AA: Should I list My Junk Bond Fund Under Stocks or Bonds?

[Cheesehead]

I ask because these high yield junk bond funds act more like a stock fund rather than traditional bonds. So, in terms of thinking about volatility should I list it, in this case Vanguard's High Yield Bond Fund VWEHX, under equities or bonds?

Thanks,

Nick

[43210]

A mixture.

[audreyh1]

If high yield bonds act a lot like equities, why not own equities instead?

[bingybear]

I would say bond. The bond may be issued buy a company or city with low credit ratings (junk). Yes they will vary more than a higher rated issuer. Just because they are low rated does not mean they "act like an equity". They act like a low rated bonds.

By your logic.. would it be high rated bonds are bond, low rated bonds are "like" equities, high rated equities are equities? .. then low rated equities are what?

one buys lower rated bonds for higher interest rate in return for more risk.

if you take a high rated bond and the rating is changed downward.. the value of the bond drops. If you take a junk bond and the rating is lowered, the bond value drops. So, what is the difference?

[pb4uski]

I'm not sure if the premise that they "act more like a stock fund" is right. The graph linked below compares the Admiral versions of Total Stock, Total Bond and High Yield Corporate.

Play around and look at the price behavior for different periods of time... it seems that they are more like bonds than stocks to me.

In any event, I consider mine to be part of my bond allocation.... however, for bucket purposes I include them in inflation protection and put investment grade bonds in stable value.

VTSAX Vanguard Total Stock Market Index Fund Admiral Shares Fund VTSAX chart

[audreyh1]

The problem with high yield bonds is that they drop drastically when stocks get hit, thus they don't offer diversification from stocks. So if you have fixed income in your AA to diversify away from stocks, and to provide some cushion when stocks go south, high yield bonds will not provide this cushion. It's better to avoid them in your AA.

Really, people usually buy high yield bonds for the higher yield.

So the question is - what is the role of fixed income in your AA? Is it to provide diversification against equities? Or something else?

[Montecfo]

It's stock.

[bada bing]

I use a split percentage for a high yield fund I hold: PIMIX
There are two factors I look at to estimate the split; the volatility (STD) and the Correlation.
In the case of PIMIX, the STD is 4.73% vs 15.7% for the Total Stock Market USA (VTI).
The correlation of PIMIX is .57, which indicates a weak but positive correlation. (I.E. it tracks
the stock market with about 1/4 the volatility a little over 1/2 the time.)

From that analysis, I seat-of-the-pants WAG that PIMIX should be counted as 66% bond
and 34% stock. Your WAG may be different.

Here is a link to portfoliovisualizer that compares my fund, PIMIX, to VTI and BND. You
can replace PIMIX with whatever high yield fund you use to run a comparison with
Total stock market and Total bond market and see how it behaves.

portfoliovisualizer.com PIMIX vs VTI vs BND

Here is a link to your fund VWEHX compared to total stock market and total bond market:

portfoliovisualizer.com VWEHX vs VTI vs BND

[marko]

I have a HY bond fund and a regular bond fund too but consider the HY as bonds for AA. They're less than 10% of my portfolio.

I own HY because they deliver a nice monthly income rather than a cushion against volatility. Within reason I don't worry too much about the price as the income has been steady for almost 20 years now with an 8.5% total return over 15 years.

[bingybear]

PIMIX is really a bad example. It has significant leverage which can increase volatility. This is one of the no win discussions. Everyone has their pet way of looking at this.

But look at BND in 2008. It has a nice dip... following stocks. OK, it was not as deep. But I see that as the difference of quality of the bond, not that it acts more like a stock. (my view).

I don't disagree that lower quality bonds will have higher volatility. One would expect that. But it is a matter of degree. In 2008/9 corporate quality bonds got hit as I recall. I think treasuries were about the only ones that were spared.

However, I would expect that treasuries were likely hit when the US dept rating was cut.

Not all bonds are real stable.

[pb4uski]

Quote:

Originally Posted by audreyh1 The problem with high yield bonds is that they drop drastically when stocks get hit, thus they don't offer diversification from stocks. So if you have fixed income in your AA to diversify away from stocks, and to provide some cushion when stocks go south, high yield bonds will not provide this cushion. It's better to avoid them in your AA. Really, people usually buy high yield bonds for the higher yield. So the question is - what is the role of fixed income in your AA? Is it to provide diversification against equities? Or something else?

From 10/1/2007 to the trough, Total Stock declined 54% ($10k became worth $4.4k)... Total Bond increased $750 and High Yield Corporate declined 22% (from $10k to $7.7k).

Given that was the "worst of times"... high yield doesn't seem very stock-like to me..... it obviously has more volatility than investment grade bonds along with higher returns.... I'll take the tradeoff... I get good returns with some cushioning.... sort of like half the return of stocks with half the volatility.

http://quotes.morningstar.com/chart/...22%3A%5B%5D%7D

[UnrealizedPotential]

I have never avoided High Yield in my portfolio, although I have limited my exposure due to their sometimes stock like behavior. I guess it's whatever one feels comfortable with. The income is good but it comes at a high price,so I prefer to not have anymore than my risk tolerance lets me.

