Intermediate Bond Fund Allocation

[WilliamG]

Would like some feedback on how folks are allocating the fixed income portion of their portfolios, particularly intemediate term. We currently are 50/50 equity and non-equity. Within non-equity we are targeting 20% as reserve (stable value, short term bonds) and 30% for intermediate bond
fund(s). Currently leaning toward the following for intermediates:

8% Vanguard High Yield Corp
10% Vanguard TIPS
12% Vanguard GNMA

Comments? thanks, bill

 

[brewer12345]

Is there some reason you wouldn't just put the allocation in the VG total bond market index fund? You'd get treasury, high grade corporate, and MBS (GNMA, etc.) exposure all in one. I'm not convinced junk is a good idea at the moment.

 

[audreyh1]

I agree. Just use a total bond market or total return type bond fund.

Audrey

 

[LOL!]

Maybe you don't want long and intermediate term bonds at all. The 3 year annualized return of the Vanguard Total Bond Market Index Adm is about 2.5%. It is under 1% for the last year and under 0% for YTD.

We are 20% fixed income with about 9% in cash paying above 4% and 11% in a TIAA guaranteed fund that was part of a 403(b) from 20 years ago that is paying between 5% and 7%.

Many years ago I owned Vanguard bond funds. I was at the mercy of other shareholders ... when they redeemed the fund managers had to sell bonds to pay out the redemptions. I saw that if I owned the bonds themselves, I could hold to maturity or until they were called and avoid some of the interest-rate risk.

My MIL used to own some closed-end Nuveen bond funds. So there is a lot more out there than just the Vanguard offerings.

 

[brewer12345]

Maybe you don't want long and intermediate term bonds at all.  The 3 year annualized return of the Vanguard Total Bond Market Index Adm is about 2.5%.  It is under 1% for the last year and under 0% for YTD.

We are 20% fixed income with about 9% in cash paying above 4% and 11% in a TIAA guaranteed fund that was part of a 403(b) from 20 years ago that is paying between 5% and 7%.

Many years ago I owned Vanguard bond funds.  I was at the mercy of other shareholders ... when they redeemed the fund managers had to sell bonds to pay out the redemptions.  I saw that if I owned the bonds themselves, I could hold to maturity or until they were called and avoid some of the interest-rate risk.

My MIL used to own some closed-end Nuveen bond funds.  So there is a lot more out there than just the Vanguard offerings.

Holy crap, do you need to do some reading! You are worried about interest rate risk, yet you are suggesting high expense, leveraged closed end bond funds? :boggle:

Bond funds are about total return, not just yield. Rates have been rising in the last couple of years, so bond funds have lagged. But between 2000 and 2003, rates were falling and most diversified medium term bond funds did considerably better (think double digit returns) than their yield. So if you are buying bond funds as a component of a carefully allocated portfolio, don't lose sight of the forest for the trees. The bond fund is there to diversify you whikle providing positive returns that are not highly correlated with equity returns.

Oh, and just because you hold the bonds to maturity doesn't mean you avoid interest rate risk. You just have an easier time fooling yourself.

 

[mathjak107]

"Bond funds are about total return, not just yield. Rates have been rising in the last couple of years, so bond funds have lagged. But between 2000 and 2003, rates were falling and most diversified medium term bond funds did considerably better (think double digit returns) than their yield. So if you are buying bond funds as a component of a carefully allocated portfolio, don't lose sight of the forest for the trees. The bond fund is there to diversify you whikle providing positive returns that are not highly correlated with equity returns." quote

actually the belief that bond funds have a low correclation to stocks is not very true it seems..except for recessions of which they are few and very far between whats good for bonds is even better for stocks...the interest rate drop from 1980 until well into the 2,000's had coincided with the greatest bull market and it didnt diverge until the great fall of 2,000......going year by year since the 60's shows stocks and bonds moving in the same direction 70% of the time.......of course the good thing about bonds is they aint stocks.as such we can fine tune the risk in our portfolio's as bonds may go up less than stocks but they fall less too...even a money market would work well but at least bonds can give you a little kicker if rates come down,but what they do for a portfolio has nothing to do with their correlation its more their lack of volitilaty that adds stability

 

[brewer12345]

actually the belief that bond funds have a low correclation to stocks is not very true it seems..except for recessions of which they are few and very far between whats good for bonds is even better for stocks...the interest rate drop from 1980 until well into the 2,000's had coincided with the greatest bull market and it didnt diverge until the great fall of 2,000......going year by year since the 60's shows stocks and bonds moving in the same direction 70% of the time.......of course the good thing about bonds is they aint stocks.as such we can fine tune the risk in our portfolio's as bonds may go up less than stocks but they fall less too...even a money market would work well but at least bonds can give you a little kicker if rates come down,but what they do for a portfolio has nothing to do with their correlation its more their lack of volitilaty that adds stability

Pay attention: I didn't say bonds had "low" correlation with equities. I said they were not highly correlated with equities. Big difference.

