Bonds in AA - what type of bonds?

[Gearhead Jim]

I should have explained that my previous preference for CD's was due to the combination of FDIC insurance, absence of interest rate risk, and acceptable returns. The CD returns have plummeted but when I look at the 5 year treasuries vs 5 year CD, I can still do slightly better in CD's.

How complicated is it to buy 5 year treasuries through Vanguard? Fees?
Would the actual paper be in Vanguard's name, or mine?

My custodian is mostly Vanguard, but the CD's are directly owned by me.

 

[ERhoosier]

I also view my AA in "fixed income" rather than "bonds" per se. I lump non-variable annuities, CV life insurance, CDs, etc. with my FI allocation. Along with a couple money market accounts I still have which were locked in at "promo" rates of 2-2.5% (remember those days?). I view my FI AA with safety as #1 priority. Cash is separate, but lately I am questioning the rationality of holding anything other than short term (1-3yrs) bonds. With Federal deficits at record levels and growing, inflationary pressures could explode at most anytime. IMHO- The minimal additional interest paid just ain't worth the risk of holding longer term bonds these days so I have not been reinvesting some bonds as they mature. Thus cash AA has been increasing by default.

 

[pb4uski]

I should have explained that my previous preference for CD's was due to the combination of FDIC insurance, absence of interest rate risk, and acceptable returns. The CD returns have plummeted but when I look at the 5 year treasuries vs 5 year CD, I can still do slightly better in CD's.

How complicated is it to buy 5 year treasuries through Vanguard? Fees?
Would the actual paper be in Vanguard's name, or mine?

My custodian is mostly Vanguard, but the CD's are directly owned by me.

It is no different than if you buy an individual stock... the instrument is held by Vanguard in an account in your name. While I haven't bought CDs or Treasuries through Vanguard, I suspect no fees since they don't charge fees for stocks that I buy.

 

[big-papa]

I hold bond funds 3 ways:
1. For my primary AA (60/40) I use intermediate treasuries (FUAMX) At Fidelity, primarily as ballast for my stock holdings. In the very long term, they have near zero correlation stocks and since the Volker era they have tended to be strongly anti-correlated to stocks during market stresses (.com bubble, 2008, Covid, for example). I do this even knowing full well that the returns on these are likely to be negative, in inflation adjusted terms, over the next 5-10 years or so. Many instead choose a total bond market approach instead and there's nothing wrong with that, but they haven't tended to react as strongly during market stresses as treasuries have, though they have tended to have slightly better long term returns. You can't have everything...
2. I own Ibonds which I intend to use as an inflation adjusted supplement to Social Security when I turn 70.
3. A TIPs pseudo-ladder which is also intended to be used as an inflation adjustment supplement to Social Security when I turn 70.

 

[Gearhead Jim]

It is no different than if you buy an individual stock... the instrument is held by Vanguard in an account in your name. While I haven't bought CDs or Treasuries through Vanguard, I suspect no fees since they don't charge fees for stocks that I buy.

Thanks for the info.
The issue of bonds at VG being held by them in my account, I consider to be a minus. About 2/3 of our investments are already at VG, with the rest spread around CD's at various institutions.
It's highly unlikely that VG would go belly up or be a victim of massive fraud/hacking/ransomeware. But I've experienced a number of highly unlikely disasters in my life, and will probably keep a least a portion of my investments in separate locations. Those other locations are probably no more secure than VG, but there is a diversification of "disaster risk."

Some people would consider that a tinfoil hat, but I'm ok with it.

If I decide to go with individual bonds, then your info will get me started.

 

[pb4uski]

A bit funny... as I was reading your post I started thinking "Wow, this guy needs a tin foil hat" and then in the next paragraph you conceded to it.

