Fixed Income Investing II

[target2019]

It is an investment that produces income and returns to a predetermined fixed amount at maturity.

That is so simple. Thank you for answering.

 

[Chuckanut]

So it’s all about matching ones personal needs and goals to their own appropriate investing style.

Very true.

We have all heard the saying that the three most most importance factors in the real estate market are location, location and location.

IMO, the three most important factors for most investors are diversification, diversification and diversification. As I age I realize I don’t have much time on my side in case I bet the farm and lose. So, I diversify. I’ll never make the cover of FIRE’d magazine’s 100 Most Successful Amateur Investors. But, I can’t eat magazine covers anyway.

 

[Quattro73]

They still are issuing noncallable 5 year CDs. They just arent at the yield people had a shot at a few months back. Discover Bank and United Fidelity Bank presently have 5 year noncallables for sale with coupon yields of 4.45% and 4.5%.

Hopefully those non-callable rates will rise soon.

 

[Echard]

+1

This is my main objection to the proliferation of posts praising market timing over the last 15 months.

Lots of smiles are gonna turn to frowns in the next couple years.

Yes true, but an inverted yield curve and high uncertainty about whether inflation is under control, does give a bit of pause on filling out the far end of the ladder, unless its with TIPS. A duration bond of 10 years likely has a maturity date of much longer than 10, and if rates do spike it would be pretty painful, until or unless they settle back down over the coming several years.

 

[COcheesehead]

Yes true, but an inverted yield curve and high uncertainty about whether inflation is under control, does give a bit of pause on filling out the far end of the ladder, unless its with TIPS. A duration bond of 10 years likely has a maturity date of much longer than 10, and if rates do spike it would be pretty painful, until or unless they settle back down over the coming several years.

Painful in what way? Mark to market price? It’s meaningless if you hold to maturity. So if income is your desire, it’s mine, make sure you are buying good coupons because if your 6% $100 bond goes to $50 for awhile before returning to par, you still get paid that nice 6% coupon. You should also have your rungs maturing to take advantage of higher yields - if they even happen.

 

[dobig]

With my ladders, I balance trying to get the best yield with having reliable income - the whole purpose of my ladder. I may give up a little in yield by going longer or with non call or longer call window bonds, but in return I get income I know is going to be there. So reinvestment risk, while there with any maturing bond, does not hurt me as much. I am almost equally balanced between short, intermediate and long bonds with a few percentage point leaning to short. All investment grade. The ladder throws off almost 145% of our spending needs. Equities remain untouched and may stay that way forever.

COcheesehead, any chance of getting your equities asset allocation? If it's complicated or you do not wish to share no problem. I just like your thought process on the fixed income side and imagine it would likely be similar on the equities side. Something I'm struggling with currently (thinking 60% SPY/SCHD and 40% Wellington and Wellesley for simplicity).

 

[Montecfo]

Good call- maybe. I am going out 5 years when I can 4.5 - 4.84 CD's. I know I can get 5% or better for a 2 year. but don't want a bunch if money coming due as rates drop. All my CD's are paying at least a1 point higher then the one maturing. Which is equal to 20-30% more return. I am OK with 4.5% I am combining maturing CD's as they come due.

Unfortunately we may have seen the highs in the 5y+ at least for this cycle. But maybe we get another mini-banking crisis and some cds pop up.

 

[Montecfo]

Mulligan,

You made some interesting comments some time ago about utility debt. Don't let me misquote you but it was something to the effect that you find lower rated utility debt interesting because defaults are so rare with utilities? Because they are essential infrastructure and regulated perhaps?

 

[Mulligan]

Mulligan,



You made some interesting comments some time ago about utility debt. Don't let me misquote you but it was something to the effect that you find lower rated utility debt interesting because defaults are so rare with utilities? Because they are essential infrastructure and regulated perhaps?

Yes, largely regulated subsidiary debt from the actual operating utility not the holding company. But the brass tacks is this. When someone is buying A debt they are basically either saying they want to greatly minimize owning debt from a company that could go bankrupt, or if it does they want a piece of the recovery if it does. You can get subordinated BBB type debt from A debt rated companies via lower cap stack. You get the higher yield and still get the A rated quality from risk of bankruptcy. What you give up is any claims to any assets if there was a bankruptcy because by the time any assets are doled out, its long gone typically before the subordinate debt is next up.
Its a personal risk level though. And just because a company is not investment grade does not mean it will go bankrupt. Subordinate debt NSS for MLP NuStar was issued in 2013 with a lowly B rating and hasnt missed a payment since issuance. I keep abreast of it though and certainly dont treat it like a CD that is certain.

 

[Echard]

Painful in what way? Mark to market price? It’s meaningless if you hold to maturity. So if income is your desire, it’s mine, make sure you are buying good coupons because if your 6% $100 bond goes to $50 for awhile before returning to par, you still get paid that nice 6% coupon. You should also have your rungs maturing to take advantage of higher yields - if they even happen.

I ran some numbers, and I think you're right that the odds of a problem are pretty unlikely.