 

[samclem]

Brewer,

Can you school me up here? If I hold the bonds to maturity, how am I subject to interest rate risk? While I agree that rates might go up and I wouldn't benefit from it, I also wouldn't get burned either way. I'd get exactly what I expected when I bought the bond--right?

samclem

 

[brewer12345]

Brewer,

Can you school me up here? If I hold the bonds to maturity, how am I subject to interest rate risk?  While I agree that rates might go up and I wouldn't benefit from it, I also wouldn't get burned either way.  I'd get exactly what I expected when I bought the bond--right?

samclem 

If you hold bonds to maturity, you are subject to interest rate risk unless we are talking about a floater or extremely short term instrument (in which casre IR risk is still there but it is de minimus). How about an example:

Let's say you lost your mind, put your underpants on your head, and bought a 10 year treasury back when they paid 3.5%. I hate to tell you this, but that bond is worth considerably less than par (which is what you paid). Since there is no credit risk (by definition), where did the loss come from? Rates rose and the value of the bond dropped = interest rate risk. It doesn't matter whether you sell the bond now or not. You still have losses due to interest rate movement.

Now you may say, well, I plan to hold the bond to maturity so I don't really have a loss, right? Not true; a loss is a loss whether realized or not. If you own a stock that goes down, did you not lose money regardless of whether you sell it? Same thing with a bond, bond fund, house, car, Venezuelan beaver cheese futures, etc.

If you don't want a lot of interest rate risk, stick to shorter matury bonds or funds, or stick with floaters. Simple as that.

 

[TromboneAl]

loss is a loss whether realized or not

OK, now I'm confused here.

I hold a bond to maturity. When I'm done, whether interest rates went up (had a non-realized loss), went down (had a non-realized gain), or stayed the same, I look in my pocket and see the same amount of dough.

 

[brewer12345]

OK, now I'm confused here. 

I hold a bond to maturity.  When I'm done, whether interest rates went up (had a non-realized loss), went down (had a non-realized gain), or stayed the same, I look in my pocket and see the same amount of dough. 

Sure. But the difference is that you either collected a lot of extra yield along the way( had an unrealized gain), or you collected a lot less than market yield along the way (had an unrealized loss). If we make a simplifying assumption that real yileds on average don't change over your holding period, the difference is not in the nominal amount of cash you have at maturity, but in what that cash is worth after adjusting for inflation. A spike in bond yields after you bought the bond generally means that inflation went up more than expected, so your future cash is worth less in real terms.

I'll repeat it again: just because you are a hold-till-maturity bond investor, you still can't safely ignore total return. Just focusing on yield leads to poor decisions and lower returns.

 

[Nords]

a hold-till-maturity bond investor

That sounds more like buying a CD.

 

[TromboneAl]

OK, that's what I expected you to say originally.

You had a loss because of the lost opportunity to benefit from the higher yield that everyone else was getting.

 

[brewer12345]

OK, that's what I expected you to say originally.

You had a loss because of the lost opportunity to benefit from the higher yield that everyone else was getting.

Pretty much. The higher yield is usually driven by increased inflation expectations in the marketplace or by increased demands for real yield (which can be hard to distinguish).

 

[WilliamG]

Thanks for the comments.  I am attracted to minor league slice and dice in intermediates rather than the Total Bond Market Fund for much the same reasons i have a coffee house like portfolio in stocks.  Also, the total bond market does NOT have high yield or TIPS if you feel one or both are attractive to a bond portfolio.  I actually have these funds now, so it isn't a question of timing but general asset allocation.
ps - most of my 20% short term is in 5 year cd ladder   

 

[samclem]

That sounds more like buying a CD.

Right. I wish there was was more competition in the market of inflation linked CDs--I'd be interested if they had a real return close to the TIPS rate.

Brewer,
I understand your explanation, I've just got a different mindset on "gain and loss." I don't feel like I've lost anything unless I actually sell the item at a lower price than I paid (a "realized" loss). Sure, if asked to give a snapshot of my net worth when my stocks are down or my bonds are sub-par, I guess I'd have to say I had "lost money, but that's not how the IRS views it (and for once I agree with them). Since, at maturity I'll get exactly what paid for the bonds and also have received all the interest, I would have trouble saying that this was a loss. If so, then 99% of other investments also had a "loss" since the owner could conceivably have invested in something more profitable ("who knew Styrofoam Lawn Ornaments, Inc stock would go through the roof!")

samclem

 

[brewer12345]

Sam, its not that you could have had more that is necesssarily the issue. Its more that the market value of the bond is below par, just like a stock that has slumped.

 

[azanon]

Pay attention: I didn't say bonds had "low" correlation with equities.  I said they were not highly correlated with equities.  Big difference.

Using the word "low" or "high" when describing coorelation is just asking to be misunderstood.   Correlation between two variables is either positive, negative, or the variables are mutually exclusive of each other.  When you say "not highly correlated", i would guess that you mean a slightly positive coorelation (say 0.2), but that's only a guess since its a poor descriptor of correlation.    If someone described a correlation as being "low"... i'd also guess a slightly positive coorelation (~ 0.2).    So, actually no difference between those two.   

