Bonds & Fixed Income Allocation, comments pls

[jj]

All this talk about bond funds has set me to thinking about our allocations in this area.  We are age 51/47 + 3 teens, newly ER and still worrying watching everything like a hawk to see how things go in these next few crucial years.  Our current allocation is as follows:

Cash                            1.1% (all except checking a/c at Emigrant Direct @ 4.5%)
cds                             12.5% (yielding ave. 4.55%, maturities out to 7 yrs)
i bonds                        2.6%  (thinking we'll cash these for education expenses)

VMLUX TE Ltd term muni     9.7%
VILQX TE Ins LT muni          6.3%
VWALX High Yield TE muni   6.3%

VWETX LT Inv Grade          4% (IRA)
VBILX Int Term Ind             6.1%(IRA)
-----------------------------------------
                             Total    48.6%

This is a percentage in fixed income that we are comfortable with.  As you see we are trying to hedge our bets as much as possible between taxable and tax exempt, bond funds and cds, and a few i bonds thrown in for good measure.  The average yield on the cds at 4.55% is not too good as we could have cash with Emigrant Direct at 4.5%, but we've had 4 to 4.5% for some time now on our longer term cds.  The cd ladder smoothes things out.  Soon our lowest yielding cds (2.75%) will mature and we shall see 7 yrs of 6% from our Pen Fed cds.  I am struggling with putting any more in our Vanguard bond funds as I see the NAV go down almost every day. 

Comments guys?

PS forgot to say, we also have an additional 4% in a Dutch pension fund which we understand is very conservative and can be considered equivalent to bonds in Euros, can't do anything with this for another 14 years. 

By the way - I LOVE this board - who is that bozo who wants "better quality" posts?  If he wants serious tell him to go to the Diehards.  (That's also a good board IMO, just with a completely different character from this one.)

 

[brewer12345]

Um, you are retired now and presumably are in a low tax bracket, right? If so, there is just about no earthly reason for you to have munis of any description. I would swap them for some medium term bond fund/Lehman agg exposure.

I also would probably toss the LT bonds in favor of medium term/lehman agg exposure. LT bonds offer a lot more volatility for a little more return, which is not what I would call a great trade-off.

 

[jj]

Thanks for replying Brewer, I appreciate it.

Um, you are retired now and presumably are in a low tax bracket, right?

No not in a low tax bracket yet, part of the ER package was being able to retain share options, some of which do not lapse until 2011 (some deeply under water  .)  We are exercising the options quarterly for cashflow and income and guess we will be in the 28% (maybe 25%) tax bracket for 2006 (providing the company stock doesn't tank!)  That is the hedging between taxable and tax exempt fixed income investments I am talking about.  Am I right in thinking that at a marginal tax rate of 25% or above the tax exempt bonds are worth it?

I also would probably toss the LT bonds in favor of medium term/lehman agg exposure. LT bonds offer a lot more volatility for a little more return, which is not what I would call a great trade-off.

You would get rid of all the long term bonds in both IRA and taxable a/cs.  Would Total Bond Mkt Idx be a sensible replacement for the LT in IRA?  The IRA is our longest term money and we do not anticipate touching it for 19 years.  And Intermediate term muni instead of LT for the taxable?

I don't fully understand why many experts don't like LT bond funds as they seem to perform better over 5 or 10 years when you look at the Vanguard data.  Does the extra volatility really matter that much?

Thanks   

 

 

[brewer12345]

At the 25% bracket, munis are not a good deal.  At 28% they are kind of a toss-up with taxables.  Sometimes you come out ahead in th 25/28 brackets if you are in a high tax state.  So for you, munis vs. taxables is probably a wash.  When you are done cashing in options, make sure you revisit the subject and plan to swap to taxable.

I think a lot of people are down on LT bonds because they are high duration and therefore interest rate-driven volatility.  Unfortunately, since life insurers, pension funds, etc. need this kind of duration to match their liabilities, they pay up for it.  The net result is that you have lots more volatility than medium term bonds and you don't generally get paid enough to make the extra volatility worth it.

If you look at 10 and 5 year trailing numbers, things look pretty good because of the falling rate environment.  As rates have been trending back up, it hasn't looked so great.

I suggest that you use VBMFX for intermediate bond exposure. This fund tracks the Lehman Agg and includes treasuries, corporates and mortgage backed paper. It has higher credit quality and somewhat lower duration (interest rate sensitivity) than VGs "intermediate bond fund".

modified to mention the total bond fund vs. intermediate