Where to put fixed income. Vanguard Total Bond

[free4now]

It's been a year and a half since I FIREd, and only now am I starting to get serious about deciding where to invest my fixed income allocation. When I first retired my home equity was my fixed income allocation, and when I sold the home I just kept it in an ING Direct savings account.

I'm finally getting serious about looking into the various options for the roughly 20-25% of my portfolio that will go into fixed income. Options I'm considering include:

- Building my own CD ladders
- Buying TIPS or Tbills at auction to build a ladder
- Putting most of it in Vanguard Total Bond (VBTLX)
- Just leaving it all in the Vanguard Prime sweep account

I'm leaning towards VBTLX Admiral Shares:

https://personal.vanguard.com/VGApp/...FundIntExt=INT

It has low expense ratio of just .11%, a duration of 4.6 years which roughly matches up with my intention that this serve as 5 years worth of spending money for downmarkets, and I like the flexibility of not tying all that money up into lots of little buckets or rungs.

What I'm not sure about is whether this is as good as a self-built ladder in terms of managing volatility. It seems like a bond fund like this is essentially a ladder behind the scenes, as the fund keeps a range of maturities, and replenishes the longer maturities as the shorter maturities drop off. But in a market where the stock market was declining due to rising interest rates, it seems like the bond fund wouldn't work as well for me, because I would be selling for income at low prices.

I'm curious to hear from others about how they would start a fixed income allocation right now.

[Independent]

If TIPS are on your list, don't forget that Vanguard also has an "Inflation Protected Securities" fund -- VIPSX.

I've also wondered about ladder vs. mutual fund.

Intuitively, it seems that if I know when I want to spend the money, and I'm spending principle, then the ladder gives me more predictability. However, if I don't know exactly when I want it, and most of the maturities are just going to roll over anyway, then the market risk in the fund seems like a reasonable trade-off for simplicity.

But that's intuition, I've never invested the time in proving that to myself.

[free4now]

A google search found this treatise on fund vs ladder:
http://www-ac.northerntrust.com/cont...-MuniFunds.pdf

It's a bit biased since it seems to be sponsored by a bond fund company, but does a good job of laying out the issues.

One thing that jumped out at me is they say that bid/ask spreads represent a very significant cost of buying a ladder... they say the spread averages 2.23% for bonds valued at $25k or less. My understanding is that buying from treasury auctions avoids those spreads, so that may be a red herring.

[Maurice]

Yeah, I agree re spreads. The secondary market for retail investors really sucks. Treasury auctions are great, but it can take you a long time to build your ladder.

I'm investigating a TIPs ladder right now myself. I also have been building an ibond ladder of sorts. They have the advantage of being tax deferred, but pay quite a bit less than the TIPs.

[jIMOh]

T Rowe Price Spectrum Income

RPSIX

Holds various types of government, corporate and international bonds (75% of portfolio)
Plus also generates some dividend income (25% equity income).

It is a fund of funds.

[ats5g]

Vanguard wrote a fairly easily readable article called Taxable Bond Investing: Bond Funds or Individual Bonds?

Also, just doing a search on this forum with bonds + cds + brewer, I got the following prior conversations:

Best choice: Bond Fund or CD or...

recommended bond portfolio

Bond fund or CD

If you ladder bonds/CDs, you've just created your own little bond fund. If you don't mind the hassle of reinvesting coupons or finding another to buy when one matures, then managing Treasury bills/notes and CD's is usually very inexpensive and can be easy. Also, if you're attempting to match cash-flow/liabilities then individual treasury bonds/cd's are usually better. But, if you plan on just rolling the bonds over and either taking the coupons or reinvesting them, the low cost ST bond funds [like Vanguard's admiral kind - VFSUX, VSDGX, etc] can be much, much less hassle than a 5 year ladder of CDs. Some of this forum like to be deal hunters when it comes to CD's, but I'm more of a set it and forget it person and would rather have everything at one place.