But then again, who knows what one means by saying either "low" or "not highly correlated" since both are poor descriptors of correlation.   Try slightly positive, strongly positive, slightly negative, strongly negative, or if you want to eliminate all confusion, give us the number (between -1.0 and 1.0)

 

[mathjak107]

Brewer,

Can you school me up here? If I hold the bonds to maturity, how am I subject to interest rate risk?  While I agree that rates might go up and I wouldn't benefit from it, I also wouldn't get burned either way.  I'd get exactly what I expected when I bought the bond--right?

samclem 

thinking in the financial market is if your not making the money you are loosing the money...getting 4% on a bond is a bad investment if bonds today or even money markets are paying 8%....you could have gotten 8% doing nothing and since you didnt because you own the 4% bond you are considered behind.........

 

[veritasophia]

But then again, who knows what one means by saying either "low" or "not highly correlated" since both are poor descriptors of correlation. Try slightly positive, strongly positive, slightly negative, strongly negative, or if you want to eliminate all confusion, give us the number (between -1.0 and 1.0)

According to charts in "The Intelligent Asset Allocator" by Bernstein, here are some correlations of bonds/bills to S&P 500 (1973-98):
L/T bonds .57
Int'l bonds .06
T-bill -.09
1 yr corp bd -.04

Obiously the lower the correlation the better the diversification. Just because most bonds don't have a negative correlation to stocks (very few investment vehicles do) doesn't make them unvaluable for asset allocation purposes (just voicing my opinion, I'm not saying that this is what anybody implied; I've just read articles that make this claim).

 

[brewer12345]

According to charts in "The Intelligent Asset Allocator" by Bernstein, here are some correlations of bonds/bills to S&P 500 (1973-98):
L/T bonds       .57
Int'l bonds      .06
T-bill            -.09
1 yr corp bd   -.04

Obiously the lower the correlation the better the diversification.  Just because most bonds don't have a negative correlation to stocks  (very few investment vehicles do) doesn't make them unvaluable for asset allocation purposes (just voicing my opinion, I'm not saying that this is what anybody implied; I've just read articles that make this claim).

Moreover, the correlations change over time, so it is hard to say with certainty exactly what the correlation is. But it seems pretty clear that bonds are not highly correlated with stocks, so they provide some diversification benefit.

 

[mathjak107]

INTERESTING VIEW....they go upto 2000...after the lows of the early 2,000's stocks and bonds once again followed each other as rates dropped and stocks rose until the feds recent tightning
http://nbr.infometrics.co.nz/bonds-in-growth-portfolios--no-diversification-value_442.html

 

[ats5g]

INTERESTING VIEW....they go upto 2000...after the lows of the early 2,000's stocks and bonds once again followed each other as rates dropped and stocks rose until the feds recent tightning
http://nbr.infometrics.co.nz/bonds-in-growth-portfolios--no-diversification-value_442.html

Interesting article. I wonder were he got the data. Using Ibbotson's data for Tbills, LT Treasuries, and LT Corps, I get correlations of -0.0097 [tbill], 0.3036 [LT Treasuries], and 0.4019 [LT Corps]for correlations with the CRSP 1-10 for 1990-1999.

Also interesting is that the correlations turned around after 1999, to be -0.1953 [Tbills], -0.2614 [LT Treasuries], and -0.0845 [LT Corps] for the 5 years 2000-2004.

His return data must be off, b/c the CRSP 1-10 returned 8.27% in the 1960's and 6.19% in the 1970's. Also, stocks and bonds returned similarly in the 1970's [b/w 6-7%], and stock beat bonds in the 1980's.

Data issues aside, LT bonds definitely had a higher correlations with stocks in the 1990's than in the following 5 years. I think the conclusion should be something along the lines of "we can never know in advance whether or not stocks and bonds will be + or - correlated."

Finally if bond and stock returns are positively correlated, or at least not ever significantly negatively correlated, why would you invest in an asset class that affords lower long term returns?

A couple of reasons:

1. I may care about "risk adjusted" returns. If so, then the portfolio with the highest risk-adjusted return [like sharpe ratio] may be a combo of stocks and bonds, not one or the other.

2. If I hold a bond [or bond fund] for it's duration, I know what my return will be. If I use TIPS, I know what my real return will be in advance.

3. A portolio of stocks and bonds may provide a higher withdrawal rate than stocks alone. [see Jaye Jarrett's The Fixed Income Portion of a Retirement Withdrawal Strategy - I couldn't find his website anymore ]

- Alec

 

[mathjak107]

Quote
Finally if bond and stock returns are positively correlated, or at least not ever significantly negatively correlated, why would you invest in an asset class that affords lower long term returns?

answere is because we are all a little chicken at heart as we get older and don't want the volatility to be as great...as i said before dosnt matter if bonds are + or - correlated ,point is they dont fall as much as stocks do...even a money market would work

 

[LOL!]

...
Let's say you lost your mind, put your underpants on your head, and bought a 10 year treasury back when they paid 3.5%. 

... a loss is a loss whether realized or not. 

I think if you extend that logic to absurdity then every investment we make is a loser because there was always something out there that we could have invested in and made more money.