 

[kevink]

I hold bond funds 3 ways:
1. For my primary AA (60/40) I use intermediate treasuries (FUAMX) At Fidelity, primarily as ballast for my stock holdings. In the very long term, they have near zero correlation stocks and since the Volker era they have tended to be strongly anti-correlated to stocks during market stresses (.com bubble, 2008, Covid, for example). I do this even knowing full well that the returns on these are likely to be negative, in inflation adjusted terms, over the next 5-10 years or so. Many instead choose a total bond market approach instead and there's nothing wrong with that, but they haven't tended to react as strongly during market stresses as treasuries have, though they have tended to have slightly better long term returns. You can't have everything...
2. I own Ibonds which I intend to use as an inflation adjusted supplement to Social Security when I turn 70.
3. A TIPs pseudo-ladder which is also intended to be used as an inflation adjustment supplement to Social Security when I turn 70.

I think this is a really smart approach with good diversification across the highest-quality bonds.

The first book on bonds I read some decades ago, Annette Thau's "Investing in Bonds," recommended IT (~5 year) Treasuries as the "sweet spot" default bond choice and that's been echoed by Larry Swedroe and other experts over the years. In addition to performing far better in market panics than TBM funds one needs to remember that Treasuries are exempt from state taxes which often means that their after-tax returns are equal or superior to funds that are composed largely or solely of corporates.

 

[big-papa]

I think this is a really smart approach with good diversification across the highest-quality bonds.

The first book on bonds I read some decades ago, Annette Thau's "Investing in Bonds," recommended IT (~5 year) Treasuries as the "sweet spot" default bond choice and that's been echoed by Larry Swedroe and other experts over the years. In addition to performing far better in market panics than TBM funds one needs to remember that Treasuries are exempt from state taxes which often means that their after-tax returns are equal or superior to funds that are composed largely or solely of corporates.

Thanks. It's a somewhat belt-and-suspenders approach that helps me sleep at night even though I admit that there is at least some "mental accounting" going on.

 

[big-papa]

I think this is a really smart approach with good diversification across the highest-quality bonds.

The first book on bonds I read some decades ago, Annette Thau's "Investing in Bonds," recommended IT (~5 year) Treasuries as the "sweet spot" default bond choice and that's been echoed by Larry Swedroe and other experts over the years. In addition to performing far better in market panics than TBM funds one needs to remember that Treasuries are exempt from state taxes which often means that their after-tax returns are equal or superior to funds that are composed largely or solely of corporates.

By the way, there are at least a couple of schools of thought on how to deal with bonds. In my description I'm doing both, it turns out
1. An income stream approach (that's my Ibonds + TIPs pseudo ladder)
2. Ballast only - that's my FUAMX in my 60/40 portfolio with rebalancing.

There are those who advocate an income stream approach regardless, even for nominal bonds. If you take that approach, you generally start with an overall long duration, then gradually reduce the duration over time in a systematic way. This pretty much eliminates interest rate risk (though not other types of risk). Or you just purchase individual bonds of varying duration which, as long as you don't sell them, are guaranteed to have a certain nominal income stream.

No right choice for everybody...

 

[OldShooter]

... I admit that there is at least some "mental accounting" going on.

I don't think Richard Thaler, who invented the term, has ever said that mental accounting is a bad thing. Indeed, we almost have to do it to survive financially. Simple household budgeting is mental accounting, as is separating our fungible retirement savings dollars from the household operations money. Even to speak of AA is mental accounting.

Once in a while, though, it can lead to bad decisions. The classic is a corporate budget policy that money cannot be moved from an account with a surplus to an account with a deficit, where the money is critically needed. Another classic is "house money," where we humans are risk takers with the fungible dollars we have just won while fiercely protecting the fungible dollars in our wallets. (Richard Thaler on house money: " ... the fact that some of your money has been made recently should not diminish the sense of loss if that money goes up in smoke.")

So the key is not to avoid mental accounting. That's impossible. The key is to understand the benefits of mental accounting and to avoid being led unconsciously astray.

 

[Out-to-Lunch]

3. A TIPs pseudo-ladder which is also intended to be used as an inflation adjustment supplement to Social Security when I turn 70.