IOW, High Yield is more of a compliment rather than a centerpiece to my portfolio. So what would I consider it? HY would have to be considered bonds I think. Maybe bonds on steroids?

[pb4uski]

Agree... it is 5.6% of my portfolio.... good returns albeit with some volatility.

[audreyh1]

Quote:

Originally Posted by pb4uski From 10/1/2007 to the trough, Total Stock declined 54% ($10k became worth $4.4k)... Total Bond increased $750 and High Yield Corporate declined 22% (from $10k to $7.7k). Given that was the "worst of times"... high yield doesn't seem very stock-like to me..... it obviously has more volatility than investment grade bonds along with higher returns.... I'll take the tradeoff... I get good returns with some cushioning.... sort of like half the return of stocks with half the volatility. VTSAX Vanguard Total Stock Market Index Fund Admiral Shares Fund VTSAX chart

It doesn't matter if one goes down less and up less than the other. What matters is correlation. High yield bonds are highly correlated to stocks, unlike many other bond classes. So they don't provide diversification against equities.

Thats why people recommend to treat them as equities in your allocation, or to own equities instead.

[Cheesehead]

OP HERE: Thanks Everyone!

Since we recently retired I have been trying to figure out how to draw a steady income from our Nest Egg of $1.2 mil and decided to use Evensky's Bucket Strategy. I did not know whether to put the HY fund into Bucket #2 which is bonds and supposed to be fairly safe, or Bucket #3 which is stock, more volatility and long term growth.

Hey pb4uski, you used the word bucket in your post. Are you using the Bucket Strategy? My wife is a very conservative investor so by showing her that we will have 3-4 years of living expenses in cash in Bucket #1, she will let me do what I want with Buckets 2 and 3.

Thanks,

Nick

[Lsbcal]

If I were trying to answer this question for myself, I would construct 2 portfolios:

1) SP500 + Treasuries
2) SP500 + high yield bonds

Then see what amount of SP500 in portfolio #1 is required to roughly equalize the returns. I would do this over a long period using the data in the Bogleheads "Simba" spreadsheet. That data goes back to 1952.

I have done this but for different bond cases since I don't own high yield bonds for the reasons Audrey has mentioned. FWIW, the cases I chose were:

1) SP500 + intermediate treasuries
2) SP500 + total bond market
3) SP500 + short term Treasuries

And the amounts of SP500 needed to equalize the returns over 1952 - 2016 were:

1) 60/40
2) 60/40
3) 63/37

In words, the intermediate Treasuries matched the Total Bond Market returns so no extra stocks were required. About 3% extra stocks were required to hold short term Treasuries.

[pn3069]

Avoid HY bonds all together... that is what I do.

If you examine many of the popular HY bond funds (say the etf HYG) you will see telecom and energy as the two very large sectors.. and both will continue to struggle (my expectation) in the intermediate term.

Plus, the incentive i.e., HY spread over treasuries is not large enough for me to take risk there.

I have stocks, and investment grade bonds...that's it. You really don't need any other asset class (in my opinion).

[gayl]

Under gambling ...Unknown if profit or loss

[pb4uski]

Quote:

Originally Posted by Cheesehead OP HERE: Thanks Everyone! Since we recently retired I have been trying to figure out how to draw a steady income from our Nest Egg of $1.2 mil and decided to use Evensky's Bucket Strategy. I did not know whether to put the HY fund into Bucket #2 which is bonds and supposed to be fairly safe, or Bucket #3 which is stock, more volatility and long term growth. Hey pb4uski, you used the word bucket in your post. Are you using the Bucket Strategy? My wife is a very conservative investor so by showing her that we will have 3-4 years of living expenses in cash in Bucket #1, she will let me do what I want with Buckets 2 and 3. Thanks, Nick

I'm not using a bucket strategy, but I looked at buckets a number of years ago and quickly concluded that buckets and my 60/35/5 AA were not sufficiently different to make any changes.

For example, let's say that your spending gap/withdrawals is $3.5/year and you have $100 nestegg. After considering income from dividends (@2%) and bond interest (@3%), the $5 in cash could support spending $3.5 a year for about 4 years without selling any stock or bonds. Then the $35 in bonds could carry me another 20 years.... so in theory, the $40 of cash and bonds could carry us for ~24 years without needing to sell any equities.... plenty of time to ride out any sequence-of-returns storm.

In reality, I would plan to rebalance annually but it is good to know that if we had adverse sequence of returns that I could shift to buckets if needed.

While I haven't inflation adjusted the withdrawals, I have also not adjusted the equity dividend income for appreciation or increases in dividends and those will offset to a significant extent.

[Cheesehead]

Thanks pbuski!