long term corporate?? (Be gentle)

[floatingdoc]

Ok, I am probably about to get thrown off of this board. Oh, just about 1 week ago I posted my crazy (yah...I think that was the consensus) plan to "reach for yield" with "all junk portfolio". I was appropriately awoken to the fact that I could expect steadily declining net asset values due to the nature of the high yield and its all to close ties in terms of dividend payout to the stock markets general movements. It certainly seems as though the nav of high yield is slowly declining into nothingness. My questions are 2:

1. What is the best way to diversify a 100% bond fund portfolio besides holding the "total bond market" index? (should I decide to abandon the plan below)

2. (cringe) Dare I ask (beg) for this fine groups opinion on the relative safety of an all investment grade long term portfolio with similar principles (reinvest all dividends next 7-8 years then live on a portion of the dividend income and reinvest the remainder in the fund). Historically, going back to 1987, the monthly dividend has never been below 4 cents per share per month. Again, I can tolerate the declining NAV in the inevitable higher interest rate environment right around the corner. Perhaps running man can work some magic with that spread sheet of his? This fund should be much less correlated with stock prices. The current nav is 9.00 per share and a little rich for average since 1987 but not to bad. In a rising interest rate environment I would generally expect lower n.a.v. but a rising dividend payment yes? Again, I can live with that. I am seeking SHARE NUMBER appreciation, not overall value of portfolio. The overall value, while important, is not what I am after. In fact, I prefer higher interest rates. My reinvestments monthly are higher and share price supposedly lower. Ok...be gentle.

Scenario as follows:

50k out emergency fund
925k purchases 102,663 shares at nav 9.01 paying dividend .044 = 4517/month. Remove 30% for taxes to emergency fund monthly and Reinvest 70% of the distribution (0.7 x 4517= 3162 per month)

3162 per month reinvested at 9.01 is 4211 shares per year (more if nav declines, more if interest rates rise)

I also estimate contributing at least 70K year to this myself for next 7 years

so...

102,663 + (4211 x 7 years work) + (70000/9.01 x 7) =

102,663 + 29477 + 54,384 shares = 186,524 shares (all assuming 9.01 as nav throughout my lifetime)

186,524 shares paying 0.04 (a low lifetime estimate for this fund) = 89,531 annual Income. Inflation protection built in as interest rates will rise if inflation kicks in...which will produce a higher dividend as the fund is reinvested in higher coupons.

Assumptions:
1. The nav does not change or decrease (which would help my position)
2. Interest rates do not rise (which would also help my overall position ...I think)
3. I can continue working for 7 more years ?
4. I can continue contributing 70 K per year on my own.
5. That the fund will continue to pay at least 4 cents per share per month in dividends (history on my side here)

SHOULD I DOLLAR COST AVERAGE THE INITIAL PURCHASE?

 

[LOL!]

Why don't you go with a 100% TIPS bond portfolio as suggested by Zvi Bodie?

Have you read Larry Swedroe's book on bond investing?

 

[ERD50]

floatingdoc - I'll give you the short answer. There has been a ton of research around the concept of diversification and asset allocation. There are good reasons that these are very strongly held concepts across so many successfully retired people. It's not 'group think', it is what makes sense after much review of the alternatives.

So first, you wanted a non-diversified portfolio of 100% Hi-Yield. Now you want only long-term bonds. You are searching for 'something', some magic bullet, perhaps?

I guess you will need to learn it on your own, but I can practically guarantee that after you put in more than 4 weeks of study, you will decide on some plain-Jane, vanilla AA/diversification that fits your risk tolerance. Those that have taken other paths have either gotten very lucky, or don't post here anymore after being wiped out. Good luck on your search.

No, I would not have a portfolio invested in mostly long term bonds. You end up locking in an interest rate - and right now those are historically low. Terrible idea - in hindsight, it would have been a great plan in 1982. This is not 1982.

BTW, I've got a higher allocation of Hi Yield than most on this forum, but it sure isn't anywhere near 100%, and I then count half of it as 'stock' allocation.

-ERD50

 

[samclem]

In a rising interest rate environment I would generally expect lower n.a.v. but a rising dividend payment yes?