The price up's and down's until maturity obviously don't matter. I'm thinking of the remote possibility where it becomes really difficult to get inflation under control over the coming years. Yearly spending has to go way up because of inflation, but those funds in long term bonds are locked in at way below market interest rates, leading to much lower coverage of expenses.

I ran scenarios yesterday with different inflation rates, spending coverage rates, and return rates, and unless inflation really spirals out of control in the next few years, the odds of this scenario happening are pretty low. And of course having a bond ladder limits the damage to a few years.

 

[COcheesehead]

COcheesehead, any chance of getting your equities asset allocation? If it's complicated or you do not wish to share no problem. I just like your thought process on the fixed income side and imagine it would likely be similar on the equities side. Something I'm struggling with currently (thinking 60% SPY/SCHD and 40% Wellington and Wellesley for simplicity).

I am overweight in small/micro caps which has been a good performer for me. The rest is evenly divided in mid and large cap with only 4% in international. I add occasionally, haven’t sold anything in a long time. I look at equities as 10+++ year money.

 

[COcheesehead]

I ran some numbers, and I think you're right that the odds of a problem are pretty unlikely.

The price up's and down's until maturity obviously don't matter. I'm thinking of the remote possibility where it becomes really difficult to get inflation under control over the coming years. Yearly spending has to go way up because of inflation, but those funds in long term bonds are locked in at way below market interest rates, leading to much lower coverage of expenses.

I ran scenarios yesterday with different inflation rates, spending coverage rates, and return rates, and unless inflation really spirals out of control in the next few years, the odds of this scenario happening are pretty low. And of course having a bond ladder limits the damage to a few years.

I’ve said this before. Don’t buy bonds for inflation protection. Buy for current income and capital preservation. I have other things that would benefit if inflation goes nuts, but right now the ladders overfund our retirement.
Reliable income is a priority for us. We have no pension, no social security and have no plans to start it for years yet.

 

[Echard]

I’ve said this before. Don’t buy bonds for inflation protection. Buy for current income and capital preservation. I have other things that would benefit if inflation goes nuts, but right now the ladders overfund our retirement.
Reliable income is a priority for us. We have no pension, no social security and have no plans to start it for years yet.

I hear you. We have the same exact situation, and I've built an income stream that more than covers our expenses right now, by about 50%. What I'm trying to figure out is how to make sure the portfolio survives 30-35 years, and it seems like the only real exposure is high inflation.

For example, under a 5% inflation rate, a 40-50% income cushion might get eaten away by year 8-10, unless reinvestment rates on the bonds increases due to the inflation. Maybe/probably the rates would increase and there's no issue.

But for the sake of argument, let's just say inflation continues to run hot and rates don't increase in the coming years. That scenario is possible because of extreme government deficits. In that scenario, something in the portfolio via total returns and distributions needs to cover the gap, as you correctly point out. And, it needs to be a big enough percentage of the portfolio to actually address the gap effectively, because the bonds are 50% or more of the total portfolio.

Real estate, stocks, or alternative investments probably will likely do well enough under inflation to provide cover. Is that your thought? I'm surprised there are so many proponents of TIPS, because the low comparative returns of TIPS vs other investment classes makes me question their value.

For kicks, I ran am extreme 35 year scenario with 5% inflation where I assumed alternative, real estate, and stocks only returned whatever their distribution rate was (<2%). Obviously, that's an extreme scenario that's very unlikely. I started with a 40% cushion on expenses vs income. Just doing straight math, that portfolio survives ten years before you have to start selling stocks or other investments to cover the shortfall of spending vs. income. So, effectively it delays SoRR for 10 years. Great. At that point, you have to start selling stocks or other investments to cover ever increasing gaps. You make it to 35 years, but there is SoRR risk due to the investment selling. Now, obviously, it is much more likely that stocks, real estate, alt investments are returning way more than 2%, so the SoRR risk would be minimal at that point.

 

[COcheesehead]

I hear you. We have the same exact situation, and I've built an income stream that more than covers our expenses right now, by about 50%. What I'm trying to figure out is how to make sure the portfolio survives 30-35 years, and it seems like the only real exposure is high inflation.

For example, under a 5% inflation rate, a 40-50% income cushion might get eaten away by year 8-10, unless reinvestment rates on the bonds increases due to the inflation. Maybe/probably the rates would increase and there's no issue.

But for the sake of argument, let's just say inflation continues to run hot and rates don't increase in the coming years. That scenario is possible because of extreme government deficits. In that scenario, something in the portfolio via total returns and distributions needs to cover the gap, as you correctly point out. And, it needs to be a big enough percentage of the portfolio .

I have equites and besides our house, real estate in the form of land. The land is in a really nice spot with mountain views and all utilities. That and I have a secret weapon - I can start COLA adjusted social security in a few years if I really want to/need to. Though the plan is to wait until 70. I built my ladder under that premise.
We also assume we’ll liquidate the house and move into some sort of senior living at some point. So though I don’t include our residence in our investment portfolio, the value of it is in our life plans.

