Bond diversification?

[steelyman]

Last year, I started to move some money around in my tax-deferred employer plan in order to be a little more diversified within the bond portion. Previously, I only held a total US bond index and a high-yield fund. I moved money to include TIPS and international bonds, so I suppose I now have 4 different types of bonds represented. Am I missing something obvious (other types of bonds?). I will admit I am mystified by bonds in general.

 

[Animorph]

Emerging markets bonds are a new darling. Floating rate bonds are also being mentioned for inflation protection. EM at least might be worth considering.

 

[eytonxav]

Emerging markets bonds are a new darling. Floating rate bonds are also being mentioned for inflation protection. EM at least might be worth considering.

I would at least suggest checking to see whether your international fund holds any EM% and keep that in mind if you decide to add an EM bond fund.

 

[LOL!]

Many folks would say that bonds are for stability when it hits the fan. They should be steady eddy things. Thus, those folks would recommend that you only need US Treasuries. Anything else is basically taking on risk that you should take with your equities. You can do only one more thing: Control the duration. So you can have short-term bonds and intermediate-term bonds.

What that means from a practical sense is that one does not need high-yield bonds at all. One can get the same risk/return characteristics of high-yield bonds by buying US Treasuries and an equity fund. So if you have 10% in high-yield bonds, is that not the same as have 5% in US Treasuries and 5% in the S&P500?

The same goes for international bonds.

TIPS are nice, but not at current real yields. You might as well go to shorter duration bonds which already have inflation-changes priced into them. Longer term, a retiree might want TIPS, but they are not safe if you have to cash them in before maturity. If real yields go above 2.5% and 3% like they did in late 2008, then TIPS are a buy.

Some folks would avoid even total bond index because it has some mortgage-backed securities in it and intermediate-term corporate bonds.

So I use a total bond funds and short-term bonds funds. I don't need to get more exotic than that. I take my risk on the equity side.

 

[steelyman]

Thanks for your comments and input, I will definitely be looking at my bond situation with these in mind. e-r.org and its members are a fantastic resource.

I haven't added any new money to bonds since '08 and don't intend to for the foreseeable future - yep, the market tumble "rebalanced" me that much!

 

[veremchuka]

IMO short term and intermediate term treasuries are adequate. According to Larry Swederoe you don't need to diversify fixed income like equities so corporate don't need to be added to that mix. TIPS are also worth holding but not now, maybe in a few years. Other than that I don't see what else you'd need for fixed income.

As it has been said, bonds are for stability, take risk with equities and don't hold high yield bonds. I am keeping a good chunk of my 401k for the Stable Value yield and view it as a ST bond fund but not as safe as a ST treasury fund.

 

[Gearhead Jim]

I would disagree about needing only treasuries in the bond portfolio. The current financial problems in our government may produce gyrations we can't predict, I prefer a mix of treasuries and VG Intermediate Term Investment Grade.

 

[veremchuka]

I would disagree about needing only treasuries in the bond portfolio. The current financial problems in our government may produce gyrations we can't predict, I prefer a mix of treasuries and VG Intermediate Term Investment Grade.

Yeah I think I failed to say what I meant! Larry Swedroe says that it is not necessary to diversify your bond fund holding like you would equity holdings. For example, all intermediate term corporate bond funds would basically have the same results so having more than 1 wouldn't really be necessary but it would be ok to hold large, midcap and smallcap funds.

Treasuries have less correlation with equities than corporate bond funds and are safer, treasuries don't default whereas corporate bonds within a fund could, so that's why Larry says to stay with treasuries.

 

[In-control]

Just like stocks diversification is important. I split my bond portfolio between Total Bond Index, TIPS, High Yld Corp bond funds.

 

[DblDoc]

Just like stocks diversification is important. I split my bond portfolio between Total Bond Index, TIPS, High Yld Corp bond funds.

Those are like owning stocks - which you already have. They don't diversify your bonds except in a bad way.

DD

 

[eytonxav]

Those are like owning stocks - which you already have. They don't diversify your bonds except in a bad way.

DD

In general I would agree with respect to HY, but in a raising rate enviroment they probably will fair better than treasuries. That said, you need to watch them closely cause if the economy tanks they could be in trouble.

 

[kumquat]

Don't forget that bonds denominated in a currency other than the one you intend to spend in retirement subject you to forex risk.

 

[chinaco]

Bonds... duration (sensitivity to rate changes/inflation), credit quality (risk of default and or lowered rating could reduce current valuation), Maturity (your liquidity... risk of selling below par), and reinvestment risk.

Today, Treasuries are considered extremely high quality and diversification for credit quality is often ignored. We will see if that remains. While the govt may not default, a drop in rating could affect the valuation of current bonds (because if interest rates go up to offset the risk... the valuation of existing bonds could go down).

