40-50% allocation to stocks compared with a 100% bond portfolio.
Just chose a widely diversified, low cost index fund or ETF and put 20-30% of your holdings there.

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Old 02-16-2017, 02:24 PM   #10
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I have always used the rule of thumb that as long as your time horizon is longer than the duration of the bond fund it usually makes sense.
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Old 02-16-2017, 02:38 PM   #11
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Want to save some money, or at least save some aggravation? Dump your FA. You obviously don't value his advice, so why pay for it (or pay for it with your time by talking/corresponding with him).

Over the long term, bonds have historically not done a good job of keeping up wit inflation (over some periods, some types of bonds have done okay). Historically, adding even 20-30% stock to your portfolio (and rebalancing every year or so) will do wonders for your return (improve it by about 2% per year) and will >decrease< the volatility of your portfolio. By adding 20-30% stocks, you'll be appreciably reducing risk (from inflation) while also decreasing the volatility of your portfolio. Look at the slope of the "efficient frontier" graph below. There's a lot of return for no/little increase in volatility for the first 40-50% allocation to stocks compared with a 100% bond portfolio.
Just chose a widely diversified, low cost index fund or ETF and put 20-30% of your holdings there.

Apologizes for intruding in the thread but where can I go to learn how to interpret this chart? I've no idea what it's telling me.
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Old 02-16-2017, 02:43 PM   #12
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Just chose a widely diversified, low cost index fund or ETF and put 20-30% of your holdings there.

....or put everything into.......pssst Wellesley
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Old 02-16-2017, 02:45 PM   #13
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Apologizes for intruding in the thread but where can I go to learn how to interpret this chart? I've no idea what it's telling me.
It is called an "Efficient Frontier" chart. Here's a pretty good explanation (it runs a couple of pages).
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Old 02-16-2017, 02:46 PM   #14
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Apologizes for intruding in the thread but where can I go to learn how to interpret this chart? I've no idea what it's telling me.
Explaining The Efficient Frontier - Video | Investopedia
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Old 02-16-2017, 02:46 PM   #15
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Apologizes for intruding in the thread but where can I go to learn how to interpret this chart? I've no idea what it's telling me.
It's telling you the average gain versus volatility (in terms of standard deviation) for a set of asset allocations that use rebalancing. For example, it shows that over time you can get a higher gain and lower volatility with 20% equities/80% bonds rebalanced periodically than with just 100% bonds. Most people would go for the higher gain and lower volatility choice.

Also it shows that as % equity increases, how much additional volatility and gain you might expect and how it compares to other allocations.
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Old 02-16-2017, 02:49 PM   #16
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So......what am I missing? Is my advisor right that I should sell my funds and buy his equities?
I believe you have the answer when you say, "buy his equities". People often think equities have an implicit, inflation beating coupon. IMO, they do not. You can keep average duration in your bond funds at a relatively low end and certainly avoid >= 10 year average durations.

Anyway, no one can know for sure what the interest rate curve might do, now or later. In fact, the heavily embraced view that rates are certainly going up meaningfully might make one at least wonder how likely this is to be true, or more accurately, will reacting in accord with this opinion have a high probability of being profitable?

Ha
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Old 02-16-2017, 02:59 PM   #17
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Apologizes for intruding in the thread but where can I go to learn how to interpret this chart? I've no idea what it's telling me.
The vertical scale is average annual return... the horizontal scale is a measure of portfolio volatility... the graph indicates that the data suggests that an allocation of 10 or 20% to stocks results in better portfolio return and lower volatility... that a 30/70 portfolio has about the same volatility as a 100% bond portfolio but much better return... and that from 30/70 that higher allocations to stock are a linear trade off of higher return but with higher volatility.
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Old 02-16-2017, 03:05 PM   #18
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The vertical scale is average annual return... the horizontal scale is a measure of portfolio volatility... the graph indicates that the data suggests that an allocation of 10 or 20% to stocks results in better portfolio return and lower volatility... that a 30/70 portfolio has about the same volatility as a 100% bond portfolio but much better return... and that from 30/70 that higher allocations to stock are a linear trade off of higher return but with higher volatility.
Thanks for the lesson...It makes sense now.
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Old 02-16-2017, 03:31 PM   #19
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Long time since I've been here but lately I've been slammed by my financial advisor for being invested almost entirely in bond funds..(Mostly intermediate investment grade)..I'm retired with capital preservation as my primary goal..I do not plan to ever sell shares but likely will one day begin drawing my dividends..I do not want to actively manage my account..I don't care what interest rates do short time and in fact nothing would please me more than for rates to go up..Again, I have no plans to ever sell shares..Advisors seem to ALWAYS steer me to equities which in my humble opinion are riskier than bonds..I don't need more money I just want to keep what I have..I understand inflation risk and have a lot of I Bonds that I am happy to have..I also believe that interest rates are more likely to track inflation than equities..So......what am I missing? Is my advisor right that I should sell my funds and buy his equities?
As the graph suggests, while you are right that equities are riskier than bonds, the data suggests that a portfolio of 10-30% equities and the rest bonds is less or equally volatile with a 100% bond portfolio.

You say that you take a long view and that you believe that interest rates are more likely to track inflation than equities... what you are missing is that inflation is the base for both bond interest and equity returns so both will exceed inflation over the long run... however, equities will exceed inflation by more.

Buy "his" equities... perhaps depending on what he is recommending, but IMO your advisor is right that you should sell SOME of your bond funds and buy equities. How much, as a percentage, is he recommending that you sell and divert to equities... if it is 30% or less then IMO it is good advice.... unless your are totally risk-averse you will likely get the same volatility and much better returns.
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Old 02-16-2017, 04:13 PM   #20
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I know a guy that is so afraid of the market he buys only US Treasury bonds.

He picks up aluminum cans on the weekend to make some extra dough.
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