Nestegg + one basket - bad event = shattered retirement.
I guess the good news is I think I may have found the person who wants to buy my Vanguard High Yield fund shares. I bought 100K worth back in Nov 2008, when VWHEX was yielding more than 10%. This was a less than 5% of my portfolio and having seen it raise in value and the yield drop to 7.3%, I am thinking it maybe a good time to sell. Especially after hearing that somebody that had devote 4 whole weeks to research wants create 100% high yield research portfolio. Ok that was a cheap shot but...
One important thing to understand is that accumulation phase while saving retirement is a lot different than the distribution phase after you are retired. Dollar cost averaging works great while saving for retirement, not so great while in retirement. In your case when you retire you will have X number of shares of High Yield and for the most part that will be a fixed number.
Lets consider 3 scenarios where your plan fails.
1. High inflation
2. Lower income due to defaults
3. Lower income due to reinvestment risk
There is a large number of smart people who think that the massive deficits will lead to intentional or unintentional high inflation. If inflation is 10% a year your 7.3% yield doesn't look so great. Three years of 10% inflation and your $72K income can only buy the equivalent of 48K.
The nightmare scenario for a junk bond owner, is high inflation couple with a weak economy (stagflation like we had in the late 70s). I am pretty sure that is zero political will to continue to bailout failing companies. So bond holder of shaky companies like Ford, or Citigroup, BofA, Quest, Charter Communication (My mom's cable/internet provider a horrible company IMO) will likely in be for a big haircut of these companies go under or are taken over by the FDIC. Oh BTW, these are the top holdings of VWHEX. If the bailout hadn't happen VWHEX would have lost a lot of money on bank bonds.
Finally, the most likely risk you face is reinvestment risk. This same situation people are finding today with CD ladders. The same 3-5 year CD that was earning 6 or even 7% a few years ago now has come do and the best you can find is 2.5-3%.
Lets take the case of the smart retiree who in Aug of 2008, decided to get out of the market and take his 1 million dollar portfolio and buy 100,000 shares Vanguard GNMA bond fund (Admiral VFIJX). Unlike your junk bond fund, the principal of GNMA bonds is backed by the full faith of the US government so it gets a AAA credit score.. Vanguard fund share price is very stable $10 +/- $.50 for most of the last twenty odd years. In short a much safer investment than a junk bond fund even a great one like Vanguards.
Back in Aug 2008, 100K share of VFIJX provided a monthly income of $4,467 probably enough to live on with a paid of house for many people in much of the country. Fast forward to today. The value of VFIJX shares has increased from $10.27 to $10.75, certainly a better than leaving the money in the stock market. What do you think the income is $5,000? $4,000?
Click on this
link and check out Jan 2010 distribution of the GNMA fund. Then explain why this couldn't happen to the Vanguard junk bond fund. My betting is it will soon.