Wrestling with bond allocation... again!

[nun]

I suppose this isn't the tread to say

"Psst, Wellesley"

 

[HadEnuff]

The way I looked at it when establishing my AA, was to look at what my bond allocation would generate in income at today's rates. I was in short, and intermediate bond funds.
I figured that if interest rates rise, that while the principle diminished, I would get a higher % on a smaller principle, but my income would remain steady. As the older bonds matured out of the fund, and that money bought newer bonds, they would not buy as much, but would get a higher rate.

Is that wrong?

BTW, I decided that was too much work, and moved my $ to a titration of Wellington and Wellesley, to duplicate my desired AA, and now I let them worry about it.

 

[REWahoo]

The way I looked at it when establishing my AA, was to look at what my bond allocation would generate in income at today's rates. I was in short, and intermediate bond funds.
I figured that if interest rates rise, that while the principle diminished, I would get a higher % on a smaller principle, but my income would remain steady. As the older bonds matured out of the fund, and that money bought newer bonds, they would not buy as much, but would get a higher rate.

Is that wrong?

I sure hope not, as that's also the rationale (along with my risk tolerance) I used in establishing my AA.

BTW, I decided that was too much work, and moved my $ to a titration of Wellington and Wellesley, to duplicate my desired AA, and now I let them worry about it.

Ditto.

 

[audreyh1]

The way I looked at it when establishing my AA, was to look at what my bond allocation would generate in income at today's rates. I was in short, and intermediate bond funds.
I figured that if interest rates rise, that while the principle diminished, I would get a higher % on a smaller principle, but my income would remain steady. As the older bonds matured out of the fund, and that money bought newer bonds, they would not buy as much, but would get a higher rate.

Is that wrong?

That is correct.

Since I am a total return investor that uses rebalancing, I know that when the bonds take a hit relative to stocks, I will be buying more of them. This speeds up that recovery process.

I also don't blame anyone for using a balanced fund to manage all of this for them.

 

[DawgMan]

I expect interest rates to increase, causing my bonds to drop in value. But I don't sweat it too much - here is why:

1. Bonds are in my portfolio for ballast, to reduce the volatility of the equities in the portfolio. This is their primary function.

2. If bonds have dropped, when I rebalance I will add more to the lower bonds.

3. If something drastic happens to equities, bonds usually rise in value. Interest rates usually drop during a recession that causes equities to be hit hard. If you have high quality bonds, they will rise in value during this period. And you can rebalance using some of your bonds to buy stocks.

I have had a large position in bond funds since I retired in 1999. There have been many interest rate up and downs since then. The average duration of my bond funds are around 5 years, so they gradually catch up with major interest rate changes, and in the meantime rebalancing is an opportunity to add when bonds are down, and trim from them when they are up.

BTW - my bond funds are still up about 5% YTD even though there has been a recent increase in interest rates causing almost 2% decline over the past month. The thing is we're just back to where interest rates (10 year treasury) started at the beginning of the year.

Ok, I finally had a chance to jump back on this thread. I am still trying to make peace with my bond allocation/strategy, but this seems to make more sense to me and perhaps keep me tracking. I dug into one of my intermediate bond ETF holdings to try and further reconcile this. Tell me if I my assumptions are generally correct...

- A slow somewhat predictable increase in interest rates should allow for a predictable and gradual "bake in" of pricing in bonds. In other words, perhaps a slower and more predictable drop in pricing as opposed to a free fall?

- In the current climate where interest rates have been flat with a continual slow tick in interest rates predicted, intermediate to short term bonds should be the safest?

- As noted above, holding intermediate/short term ETFs or funds should naturally rebalance as individual bonds within the funds/ETFs expire and buy new bonds and/or shares are repurchased at today's pricing? Eg. my intermediate bond ETF holds around 3,000 bonds and is producing a distribution of around 2.2%. In the last month the share price has dropped to the point to where the total YTD return is just slightly above the distribution, however, the share price is now trending somewhat flat in Dec. Generally speaking, should I assume the predicted interest rate hike is baked in at this point and in a perfect world should hold steady for the moment... barring all the other things in the world that effect our markets?

