Bond Allocation - Mixing in Preferred Stocks, High Yield Bonds, & Foriegn Bonds

[ESRwannabe]

IMHO, there is more than one reason to hold bonds.

(1) If you are doing the modern portfolio strategy then I don't see why you would want to hold anything but long term treasuries. No other AAA bond works as well even if it is theoretically the same credit rating. For MPT I would use 30 year treasury ETF and cash.

(2) The second reason to use bonds IMHO is to create cash flow. If you are investing to create cash flow then you will want to add corporates, junk, preferreds, munis, convertibles, etc. If this is your goal then IMHO the best way to do it is by using closed end funds, purchased at a discount. Couple the fixed income CEFs along with individual stocks, div focused etfs, mlps, reits, bdcs, etc. and you will have cash flow that you can live off of and will most likely grow enough to keep up with inflation. Ideally you will create a portfolio which throws off more income than you need. So you can use the excess income to re-invest strategically in whatever asset is on sale.

Strategies (1) and (2) can be easily combined. For (1) just go buy Vanguard's Managed Payout fund. For (2) just build it out slowly starting with whatever is on sale. Right now preferred stocks, utilities, and reits are on sale. Not too long ago mlps were on sale. When the market inevitably crashes again load up on VYM and VYMI, vanguard's high div yield ETFs.

 

[Blueskies123]

Stocks are not bonds.

But some bonds look a lot like stocks
There is a post in this thread that charts junk bonds vs stocks.

 

[Winemaker]

Preferreds, with a investment grade rating, are not on sale right now. With prices way above par, they are overvalued, because they currently are better place to get a higher yield than CDs, but no ways, safe enough.

 

[Running_Man]

I'm skeptical. Vanguard recently did a piece on bond investing vs bond funds. They state:
A table following that paragraph suggests that in terms of bid asked spread that small investors in individual bonds are at a 51 bps disadvantage to mutual funds due to trade size... and in most cases that 51 bps advantage overwhelms the bond fund expense ratio.


https://personal.vanguard.com/pdf/ICRIBI.pdf

I do not think it is very hard to beat Vanguard in Treasury Bond performance, at least in the intermediate and short term. On their own website they show where for the last five years they have under performed the index they measure against by 25 BP per year. Over the last year they have under performed by 60 BP. And this is the #2 rated US intermediate treasury ETF by Morningstar.
https://personal.vanguard.com/us/funds/snapshot?FundIntExt=INT&FundId=0035&funds_disable_redirect=true


Since inception 27 years ago they have under performed by 31 BP per year on average. The cost of under performance over those 31 years is $10,000 for each $100,000 invested.

 

[pb4uski]

Yup. ^^^ It's the old... do you walk to school or take your lunch?


I guess if what you wrote above had any earthly relevance to bid-asked spreads in bond pricing and how spreads vary between small purchase and large then you might have a point.

 

[ESRwannabe]

Preferreds, with a investment grade rating, are not on sale right now. With prices way above par, they are overvalued, because they currently are better place to get a higher yield than CDs, but no ways, safe enough.

Let me rephrase my comment then. Right now CEFs that invest in preferreds are on sale right now. Same with reits and utilities.

 

[mathjak107]

Just look at how those asset classes behaved in 2008.

The point of bonds is to diversify away from stocks. Use the lower correlation high quality bonds/cash.

What is the point of taking equity like risks in your fixed income allocation?

with some fund families 2008 results are a very poor way of judging things . many very very conservative funds owned what was supposed to be very safe paper and it turned out that the way they were brought to market gave them no liquidity .

my money market lost 3% . so i take 2008 returns especially with fidelity with a grain of salt . those products are gone and no longer in the portfolio's of these funds .

every fund at fidelity owned this conservative paper , from ultra conservative bond fund to junk bond funds .

 

[mathjak107]

Like many/most here, I oversee my own investments and spend time talking to and researching what the "experts" suggest (as well as many of you) in an effort to create the best "mouse trap" for me. While about 2 years out from RE, with last years run up, I have effectively "won the game", but continue to battle my logical/conservative nature with my ever present "greed glands" looking for a little more juice. While in the last few years I finally convinced myself to ratchet down to a more conservative 60/40 AA (which I suspect I will stay with thru RE), I cannot help but feel there are some better ways to turbo charge my "40". Yes, logically, I know that a big part of my bond allocation is there for stability and to counter the more volatile "60" over time, but I cant help with being discontent with a measly 2% + yield. So at the beginning of last year, after meeting with my financial executive committee (that's me), I made the decision to split my "40" as follows (and note their 2017 total returns which include reinvesting distributions and the approximate yield)...

- 25% Intermediate Bond Funds/ETFs (3.5% & 2%+) Previously, all my "40" here.
- 7% Preferred Stock Funds/ETFs (10.5% & 5.5%)
- 5% High Yield Bond Funds/ETFs (9%+ & 5%)
- 3% Foreign Bond Funds/ETFs (10% & 4%+)

While I am no expert, in simple terms, my research tells me Preferred Stocks will act more like Bonds with a little bit of stock momentum, High Yield Bond movement will generally run closer to stock performance, and Foreign Bonds will be affected more by currency changes. Again, putting it all simply.