In a rising interest rate environment, the bonds you already hold do not pay more interest. All that happens is that their value goes down. Now, when you buy replacements for them (when they mature, are called, etc) then the replacement bond you buy can be expected to yield a higher rate if interest rates are higher. But, that could be a long time, if, as you say, your plan is to hold on to them.

How are you going to feel when you are locked in to 6% interest rates and inflation is at 10%? Every year your portfolio loses 4% of its earning power, and this could go on for a decade. Long-term corporates get hammered in an inflationary environment, and some folks believe that we're overdue for a healthy dose of that medicine. Do you really want to bet everything you've got that they are wrong?

This is not a good plan. Either go 100% TIPS (and keep saving until you are 90 years old to get enough money in your nest egg) or go with a diversified portfolio with a healthy helping of equities. Or (gag) buy an annuity.

 

[FANOFJESUS]

Long term anything is not good right now. Short term is the place to be right now. When rates raise several percent then long will look good again. Remember rates have been going down for about 29 years they will not raise up high in a year or two. I think the cycle is about 27 years but nowadays it might not take that long to get them back up.

 

[FIREd]

I know of only a few people who have recommended/used a 100% fixed income allocation and who could actually convince me that their approach has some merit:

OAG (former board member) who masterfully retired with 100% of his portfolio in CDs.
Zvi Bodie who advocates a 100% TIPS portfolio.
The Richelsons who, in their book "bonds, the unbeaten path to secure investment growth", provide a blue print for the successful all-bond investor.

Even if I think that each one of those approaches, as imperfect as they are, deserves a long hard look, a mixture of bonds and stocks still looks safer to me than a 100% stock or bond portfolio.

To understand why, I highly recommend reading Larry Swedroe's "the only guide" book series.

 

[Bikerdude]

The truth is that no one knows for sure where interest rates are going. At best they are giving a "best guess" based on their field of expertise. So there is a chance that your plan could turn out great and there is a chance that it could down in flames.

This is the reason why you should diversify your bets. By making several non-correlated bets on different asset classes, you can be wrong on one but right on others. While you may not hit a home-run with this strategy, you probably won't end up eating dog food or that other stuff you eat when you have to go back to w*rk.

 

[REWahoo]

OAG (former board member) who masterfully retired with 100% of his portfolio in CDs.

I think we should remind folks OAG had a military pension, his wife had a cola'd pension and they were also both drawing SS.

 

[FIREd]

I think we should remind folks OAG had a military pension, his wife had a cola'd pension and they were also both drawing SS.

Huh, right, it's been a while and I forgot that -very important- tidbit... I still think that his approach has some merit though, for someone who is willing to live on a small SWR. Because retiring on a 100% fixed income portfolio is never a good answer for those who want to cut corners and retire on small portfolios with high SWRs IMO.

 

[Gone4Good]

I think we should remind folks OAG had a military pension, his wife had a cola'd pension and they were also both drawing SS.

So I guess he used the CDs for a place to stick all of the pension and social security income he wasn't spending?

 

[floatingdoc]

I anticipate my retirement expenses to be 40 k per year, no more.
Then to the first question, what is the best way to do a tips portfolio?

I think the main argument against my plan (from what I can see) is inflation, the great unknown. The turn over rate is 15-20% from 2004 thru 2009 which means the fund replaces 1 out of every 5-6 bonds in the porfolio annually. I imagine Wellington would start replacing bonds in a rising rate environment to pick up the higher coupon rates. So in fact, I don't think it is quite accurate to say you are "stuck at 6%". I have no pension, I am going to be 12 years from Social security and at 62 plan on tapping equity in my paid for home with a reverse mortgage. We have no one to leave the house to, and that is at least a 200k lump sum payout on top of social security so that is my inflation hedge

 

[Zathras]

Actually, I think the main argument against your plan is your lack a diversity.
A fund does give you a lot more diversity that buying a single bond, but still leaves you exposed if there is a systematic problem with bonds.
Counting on a bank product (reverse home mortgage) and price of said product 12 years away also seems to be a risk.

 

[Gone4Good]

I imagine Wellington would start replacing bonds in a rising rate environment to pick up the higher coupon rates. So in fact, I don't think it is quite accurate to say you are "stuck at 6%".