Would you mind telling me what you mean by a pseudo-ladder? I.e., how it differs from a regular ladder?

(Overall, my approach is similar to yours.)

 

[big-papa]

Would you mind telling me what you mean by a pseudo-ladder? I.e., how it differs from a regular ladder?

(Overall, my approach is similar to yours.)

Certainly. Suppose you have created a bond ladder out of regular bonds, each of which has its own duration. You can then look at the ladder in its totality at any given point in time and find out what the effective duration of the whole ladder is. As each year passes, the effective duration of the entire ladder is shortened.

Using this concept, you can perform the near-equivalency by using 2 (or more) bond funds, each having different durations. Every bond fund publishes its current effective duration. For the current, effective duration you want to achieve, you simply hold the 2 bond funds in the correct proportions such that the total effective duration is what you're looking for.

TIPs bond funds are a special case because not all fund companies publish their effective durations based on "real yields" but instead publish based on "nominal yields", which isn't correct. There are sources that correctly calculate effective durations correctly. Some believe that even using nominal based duration is probably close enough.

Anyway, for myself I mapped out what duration I need every year (every quarter actually), and I adjust the proportions quarterly, if needed, though I've seen anywhere from monthly to annually being used. I think quarterly is "good enough" for what I want to achieve. Adjustments need to be made because the effective duration you want to achieve has shortened a little bit, but also because the durations reported by the individual bond funds move around a little bit over time. My spreadsheet tells me exactly how much of one fund I need to sell to buy more of the other. Takes all of about 5 minutes to do, though depending on whether you're using mutual funds or ETFs, you may have to wait a couple of days for settlement to happen before you make the new purchase.

Some people do this with simply a long duration bond fund and maybe an ultrashort duration bond fund. I think that's probably a little too coarse since bond yield curves don't follow a straight line all the way from longest to shortest duration. I start by using a long term bond fund and an intermediate bond fund. Eventually, as time goes by, the effective duration needed is less than what the intermediate bond fund is. At that point, I keep the intermediate bond fund and add a short bond fund. Again, at some point in time, the duration needed is less than the duration of the short bond fund, so I then add an ultra short bond fund.

That's basically it. It's not perfect. Obviously doing a continual rebalance will come closest to the "real deal", but sometimes good enough is good enough.

You do have some additional drag, too, because mutual funds do have expense ratios, though at least for nominal bond funds they're really small these days. Also true for TIPs funds, except for the only existing long duration TIPs fund available to most - that's LTPZ with an e/r of 0.20%. But you also don't have to deal with income being thrown off from a true ladder before you need the income. I just have both bond funds set to reinvest dividends/cap gains so I don't have to deal with that.

There are several threads over on bogleheads which discuss this concept.
Here's one that talks about doing this with TIPs (and it also refers to an earlier posting).
https://www.bogleheads.org/forum/viewtopic.php?t=240325

Finally - I have to add that there are many who are perfectly comfortable building true bond ladders. Nothing at all wrong with that. I'm not claiming that this method is in any way superior, likely slightly inferior. But I find it suits me. YMMV.

Cheers.

 

[Out-to-Lunch]

Thanks so much for taking the time to explain that so clearly! I appreciate it.

Funny, I sorta kinda have been doing that, but in the accumulation phase. Inspired by Larry Swedroe, I have been on a 15-year-plan of shortening my average duration, and gradually shifting to TIPS, as I have been spending down my human capital. All of this in tax-deferred, so all in funds. (But I am only using nominal duration, and not distinguishing my nominals from TIPS in my average duration calculation. I did not know that was incorrect.) Like you, I have regarded bonds chiefly as ballast; as a result, the durations I chose were probably too short, in hindsight, ~5 years now. Oh well.

Hmmm... I am planning to set up a real TIPS ladder a soon as I can move money from a 403(b) account to a tIRA. That brings some (minor) complications, as that moves money from an account that I can access (Rule of 55) to an account that I can't yet (tIRA). Maybe I will think about implementing your tactic instead (but I already know how I was going to deal with the accessibility issue anyway).