- Alec

[haha]

Originally Posted by free4now

I'm leaning towards VBTLX Admiral Shares:
... a duration of 4.6 years which roughly matches up with my intention that this serve as 5 years worth of spending money for downmarkets,

I don't think these statements match. A 4.6 year duration will respond with more price movement than you might like for a 5 year living expense fund. Be sure you are fully up to speed on duration vs. price/interest rate behavior.

Ha

[free4now]

Alec, many thanks for those links. After plowing through them, I'm much more confident that a bond fund is right for my situation.

It seems that the control of a self-made ladder is mostly useful for those who like to time the market.

People who have the idea that a ladder is more stable because it always delivers the income specified are ignoring the fact that replenishing the ladder always happens at market rate, which fluctuates widely. If I had a ladder I would replenish it regularly. Replenishing irregularly is a form of market timing that I would probably find tempting to engage in if I had a ladder. With a ladder, every year you are faced with the need to buy under different circumstances from last year. It would be hard for me not to let some timing bravado intuition slip in, favoring different types of bonds in different markets or deciding to wait to replenish. But just like in the equity markets, there is no evidence that such timing measures are effective, so I think it's best to reduce the temptation.

My main reason for having a bond allocation is to control volatility and slightly boost returns with the benefits of re-balancing. From what I've seen a bond fund does this just as well as a ladder, and with significantly less hassle. And the cost (expense ratio for bond fund) is low enough at .11% for the vanguard funds that it's not a big concern. Buying a treasury ladder at auction might be able to knock that down closer to zero, but that's assuming I never have to sell or buy a bond on the secondary market, which is not something I'm willing to bet on. It's possible I could go back to work and decide to sell my ladder which would require paying a large bid/ask spread.

Ha, thanks for catching my incorrect statement about durations. To match a 5 year living expense ladder I should be looking at something with about a 2.5 year duration. But many people seem to like intermediate term (~5 year duration) bonds to serve as volatility-reduction allocations, so I'm going to need to do more research to decide between short and intermediate term.

At this point I'm still leaning towards VBTLX because it diversifies among treasuries, mortgage-backed, and corporate. However I am considering VFSUX just because the acronym is much more memorable.

[ats5g]

free4now,

You might enjoy this short article from Eric Haas Corp bond vs Ind Treasury. If you're just looking for someplace to stick the money to weather down markets and to possibly earn a more than a MM, either VFSUX or VBTLX would probably be fine - neither is going to blow up your portfolio. However, VBTLX will be more volatile b/c of the longer duration [2.3 vs 4.6]. This is more or less the strategy suggested by Frank Armstrong in Investing during retirement.

- Alec

[free4now]

Thanks. After a bit more research, I'm agreeing that short term is better than intermediate term for my needs. Hello VFSUX! Or maybe I'll try Vanguard's new Short Term Bond ETF BSV which is a bit treasurier.

Some good articles I found:

Fidelity's white paper explains how bonds beat money market.

Gene Fama article on why short term is best.

Bernstein on why short term is best.

[ats5g]

Originally Posted by free4now

Thanks. After a bit more research, I'm agreeing that short term is better than intermediate term for my needs. Hello VFSUX! Or maybe I'll try Vanguard's new Short Term Bond ETF BSV which is a bit treasurier.

Some good articles I found:

Fidelity's white paper explains how bonds beat money market.

Gene Fama article on why short term is best.

Bernstein on why short term is best.

Is there a reason you want an ETF [like BSV]? Vanguard's ETFs are just share classes of its funds. For example, BSV is the exact same portfolio and price as the admiral shares of its ST bond index admiral shares, with no transaction fees if bought from Vanguard.

- Alec

[free4now]

No strong reason... I just like ETFs because they let me keep everything in my brokerage account for easy access. I also like the fact that I can do things like use limit orders and trade in the middle of the day. I'm not sure but they might be more marginable than funds in case I ever wanted to do margin trading.