Bond Allocation Question

[haha]

In another topic (Firecalc Success %) Kramer quotes William Bernstein:

Second, it is now possible to eliminate inflation risk with the purchase of inflation-adjusted bonds. The U.S. Treasury version, the 30-year "Treasury Inflation Protected Security," or TIPS, currently yields 3.45%. So no matter how badly inflation rages, the interest payments of these bonds will be 3.45% of the face amount in real purchasing power, and the principal will also be repaid in inflation-adjusted dollars. (These are the equivalent of the gold-backed bonds of the last century.)

These TIPS rates have come down from when Bernstein wrote this; and Kramer comments on today's situation:

For instance, if you can get long term TIPs at 2.4% real (about the current rate), the SWR for 45 years is about 3.57% (40 years is 3.83%). This becomes more impressive when you consider that most folks will also have social security. Of course, there will be reinvestment risk and CPI risk and probably tax issues, but that is still impressive as an extreme example.

My question is this- if posters have bonds with maturity => 10 years, what proportion are indexed, and what proportion are straight?

Mine are all indexed- my only straight bonds have maturites =< 3 years.

Ha

 

[kramer]

HaHa,

You will find some info in this post at raddr's board, including the charts from Larry Swedroe's bond book about what portion of your bonds should be TIPs and the rationale behind it:

http://www.raddr-pages.com/forums/viewtopic.php?t=3145

Also, more info here about how much bonds in general for a FIREee to own:

http://www.raddr-pages.com/forums/viewtopic.php?t=3133

Kramer

 

[wabmester]

My question is this- if posters have bonds with maturity => 10 years, what proportion are indexed, and what proportion are straight?

I don't try to maintain a specific allocation. I just try to buy and keep good deals, which basically means I haven't purchased a long-term bond in several years, except for some 2.5%+ TIPS from not-too-long-ago.

I have a nice batch of i-bonds from 2000-2001. Some high-yield munis from the same period. Some 8-9% junk that got upgraded to AA. Etc.

The only bonds I've purchased in the last year are ISM (11 year) and 6%+ CDs (3-7 year).

 

[brewer12345]

I don't generally buy low risk nominal stuff with a maturity longerthan a few years. The longer term stuff I have bought is A) indexed/floating, B) scratch & dent junk at a discount to par, or C) convertible.

 

[cute fuzzy bunny]

The only bonds I've purchased in the last year are ISM (11 year) and 6%+ CDs (3-7 year).

Me neither.

That tips theory is consistent with the one Ho-ho-suc and jwr were bandying about a few years ago.

Works great if your spending tracks the cpi-u and you die on schedule.

 

[MooreBonds]

I have a nice batch of i-bonds from 2000-2001. Some high-yield munis from the same period. Some 8-9% junk that got upgraded to AA. Etc.

Just out of curiosity, which company was upgraded from junk to AA? Corporate buyout?

I don't generally buy low risk nominal stuff with a maturity longerthan a few years. The longer term stuff I have bought is A) indexed/floating, B) scratch & dent junk at a discount to par, or C) convertible.

Hey Brewer - which scratch n' dents looked good to you? (I know they probably don't look as good now, but always interested in learning how people analyze individual corporate bonds). I took a chance two years ago and purchased Salton and Bally's corporate bonds. I used their book value as a guide, and reasoned that they had enough assets to pay back the bonds. Salton had to sell off one of their units, and did have some rumors that they wouldn't be able to pay off their bonds that matured in 2005 (which brought the bonds down to $.65 on the dollar for a while...before rising back up to close to par). The Bally's bonds mature Dec 07, so I'm still a little nervous about them, and will be thinking twice before buying individual corporate junk again...but am always open to ideas.

 

[wabmester]

Just out of curiosity, which company was upgraded from junk to AA? Corporate buyout?

Yup, HFC got acquired by HSBC and inherited their credit rating. I love when that happens. I don't watch the market closely enough to buy single-issue junk anymore, but at the time, the bad news was already out on HFC, so the downside looked limited from there.

 

[clifp]

Same here haven't bought a bond in while, I sold some Munis and have had a couple mature.

I am actually a little concerned because my biggest TIPs Bond 3.875% matures in Jan 09 and I am real hesitant to commit to a 2.5% real returns.

Recently I have been purchasing Master Limited Partnerships in things like pipelines (KMP, TPP) and propane distributors (APU, SPH). They have have high dividends ~7% and generally increase there distributions at a rate near inflation 4-5%. For the most part they are pretty stable income generators, and interest rate sensitive, but they are still stocks I am not sure from AA point of view how I should treat them.

 

[brewer12345]

Hey Brewer - which scratch n' dents looked good to you? (I know they probably don't look as good now, but always interested in learning how people analyze individual corporate bonds). I took a chance two years ago and purchased Salton and Bally's corporate bonds. I used their book value as a guide, and reasoned that they had enough assets to pay back the bonds. Salton had to sell off one of their units, and did have some rumors that they wouldn't be able to pay off their bonds that matured in 2005 (which brought the bonds down to $.65 on the dollar for a while...before rising back up to close to par). The Bally's bonds mature Dec 07, so I'm still a little nervous about them, and will be thinking twice before buying individual corporate junk again...but am always open to ideas.