Not exactly

Consider a $100 bond with a 5% coupon. When rates go up to 10%, the market value of the bond goes down to $50 (not really, but I'm simplifying) so that it yields 10% ($5 coupon / $50 price =10%). If you sell your 5% coupon bond to buy a new bond with a 10% coupon you can only buy $50 of bonds instead of your original $100. So yes, you're "stuck" at your original yield.

Duration matters a lot in this exercise. Most bonds wouldn't decline by a full 50% in the example above. Short-term bonds don't decline much and longer-term bonds decline a lot. The fund you're looking at has a duration of 12.1 years, which means it would decline to ~$60 instead of $50. So churning the fund would result in some increase in current cash flow at the expense of future NAV apprecation. But this isn't a free lunch as you're actually consuming principal as "income". If you held on to your original bond you'd get $5 coupons and $100 at maturity. If you sell for a new bond you'll get $6 coupons but only $60 at maturity. So the bottom line is that, yes, you'd be stuck with a 6% yield for a very long time.

 

[haha]

My brother is very conservative and risk averse. He uses TIPs and intermediate term CDs or bonds, depending on their relative yields for at least 80% of his portfolio. The rest will sit in cash, until he sees what he perceives to be a high return speculation in equities or more often, closed end funds. When that works out he goes back to his cash waiting position.

He has a non cola pension and pretty good SS.

Ha

 

[floatingdoc]

then why does vanguard say that long bonds actually do well in rising rate environments, provided they are held. This is from the vanguard front page of their website:

Bonds and rates: The reality behind the headlines

February 02, 2010

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Moves in interest rates are notoriously hard to predict, but that hasn't stopped many market observers from declaring that rates are headed up in the near future. If the predictions are right and rates do climb, you're sure to see headlines about how such an environment is bad for bond investors.
As is so often the case, the headlines won't tell the whole story. It's true that a general rise in rates will cause bond prices to fall and thus reduce the returns of most bond funds in the short term. But the higher rates can boost returns for long-term bond investors who stay disciplined about reinvesting their interest income. The reality is that if you're steadily reinvesting your interest income, rising interest rates can be good news.
See for yourself

Why maturity matters to you

Wondering how your bond fund might be affected by a move in rates? A bond fund's maturity can give you an indication of its relative income and share-price stability and help you make more-informed choices about your bond investments. Learn more »

The interactive graphic below gives you some perspective on why holding on to a bond fund in a rising-rate environment can pay off over time. The hypothetical scenario assumes that interest rates rose by 1 percentage point in each of the first 2 years, climbing from 4% to 6%.
In the first year, the bond fund's total return—price change plus reinvested income—would be –0.8%. But as interest earnings and any maturing bonds are reinvested at higher yields, the fund's return would rise. After 7 years, the bond fund would have produced an average annual total return higher than the returns for two other hypothetical scenarios shown—one in which rates fell and another in which rates remained constant. Please note: These hypothetical returns are not meant to illustrate the returns of any particular investment, nor do they consider the effect of inflation.

How rates affect bond prices and yields

Interest rates influence the yield, or the annualized rate of interest income, provided by bonds and bond funds. Interest rates also influence bond prices. When rates go up, the price of a previously issued bond can fall. That's because you wouldn't pay full price for a bond with a face value of $1,000 and a yield of 4% if you could get a new bond for the same price yielding 5%.
In the short term, bond fund returns suffer because of this price drop. But then the benefit of higher interest income starts to kick in. New bonds purchased by the fund can provide higher yields. As a fund shareholder, you can earn more by staying invested and reinvesting your interest income at higher yields. And over time, the effect of compounding—earning interest on interest—can more than compensate for an initial price decline.
Keeping rate moves in perspective

Why not try to jump out of bonds before rates climb and then get back in after rates have settled? This market-timing approach sounds good in theory, but the reality is that it can be a losing strategy because of the difficulty of predicting rate moves.
Focusing on interest rate moves and short-term changes in bond prices can be counterproductive. Over the long term, it's interest income—and the reinvestment of that income—that accounts for the largest portion of total returns for many bond funds. The impact of price fluctuations can be more than offset by staying invested and reinvesting income.
So if you're holding bond funds as part of your long-term asset allocation, a rise in rates probably shouldn't prompt you to make any changes. Indeed, you can benefit by sticking with the bond allocation that's right for you.