- So, in regards to my opening post on this thread after reading thru the responses, if the assumptions above are somewhat correct, should I find peace in 1) staying with intermediate to short term bond ETF's/funds while in a slow predictable interest rate growth environment, 2) continue to let my distributions buy new shares at today's pricing, and 3) continue to rebalance staying the course with my AA (70/30) as I am buying even more shares at today's pricing (as long as my equities continue to grow beyond the 70%)?

Perhaps I am a Boglehead after all!!

 

[Lsbcal]

...Generally speaking, should I assume the predicted interest rate hike is baked in at this point and in a perfect world should hold steady for the moment... barring all the other things in the world that effect our markets?

My guess is the market has fully discounted the December hike. But other discounts may be looming and really nobody knows.

- So, in regards to my opening post on this thread after reading thru the responses, if the assumptions above are somewhat correct, should I find peace in 1) staying with intermediate to short term bond ETF's/funds while in a slow predictable interest rate growth environment, 2) continue to let my distributions buy new shares at today's pricing, and 3) continue to rebalance staying the course with my AA (70/30) as I am buying even more shares at today's pricing (as long as my equities continue to grow beyond the 70%)?

Perhaps I am a Boglehead after all!!

Sounds like a decent strategy but nobody can guarantee anything about the future working out with this strategy. We are sometimes asking each other in these forums (1) what are you doing? (2) does this sound reasonable? (3) is this or that guru on the right track? But the reality is we are all alone with our investments when the bell sounds. Well, when the market tanks that is how I feel.

So should one "find peace"? I haven't ever found that in the stock/bond market. But I have found money.

 

[nun]

I have 20% of my portfolio in bonds in Wellesley and Vanguard Balanced Index. Since retiring I've kept 15% in cash and a stable value fund returning 2.5%. I'm not too bothered about interest rate increases as I reinvest the Wellesley and Balanced Index dividends and won't be touching those funds for a long time. I might use some of the cash to buy equities if there is a significant correction. If your time horizon is long enough I bet a Bogleish AA approach will work ok.

 

[mathjak107]

Wellesley reduced down to 1/3 of the bond portfolio in long term bonds over 15 years . it used to be half . balanced is about 25% . they also used to be well up there in long term bonds

 

[Lsbcal]

Wellesley reduced down to 1/3 of the bond portfolio in long term bonds over 15 years . it used to be half . balanced is about 25% . they also used to be well up there in long term bonds

Interesting as it is hard to get such data unless one owns the fund and watches the strategy of some years. Did the reduction in LT bonds affect average duration?

 

[mathjak107]

one thing I noticed is a barbell of long term treasury bonds and cash or something like pimco mint beat vanguards total bond funds and etf with a duration that is pretty close .
agg also did about the same as the vanguard total bond index .

on the other hand I use fidelity's total bond fund which is still up almost 5% so that out performed the barbell

 

[mathjak107]

Interesting as it is hard to get such data unless one owns the fund and watches the strategy of some years. Did the reduction in LT bonds affect average duration?

I get it off morningstar

 

[audreyh1]

If the 10 year Treasury makes it to 3% by Jan 1, I will feel like next year's rate rises are well baked in. The 10 year crossed 2.6% yesterday before pulling back slightly, so it's well on its way. The 5 year similarly crossed 2.1% yesterday, the highest rate in five years!

We could get a recession next year, or the next, you never know. Recessions push intermediate and long rates back down, even if the Fed doesn't do anything on the short end.

 

[Lsbcal]

I get it off morningstar

I meant it is hard to see a fund's bond strategy over a period of years without following it. For the current fund stats M* is good or the VG site.

 

[Lsbcal]

If the 10 year Treasury makes it to 3% by Jan 1, I will feel like next year's rate rises are well baked in. The 10 year crossed 2.6% yesterday before pulling back slightly, so it's well on its way. The 5 year similarly crossed 2.1% yesterday, the highest rate in five years!