I think you are rolling the dice on Bally's. Ignore book value. Look at EBITDA. Generally if all of the debt (including off balance sheet, pension obligations, etc.) is worth 5X EBITDA or less, it is probably covered. But junk is overpriced now, so wait until you hear about junk bonds getting whacked or defaults starting up again.

 

[Gone4Good]

My question is this- if posters have bonds with maturity => 10 years, what proportion are indexed, and what proportion are straight?

I'm pretty much targeting 50/50. The way I see it, you win with conventional bonds if actual inflation comes in lower than current market expectations and you win with TIPs if actual inflation comes in higher. In view of the fact that I haven't a clue what inflation will do over the next 20 years (let alone 20 months), it makes sense to me to have equal bets on each side.

Also, I'd wager the 70's-80's stagflation would have been a whole lot less stressing to the portfolio with a significant TIPS allocation.

 

[cute fuzzy bunny]

3 Yrs...thats pretty much the way i'm going except i'm using 5&7 year 6.25% cd's and brewers ISM as the hedge. If the economy tanks and interest rates get cut, i'm locked in with the cd's. If the economy takes off, and inflation pops, the ISM shows nicely.

If it all just sits in the middle I get grumpy that I didnt put it into dividend paying stocks

 

[yakers]

I think you are rolling the dice on Bally's.

Isn't that what you're supposed to do?

 

[laurence]

So am I shooting myself because I don't play bonds at all (except for Wellington)? Stocks make so much sense to me, but bonds make my head swim. And yes, I understand debt vs. equity investment theory, I just have no idea how to evaluate a bond, and I've heard bond funds aren't that attractive right now. Hey Brewer, want to start a bond fund I can invest in?

 

[Gone4Good]

So am I shooting myself because I don't play bonds at all (except for Wellington)? Stocks make so much sense to me, but bonds make my head swim. And yes, I understand debt vs. equity investment theory, I just have no idea how to evaluate a bond, and I've heard bond funds aren't that attractive right now. Hey Brewer, want to start a bond fund I can invest in?

It's an asset allocation question.

I think there is value in holding bonds or bond funds unless you have some other source of income (not including your primary residence ). FIRECalc shows marginally declining survivability for portfolios going from 80-100% equity concentrations. I'd wager the introduction of inflation indexed bonds widens that gap.

The beauty of asset allocation is that I don't have to know whether bonds are, or are not attractive right now - the market is pretty good at pricing securities. When I rebalance I get to buy the stuff that is cheap and sell the stuff that is dear.

Remember, a couple of months ago everyone was convinced that interest rates were heading down. Now folks think maybe they might need to go up. I don't know, nor do I care, much.

 

[wabmester]

So am I shooting myself because I don't play bonds at all

Well, we've already disproven that a house is like a bond, but a job is like a bond. Even better, it's an inflation-protected bond. So, take your salary and multiply by 20 or so, and you have your bond allocation.

 

[laurence]

Well, we've already disproven that a house is like a bond, but a job is like a bond. Even better, it's an inflation-protected bond. So, take your salary and multiply by 20 or so, and you have your bond allocation.

But a job isn't like a bond because I don't get a coupon or a fancy piece of paper and the correlation between wage/equities and bonds/equities isn't......just kidding.

So in other words I should get the heck out of Wellington!

 

[Gone4Good]

So in other words I should get the heck out of Wellington!

Why would you draw that conclusion?

 

[laurence]

It's 35% bonds, I have my bond allocation with my job, to maximize my return as an accumulator for the next 20 years I should go 100% equities with my portfolio!

(I'm not selling my Wellington).

 

[Nords]

So am I shooting myself because I don't play bonds at all (except for Wellington)? Stocks make so much sense to me, but bonds make my head swim. And yes, I understand debt vs. equity investment theory, I just have no idea how to evaluate a bond, and I've heard bond funds aren't that attractive right now.

Having a high-equity portfolio is a great excuse to remain blissfully ignorant about bonds. And you might be able to achieve lower volatility with other asset classes like commodities & REITs, skipping bonds altogether. There's just not enough history to tell with the same degree of confidence that the conventional wisdom places in bonds.

But I like Bernstein's analogy of the "thousand-year storm" killing bond returns.

It's 35% bonds, I have my bond allocation with my job, to maximize my return as an accumulator for the next 20 years I should go 100% equities with my portfolio!
(I'm not selling my Wellington).

OTOH, try explaining your reasoning for a high-equity portfolio to your spouse while she's figuring out the budget for kid #2. So maybe Wellington gives everyone plenty of sleep-at-night peace, preserves domestic harmony, and lets you feel more comfortable about that international microcap value fund you've had your eye on...

 

[laurence]

The funny thing is, while DW is in total control of day to day finances, she has 0 interest in the long term stuff. She trusts me completely to invest for our retirement.

The only place where we have to consult and confer is what % of our income goes into the retirement bucket vs. needed for day to day.

 

[cute fuzzy bunny]

Well, we've already disproven that a house is like a bond

What we didnt disprove is that the financial aspects of a property being exactly like a bond for financial planning purposes.

A hat also isnt a turnip. So what?

Even better, it's an inflation-protected bond.

Actually its a 'wage adjusted' bond, which is even BETTER!