Notes

• All investments are subject to risk. Investments in bonds and bond funds are subject to interest rate, credit, and inflation risk.
• Past performance is not a guarantee of future results.

 

[jIMOh]

Assumptions:
1. The nav does not change or decrease (which would help my position)
2. Interest rates do not rise (which would also help my overall position ...I think)
3. I can continue working for 7 more years ?
4. I can continue contributing 70 K per year on my own.
5. That the fund will continue to pay at least 4 cents per share per month in dividends (history on my side here)

You do not have enough assumptions listed.
More assumptions:
6) You know what you are doing
7) You have examined other alternatives
8) You admit you are putting all your eggs in one asset class.
9) You are confident that the "past performance" of that asset class will resemble its future returns for 30-40 years.

I will reiterate my advice from last thread, and state a few new comments.

In both your plans, you did not consider starting withdraw rate, you are putting all your eggs in one basket (not following asset allocation) and in general are not looking at alternatives in enough detail.

In addition, I would project numbers backwards- you are close enough to retirement that some general hints might help you. This means for any plan you should list the following numbers- annual expenses, portfolio value, portfolio allocation and starting withdraw rate.

List income you need in retirement (first year). $75k was the number I remember from last thread. I do not know how you came to that number, but I will use it here as an example.

75k, 4% SWR (starting withdraw rate). $75,000/.04=$1.875 M.
This means if you need 75k each year, you need 1.875M earning 4% to have portfolio meet your income needs. There are various forces and risks pushing and pulling at this equation. #1 is inflation- it is a risk, and the basic idea that what is 75k today and what you need 30 years from date of first withdraw will not be the same. The 4% has a 3% increase built into it each year. meaning year 1 75k is taken out, year 2 is 75k+3%=$77250, year 2 is $77250+3%=$79,568 and so on. Another force is the returns of the investment(s) chosen. The portfolio will have an "average" return- the 4% withdraw comes from a 60-40 portfolio (this was established in something called the trinity study- feel free to research that on your own). The average return of a 60-40 porfolio is much higher than 4%... I use this site to find my numbers:

Flexible Retirement Planner

If you look at 55-45 portfolio has an average return of 8.5% and a std deviation of 9.9%. This means -1.4% happens as often as a return of 18.4% (8.5-9.9=-1.4 and 8.5+9.9=18.4).

Once you run a basic set of numbers, you can decide how much risk you want to take (or how much risk you are comfortable with). The single biggest thing I have learned from this board is many retirees are all over the spectrum with what their porfolio risk is.

There are people here 100% stocks which live off dividends... I am sure there are people at 80-20 and 60-40... and I know of others which have stated they are 40-60 and that is probably what my retirement portfolio will be too.

Each of these portfolios has characteristics which define how much risk does or does not exist. Risk cannot be eliminated, it can only be managed (for example 100% bonds have various risks which include inflation risk, interest rate risk, default risk and depending on foreign bonds, currency risk and geo political risks too. I probably missed some- like principal risk (bonds funds will have NAV change).

There are other risks too- like your own spending (75k works now, but maybe person in example decides to travel for 5 years and doubles spending), other risks like the market being down for 4-5 years when the retirement starts (to me this is the single biggest risk to me retiring- a down market the first 4-5 years of retirement).

You can tweak with SWR to adjust for risks... if what you want is a stable return of interest from a given investment, I would look to one of two porfolios (at opposite extremes). One is a 100% government bond portfolio. More than likely SWR on a portfolio like this is 2%, possibly 3%. The other is a 100% dividend portfolio- probably a 3% SWR works here (depending on what investments are used to generate dividends). If you search thread titles for yield, dividends, or search for threads I posted to, you might find some threads 1-2 years old with some good comments. I remember one thread
http://www.early-retirement.org/for...u-get-a-3-yield-37716.html?highlight=dividend

which lead me to the conclusion I just stated (100% stock porfolio should have a SWR of 3% if you spend only dividends).

In summary, your best option is to do more research- you have 7 years before you retire. Tell us your spending, portfolio value (target) at retirement and SWR and asset allocation in one post. You might get more specific feedback and more constructive feedback that way.