Some believe international exposure is needed.

Plenty of risks that make some form of diversification prudent.

I tend to use bond index funds.

 

[nun]

I agree that bonds should be a stable foundation and basic income producers.
Most people will be fine with a Total Bond Market fund, but you may want overweight TIPS or investment grade corporate bonds depending on your inclination. I would never buy a high yield bond as it has the same risk as an equity fund. Also for tax planning purposes some rich people might want to own tax free municipal bonds.

In my case I'm thinking of retiring in Europe so I need to protect myself against the falling dollar. For that I'll use European, UK and International index equity funds and I'm looking at UK Gilt funds too.

 

[slingshot]

Would you use a short term bond fund as an alternative to a money market fund?

 

[brewer12345]

Would you use a short term bond fund as an alternative to a money market fund?

That might be OK if you are comfy with a smidge more volatility than you would get with a MMF. The other issue is that if you plan on using a ST bond fund as a transactional account, you might have a painful time computing cap gains/losses at the end of the year since every deposit is a buy and every withdrawal is a sale.

 

[slingshot]

That is probably a good point. I'll know when I figure out what it means. lol

 

[brewer12345]

It means that if you use a ST bond fund as a savings account with only occasional deposits or withdrawals (like under 10 a year), its probably OK. If you use it as a checking account with 10 transactions a month, tax time will be a nightmare.

 

[BabyD]

We have 10% of our portfolio in Vanguard Inflation-Protected Securities Fund. The YTD return is 4.4%. The yield is -.19%. This was the % a financial advisor set up 2 years ago. Is this too much to have in TIPS and what is a negative yield?

 

[brewer12345]

We have 10% of our portfolio in Vanguard Inflation-Protected Securities Fund. The YTD return is 4.4%. The yield is -.19%. This was the % a financial advisor set up 2 years ago. Is this too much to have in TIPS and what is a negative yield?

Shorter maturity TIPS currently have a negative real yield, which means you are lending money to the feddle gubmint for less than the amount of inflation. As a result, I do not own any TIPS. But if you are looking for absolute safety and inflation protection, I suppose this might be an OK choice. But do your own research and come to your own conclusions. My risk tolerance and goals are undoubtedly different from yours.

 

[Gone4Good]

Is this too much to have in TIPS and what is a negative yield?

In the case of TIPS, it means your yield is negative after inflation is subtracted. Most funds quote their yields in 'nominal' terms (which is the actual dollars you get paid). The TIPS funds quotes its yield as a 'real' yield, which is the amount you get after inflation is subtracted. So you can't compare the TIPS yield directly to the yields on normal bonds. To compare them you have to make an assumption about what inflation is going to be, and either add that inflation rate to the TIPS fund or subtract it from one that quotes its yield in 'nominal' terms.

It's probably helpful to consider that most other short to intermediate funds also have negative yields after inflation is subtracted. Here is a partial list of vanguard funds with negative real yields (based on LTM CPI)

Prime Money Market
Short-Term Federal
Short-Term Bond Index
Short-Term Investment Grade
Inflation Protected Securities
Intermediate-Term Bond Index
Intermediate-Term Treasury
Total Bond Market Index

 

[BabyD]

Why own a bond fund with a negative real yield? We have VG Short-term Investment Grade bond fund and VG Total Bond market index, in addition to the TIPS fund.

Also, since the return on CD's is so low, is there a similar vehicle that is a good way to set up a "ladder"?

 

[DblDoc]

Why own a bond fund with a negative real yield? We have VG Short-term Investment Grade bond fund and VG Total Bond market index, in addition to the TIPS fund.

Also, since the return on CD's is so low, is there a similar vehicle that is a good way to set up a "ladder"?

Because in the current climate you would have to increase the risk you are willing to take for higher yields. TIPS diversify your bond portfolio as they hedge against unexpected inflation Treasury Inflation Protected Securities - Bogleheads which nominal bonds do not.

DD

 

[BayBum]

The times when US treasuries are "safe" and international bonds are "risky" are long gone. Look at how much has been lost in the the value of the dollar holdings. Looking at sovereign balance sheets there are countries that are arguably safer than US. My strategy is to team up with the smartest bond guys and let them direct my international exposure.

 

[ERD50]

I would never buy a high yield bond as it has the same risk as an equity fund.

Actually, the High Yield bond funds from Fidelity and Vanguard have about half the volatility of the S&P.

Volatility and risk are not really the same thing, but they are typically used interchangeably in discussions like this. Volatility is a calculation, risk is a kinda squishy thing that would probably mean different things to different people and situations.

-ERD50