 

[Echard]

I keep looking at municipals, both taxable and non taxable, and they never have a bid price, only ask. How in the world do you figure out what to bid? I like seeing bid prices as a check that the bond isn't a total turd.

 

[MichaelB]

A reminder. Off topic posts have been removed. Let’s please stay on topic.

Moderator note: The topic of this thread is fixed income investing, not complaining about other threads. Please stay on topic.

 

[COcheesehead]

I keep looking at municipals, both taxable and non taxable, and they never have a bid price, only ask. How in the world do you figure out what to bid? I like seeing bid prices as a check that the bond isn't a total turd.

Price isn’t the only determiner. Existing bids in many cases are low ball offers hoping the seller will bite. Fidelity provides third party pricing, you can read the latest ratings report and see the ratings. Trading in tax free munis is, was and likely always will be thin. Taxable munis on the short end almost always have a bid.
How do you figure out what to bid? Look at other bonds of similar duration. The buy yield needs to be relatively similar if you have any chance of getting it.

 

[jazz4cash]

Price isn’t the only determiner. Existing bids in many cases are low ball offers hoping the seller will bite. Fidelity provides third party pricing, you can read the latest ratings report and see the ratings. Trading in tax free munis is, was and likely always will be thin. Taxable munis on the short end almost always have a bid.

How do you figure out what to bid? Look at other bonds of similar duration. The buy yield needs to be relatively similar if you have any chance of getting it.

+1. I always bid under the ask. I look at transaction history to bid between last transaction and the ask. I’ve had pretty good luck getting in below the ask .

 

[Mulligan]

I keep looking at municipals, both taxable and non taxable, and they never have a bid price, only ask. How in the world do you figure out what to bid? I like seeing bid prices as a check that the bond isn't a total turd.

Some brokerages only offer take it or leave it pricing. TD in all its “generosity” allows you to “bid” 0.0125 if memory serves below ask. And if you need to sell you will be totally at the mercy of what they will offer. So for corporate and more illiquid bonds I view the purchase as a marriage with no option for an amicable divorce. And they can be total bond thieves too so be careful on pricing. And my brokerages love to try to annoy me with their perceived “price value” of some of my bonds. One for example they value it at $910 all while trying to sell the bond over $100 at ask. They will love you to panic sell and pocket the easy money 10% spread difference.

 

[imbatman]

I have recently moved a few accounts from Merrill to Fido for this exact problem. At ML, you have no depth of book insight at all, you are given a single buy/sell price take it or leave it (no bidding either).

 

[gayl]

Did I make a mistake?? I did my 1st 'ladder' with 16% of portfolio last week with 5 rungs going out 18 months. All steps are 5.35% ex 3 month at 5.3% & 18 months at 5.5%. Today they'd all be fractionally higher .... 5.35-5.6% and 2 at the higher rate. Should I have just done another 30 day instead?
My idea is to move each into 2, 3, 4 yr ones when they come due. But I might be too late .... it might come too far down.

Please be gentle. I'm only used to equities. I thought CDs were just for saving and bonds scare me.

 

[COcheesehead]

Did I make a mistake?? I did my 1st 'ladder' with 16% of portfolio last week with 5 rungs going out 18 months. All steps are 5.35% ex 3 month at 5.3% & 18 months at 5.5%. Today they'd all be fractionally higher .... 5.35-5.6% and 2 at the higher rate. Should I have just done another 30 day instead? View attachment 46474View attachment 46475
My idea is to move each into 2, 3, 4 yr ones when they come due. But I might be too late .... it might come too far down.

Please be gentle. I'm only used to equities. I thought CDs were just for saving and bonds scare me.

Rates change all the time. That’s why you ladder. You always have fresh funds to take advantage of rising rates. If rates drop, you have some invested at the higher rate as well.
My ladder goes out 9+ years. I don’t worry about yield, I am more concerned about total cashflow.

 

[gayl]

Rates change all the time. That’s why you ladder. You always have fresh funds to take advantage of rising rates. If rates drop, you have some invested at the higher rate as well.
My ladder goes out 9+ years. I don’t worry about yield, I am more concerned about total cashflow.

Got it.

 

[Montecfo]

I think you are fine. But what are you laddering to? Not sure why you did not ladder out to 4 years if that is the objective.

Sometimes you can "time" bond markets but this is not one of them in my opinion. Plus as Cocheesehead points out, laddering is a way to be rate agnostic and not be making rate "bets".

So ladder or speculate is what I say. My ladder goes out 8 years.

 

[beachfire]

I have found building out my ladder kind of fun and easy over the last 8 months. I now have about 50% of our portfolio in a ladder that extends out about 10 years…. 5 year average duration, yielding a bit over 5.25%. Good quality investment grade corporates.

My question is to those that have laddered for a while. Let’s say in 2-3 years the 10 year treasury is down under 2% and investment grade corp bonds with 8-10 year maturity are yielding just under 3%. Are you flat out mechanical in managing your ladder and buying 10 year bonds at those low yields or do you find yourself shortening your ladder duration and buying bonds with much shorter maturities?