Thanks for the thoughts.

 

[big-papa]

Thanks so much for taking the time to explain that so clearly! I appreciate it.

Funny, I sorta kinda have been doing that, but in the accumulation phase. Inspired by Larry Swedroe, I have been on a 15-year-plan of shortening my average duration, and gradually shifting to TIPS, as I have been spending down my human capital. All of this in tax-deferred, so all in funds. (But I am only using nominal duration, and not distinguishing my nominals from TIPS in my average duration calculation. I did not know that was incorrect.) Like you, I have regarded bonds chiefly as ballast; as a result, the durations I chose were probably too short, in hindsight, ~5 years now. Oh well.

Hmmm... I am planning to set up a real TIPS ladder a soon as I can move money from a 403(b) account to a tIRA. That brings some (minor) complications, as that moves money from an account that I can access (Rule of 55) to an account that I can't yet (tIRA). Maybe I will think about implementing your tactic instead (but I already know how I was going to deal with the accessibility issue anyway).

Thanks for the thoughts.

No problem at all - I'm also in accumulation phase and it's another 12 years before I start tapping into this. My TIPs funds are all in my IRA, but that's OK since I'll be 70 before I start tapping it. And Ibonds are already tax advantaged, so it's all good!

Best of luck!

 

[audreyh1]

I hold bond funds 3 ways:
1. For my primary AA (60/40) I use intermediate treasuries (FUAMX) At Fidelity, primarily as ballast for my stock holdings. In the very long term, they have near zero correlation stocks and since the Volker era they have tended to be strongly anti-correlated to stocks during market stresses (.com bubble, 2008, Covid, for example). I do this even knowing full well that the returns on these are likely to be negative, in inflation adjusted terms, over the next 5-10 years or so. Many instead choose a total bond market approach instead and there's nothing wrong with that, but they haven't tended to react as strongly during market stresses as treasuries have, though they have tended to have slightly better long term returns. You can't have everything...
2. I own Ibonds which I intend to use as an inflation adjusted supplement to Social Security when I turn 70.
3. A TIPs pseudo-ladder which is also intended to be used as an inflation adjustment supplement to Social Security when I turn 70.

I think this is a really smart approach with good diversification across the highest-quality bonds.

The first book on bonds I read some decades ago, Annette Thau's "Investing in Bonds," recommended IT (~5 year) Treasuries as the "sweet spot" default bond choice and that's been echoed by Larry Swedroe and other experts over the years. In addition to performing far better in market panics than TBM funds one needs to remember that Treasuries are exempt from state taxes which often means that their after-tax returns are equal or superior to funds that are composed largely or solely of corporates.

This jibes very much with my understanding, and I have used 5 year treasuries in my models.

But I confess I go for the more diversified bond index funds as they have a huge slug of US intermediate govt-backed paper and still hang in pretty well during credit panics.

But as I age I may go for more FUAMX.

I’ve been retired for a long while, and I didn’t own any bond funds at all until I retired!

 

[guitarguy]

Go to what pb4uski wrote on the first page, because it's spot on. I abandoned bonds several years ago... in this economy with the Fed Reserve propping up the economy every times it sneezes, interest rates will stay low for quite a while. Instead, a few years ago I built a healthy Dividend Income portion of my portfolio using Dividend Kings and Aristocrats. Although you could argue that it's slightly riskier, in practice that hasn't been the case for me. The best thing I ever read about it is this: for income in retirement, if you get a 5 or 7% yield every year, and it pays or grows every year, what do you care if the stock price goes down? Let your heirs worry about that.

Best investing tip I ever got. And in fact, the prcies, on average, are up over my purchase price. In 20 years or so when I die, I have no doubt that the blue chip Dividend Kings and Aristocrats will still be there, and my heirs will still see some gains.
With bonds? Not going to happen, my heirs will get screwed and I'll get low yield. I've been averaging about 7% yield every year, and I can SWAN. Works for me.