We could get a recession next year, or the next, you never know. Recessions push intermediate and long rates back down, even if the Fed doesn't do anything on the short end.

Apparently the best bet is that today's yield curve is the best future predictor we have. If that is true, then the 11 year yield today is what we should expect for the 10 year yield a year from now. So interperlating off the 10yr and 20 yr yields we would get 2.60% + .09 = 2.7% for next year's 10yr Treasury. But take that with a grain of salt.

 

[audreyh1]

Apparently the best bet is that today's yield curve is the best future predictor we have. If that is true, then the 11 year yield today is what we should expect for the 10 year yield a year from now. So interperlating off the 10yr and 20 yr yields we would get 2.60% + .09 = 2.7% for next year's 10yr Treasury. But take that with a grain of salt.

It's still adjusting though. Have to let it settle down.

Anyway, I feel much better about rebalancing at these levels compared to those on Nov 1. If the 10 year makes it to 3%, and the 5 year to 2.25%, I'll feel like maybe they overshot a little, so even better.

Interestingly, I find that interest rates tend to rise as the year end approaches. Just like stocks typically have a Santa Claus rally. This makes early Jan rebalancing good from a timing perspective.

 

[Lsbcal]

...
Interestingly, I find that interest rates tend to rise as the year end approaches. Just like stocks typically have a Santa Claus rally. This makes early Jan rebalancing good from a timing perspective.

From time to time I check the real Treasury rates (TIPS) here: https://www.treasury.gov/resource-c...rest-rates/Pages/TextView.aspx?data=realyield

Right now the 5 year rate is 0.32% ... actually positive for a change. A few years back I see:
12/16/15 0.55%
12/24/14 0.50%
12/30/13 0.07%

So at least in recent years late December has given us relatively higher rates.

I was tempted to buy 5 year TIPS (held to maturity) last December but did not. But now that I look back at the fund I held instead, VFIDX (intermediate investment grade), for the 12 months it has returned 2.89%. The inflation has been about 1.6% I think. So better then the TIPS I could have bought even with the recent bond selloff.

 

[audreyh1]

From time to time I check the real Treasury rates (TIPS) here: https://www.treasury.gov/resource-c...rest-rates/Pages/TextView.aspx?data=realyield

Right now the 5 year rate is 0.32% ... actually positive for a change. A few years back I see:
12/16/15 0.55%
12/24/14 0.50%
12/30/13 0.07%

So at least in recent years late December has given us relatively higher rates.

I was tempted to buy 5 year TIPS (held to maturity) last December but did not. But now that I look back at the fund I held instead, VFIDX (intermediate investment grade), for the 12 months it has returned 2.89%. The inflation has been about 1.6% I think. So better then the TIPS I could have bought even with the recent bond selloff.

I notice that the Fidelity Inflation Protected Bond Premium class FSIYX with duration of 5.73 years is quoting 30 day yield of 2.21%. It was 2.78% on 11/30/16.

I don't invest directly in TIPs, so I'm not that familiar. To me TIPs provide a reading on expected inflation. And apparently you can invest after the fact and do better, rather than buying ahead of any rise in inflation.

 

[Lsbcal]

As a benchmark, the 5 year nominal bonds (I think this is Treasuries) had a historical real return of 2.3% from 1926-2010 (per Swedroe). So I'd want a pretty decent number before going with TIPS. Maybe between 1% and 2%.

Regarding funds, the Vanguard VIPSX (inflation protected, 8.6 years average maturity) has a quoted SEC yield of -0.1% now. Bummer, but that's the current bond market we are looking at.

 

[RobLJ]

I'm very late to this party, but having expected interest rate to go up (eventually), 3 years ago I allocated about 20% of bonds to Floating Rate fund--but like stocks the fund should get wacked severely in a recession. It paid off this year, so I expect it's probably late to come to the party, unless interest rates/inflation start cooking.
I sold the TIPS fund a couple years ago when it went highly negative yield, but I may start to nibble back to cut my overly high cash allocation.