 

[jIMOh]

I anticipate my retirement expenses to be 40 k per year, no more.
Then to the first question, what is the best way to do a tips portfolio?

Have you looked at treasurydirect.gov?

40k income per year means you need $1 M to retire on a 4% SWR based on asset allocation theory. The question remains- do you know about that theory?

4% SWR is generally based on 60-40 allocation, but its possible the allocation can change and the SWR stays at 4%. Use calculators like firecalc (on this site) or others to test withdraw rates and market behavior for yourself.

If you are more conservative, then lower withdraw rate. Maybe 3% SWR for 40k which is $1,333,333 portfolio.

I have not bought bonds directly (only bond funds) so will leave it to others as to how to build a bond portfolio.

 

[Gone4Good]

then why does vanguard say that long bonds actually do well in rising rate environments, provided they are held. This is from the vanguard front page of their website:

They assume you are reinvesting 100% of dividends . . .

But the higher rates can boost returns for long-term bond investors who stay disciplined about reinvesting their interest income.

You are planning on spending your dividends. The open question is how much you can safely spend (which is pretty much the same question raised by the HY thread).

BTW, I don't think this is necessarily an unworkable strategy (same too with the HY portfolio) if properly constructed. But you really should have a very good understanding of how an asset class works before you decide to invest 100% of your life savings in to it. You might want to spend the next couple of years doing some in depth research before you commit to anything like this.

 

[clifp]

Ok, I am going to be more positive. I think this plan is a significant improvement from your last one, it has reasonable chance of providing a decent retirement income, under fairly benign economic conditions.

On the other hand I don't disagree with the any of the criticism.

But, I think it is worth you telling us what you have against stocks?

 

[jIMOh]

Ok, I am going to be more positive. I think this plan is a significant improvement from your last one, it has reasonable chance of providing a decent retirement income, under fairly benign economic conditions.

On the other hand I don't disagree with the any of the criticism.

But, I think it is worth you telling us what you have against stocks?

I agree with Clifp...

and I would also add if you used the buckets system, and made this most of bucket 2, then your system would have a higher liklihood of succeeding IMO

 

[walkinwood]

Are you really going to invest almost a million $s on the basis of feedback from an online board? You just threw one plan out and have come up with another with, as far as I can see, not much thought behind it.

Please read the books already mentioned. Let's see some real analysis on your part. Get a spreadsheet, get some historic data (there's a guy on the bolgeheads board that provides a spreadsheet - I think his user name is simba) and see how your strategy would have worked in different interest rate environments in the past.

I think this and other boards are a great resource for clarification of points, confirmation or for pointers to learn.

It is your hard earned money!

 

[jimnjana]

If ever there was someone who needed professional financial planning advice it is floating doc.

 

[Gone4Good]

I like that someone has shown up with a different idea and run it through the gauntlet. There is a fair amount of "group think" that takes place on boards like this (myself included) and it is good to consider, or in some cases reconsider, alternatives to the conventional wisdom.

 

[Bikerdude]

I like that someone has shown up with a different idea and run it through the gauntlet. There is a fair amount of "group think" that takes place on boards like this (myself included) and it is good to consider, or in some cases reconsider, alternatives to the conventional wisdom.

I agree with this even though I poke fun at what appears to be a question that a little research would go a long way to answering.

 

[walkinwood]

I like that someone has shown up with a different idea and run it through the gauntlet. There is a fair amount of "group think" that takes place on boards like this (myself included) and it is good to consider, or in some cases reconsider, alternatives to the conventional wisdom.

Fair enough!

I got the data from Simba's spreadsheet at
Bogleheads :: View topic - Spreadsheet for backtesting (includes TrevH's data)

There is no data on Long Term Investment Grade bonds, but there is data for High Yield bonds from 1985 to 2009. Nominal return for a 100% high yield bond portfolio is 7.51% nominal and 4.46% real with ALL dividends reinvested and NO taxes. SD is ~10.5%.

We've all learned by now, that average returns mean little if you're in the withdrawal phase, so this doesn't give us much useful information.

But it made me feel like I was doing something useful
I don't have the patience to create a spreadsheet with actual data to see how it would have fared with regular withdrawals, but maybe the OP will do that.