So while last years performance for this 15% alternative bond allocation looks great compared to my sleepy Intermediate Bond performance, is the risk/reward model over time really worth it? Am I kidding myself with my 5% High Yield Bonds... is this effectively as if I am really holding a 65% Stock allocation? I love the extra juice in 2017, just wondering if this is a sustainable or really needed "40" allocation model?

the bond side of my portfolio is very diversified . i hold not only a tiny position in a total bond fund , but a bigger position in a go anywhere bond fund with bits of everything in it which are less sensitive to us interest rates . everything from international bonds , high yield , emerging market as well as quality stuff are held . i also have a very very short term and a fund a bit longer in duration but less than a short term bond fund .

 

[Blueskies123]

with some fund families 2008 results are a very poor way of judging things . many very very conservative funds owned what was supposed to be very safe paper and it turned out that the way they were brought to market gave them no liquidity .

my money market lost 3% . so i take 2008 returns especially with fidelity with a grain of salt . those products are gone and no longer in the portfolio's of these funds .

every fund at fidelity owned this conservative paper , from ultra conservative bond fund to junk bond funds .

I have been with Fido for 30 years. I do not recall my MM funds losing 3% in 2008. Yes, I did a google search before I wrote this. You must have been in smaller MM fund and not the large main stream core MM accounts.

 

[mathjak107]

it was not the fidelity money market that lost money , it was the reserve fund money market , one of the largest .it's founder was one of the creators of money markets. they had 65 billion and we lost 3% . luckily i had little in it but i do hold the distinction of having one fail from the same paper .

 

[gwraigty]

Another vote for individual bonds

Yes, logically, I know that a big part of my bond allocation is there for stability and to counter the more volatile "60" over time, but I cant help with being discontent with a measly 2% + yield.

I've been primarily investing in individual bonds, corporate and muni, for over 10 years now. It's easy and relatively inexpensive to buy them. Right now, even with some municipalities having refinanced their higher coupon debt, you can get at least 3.5% or better on many issues. I don't concern myself too much with price fluctuations.

Some examples of purchases I made last year might be names you know:

Aflac, 4% coupon, due 10/15/46, 4.006% YTM
Campbell Soup Co, 3.8% coupon, due 08/02/42, 3.956% YTM
Cleveland Clinic Foundation, 4.858% coupon, due 01/01/2114 4.954% YTM
Fedex Corp, 4.10% coupon, due 04/15/43, due 04/15/43, 4.174% YTM
McDonalds Corp, 3.70% coupon, due 02/15/42, 3.986% YTM

In the muni area, I look for issues with coupons/yields of 3.50% or better. In contrast, I have holdings that I bought several years ago with higher coupons. One example is a DC muni I bought in 2010, triple tax exempt issue, 5% coupon, callable 10/01/20, due 10/01/39, 5.179% YTM.

 

[OUTLAW]

There are some funds out there that might be similar to what you are thinking about - they are called multi- bond funds. I am not recommending them - just saying that they do exist, the ones that come to mind are PIMIX and FSICX.

 

[mathjak107]

i like fscix a lot .

 

[Lsbcal]

To get higher returns one will have to accept more risk. It then depends on how you want to take that risk. Below is a chart comparing an intermediate investment grade fund (blue, VFIDX), Total Bond Market (orange, VBTLX), and intermediate Treasury (green, VBTLX).

We see that in 2008 you would have wanted to be in Treasuries. Next best was Total Bond Mkt. If you look over the last 30 years these returned about the same. So I don't know why people are so attracted to Total Bond.

My choice has been intermediate investment grade. But my plan is to switch into Treasury based on a monthly timing algorithm and backtesting shows it has outperformed both of those assets. Mainly switching when we are under stress which shows up as equity weakness coupled with a flat to inverted yield curve. Timing this sort of thing is not nearly as delicate as equity timing. If it doesn't get me more return, at least it won't loose money. So that is the way I've chosen to take on the extra risk.

Many here don't want the extra risk with their bond allocation. And that is fine. Another approach is to calculate what an alternate bond portfolio has thrown off over maybe the last 20 years and just boost the equity allocation to get the same thing. So maybe adding back a few % in equites as mentioned by others here.

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A final point. In 2008 we saw a massive decline which could have grown into a 1930's scenario. We all should realize that as retirees taking on risk that puts our standard of living in jeopardy is frankly ... stupid . I do not want to be looking back at a terrible mistake. Far better to leave some potential gain on the table.

 

[RobLJ]

In my main account (a 403b) I took a similar approach for income:

5% Fidelity Total Bond FTBFX
4% Foreign Income (Fidelity New Markets) FNMIX
4% Real Estate Income FRIFX
4% Floating Rate FFRHX
2.5% High Yield FSICX (probably will sell and replace with PIMIX)
4% Mortgage Fund DLTNX
2.5% Investment Grade FBNDX
3% Intermediate MWTRX
3% Intermediate Treasury (stripped) BTTRX
8% cash

As/when Foreign yields go down and Floating Rates rise, I'll sell income and place in the Intermediate Treasury for safety and intermediate, as well as rebalancing stock yields in there. The cash is enough for 2 years withdrawals; I'll probably move 1/2 into a short term fund or move stock rebalancing there just to squeeze out a few nickels.

the bond side of my portfolio is very diversified . i hold not only a tiny position in a total bond fund , but a bigger position in a go anywhere bond fund with bits of everything in it which are less sensitive to us interest rates . everything from international bonds , high yield , emerging market as well as quality stuff are held . i also have a very very short term and a fund a bit longer in duration but less than a short term bond fund .