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Optimizing a Fixed Income Ladder
Old 11-19-2023, 11:52 AM   #1
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Optimizing a Fixed Income Ladder

Iím continuing to plan a five year fixed income ladder. My goal would be equal weighted rungs, with a consistent credit quality mix of:

Treasury/CD: 40%
Corporate: 50%
High Yield: 10%

Iím intending to use Blackrockís iBonds as a way to get guaranteed YTM and diversification.

On inspection, the yield difference betwee CDs and iBonds corporate ETF in some places are a bit odd. For example:

Schwab is quoting a 5.6% YTM five-year brokered CD from First State Bank of Ohio. IBDT, the corporate ibond for 2028, is also YTM of 5.6%.

Similarly, the five year 40/50/10 iBond portfolio has a weighted YTM of 5.45%.
Thatís about what I would get from just building a 5 year CD ladder with zero credit risk.

So, a few questionsÖ

1 - Is there any reason I wouldnít just grab the 5.6% CD for the Year 5 rung rather than putting the money into the corporate ETF? The CD has zero credit risk while the corporate entails some level of default risk (small but non-zero nonetheless).

2 - Am I missing anything from a portfolio theory/structure or return perspective by not just putting all the money into laddered CDs and foregoing the complexity/risk if the aggregate YTM (5.45%) is the same?

3 - When new money becomes available (either new contribution or legs maturing), wouldnít it always make sense to do the same analysis above?

This is my first foray into building a fixed income structure, so apologies if any of the above is trivial.
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Old 11-19-2023, 12:14 PM   #2
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A few comments. The five year CD seems high, are you sure it’s not callable?
The five year corporate seems low. You should be able to get investment grade corporate rates in the mid 6% - 7%+ range. 10% in high yield? What does that mean to you?
What goal are you trying to achieve with the ladder?
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Old 11-19-2023, 03:45 PM   #3
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A few comments. The five year CD seems high, are you sure itís not callable?
The five year corporate seems low. You should be able to get investment grade corporate rates in the mid 6% - 7%+ range. 10% in high yield? What does that mean to you?
What goal are you trying to achieve with the ladder?
Last question first: My goal is to build a well diversified, laddered fixed income structure that provides certainty of returns. I also want to add a bit of risk to get higher returns. Over the next 12 years the total amount invested in fixed income will work its way up until it represents 40% of my total investments. For the next 12 years all of these funds will be re-invested. I anticipate being able to hold most of these funds in tax efficient accounts though by the out-years I may need to hold some of the fixed income in a traditional brokerage and will look at Muni's at that point.

Great catch ... The five year CD is callable. Non-callable is more like 4.8%.

The five year corporate ETF is across 584 holdings, so well diversified.

The 10% in HY is just about reaching for a bit of return. The High yield components in years 2-5 range from 7.9% YTM to 8.9% YTM. As a percent of my overall portfolio (incl my other assets classes) it is a small allocation.

thx
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Old 11-19-2023, 04:15 PM   #4
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A few more comments. If income is NOT the goal of the ladder, but rather predictable total return, you may want to consider buying below par bonds. The yield is a bit higher, but coupons lower.
For a 12 year goal, I would personally add duration and take advantage of some of the high yields available today.
My question regarding high yield is what is the actual investment in your portfolio? I use a CEF yielding almost 13%. It’s only 4% of the portfolio, but provides 15% of my cashflow. So high yield can be defined in a few ways.
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Old 11-19-2023, 06:46 PM   #5
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Thanks.

The below par idea is interesting. Would need to figure out how to ensure its sufficiently diversified.

Will also look at the upside of adding some duration.

The investment I'm considering for the HY component are the annual tranches of Blackrocks HY ibonds ETFs: IBHD, IBHE, IBHF, IBHG, IBHH.
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Old 11-19-2023, 06:54 PM   #6
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Diversification within bonds isn’t nearly as big of a deal as people make it out to be. Defaults within investment grade bonds are astronomically low and unlike equities, they return to par, their original value, upon maturity.
Laddering ETFs is a bit odd and something I don’t practice. Too many things outside of your control.
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Old 11-22-2023, 12:45 PM   #7
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Diversification within bonds isnít nearly as big of a deal as people make it out to be. Defaults within investment grade bonds are astronomically low and unlike equities, they return to par, their original value, upon maturity.
Laddering ETFs is a bit odd and something I donít practice. Too many things outside of your control.
Thanks.

The laddering only makes sense with these sorts of ETFs that only purchase bonds of a given maturity and then fully distribute/disband the ETF when that year distributes.

Your point on diversification is interesting. I'm curious, roughly how many positions do you hold?
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Old 11-22-2023, 02:20 PM   #8
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Quote:
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... Your point on diversification is interesting. I'm curious, roughly how many positions do you hold?
Not COcheesehead, but corporates are about 25% of my total portfolio. 14 positions. Most are A or better by S&P and Moody's... one BBB+ position is as low as I go. All financial or utilities.

While I have some outsize positions I recently decided to limit any single corporate issuer to 1.25% of my total portfolio to mitigate credit risk which will increase my corporates to 20 or so positions.

No need to fret about diversification for FDIC insured or UST or agency issues IMO. I am also getting back into high quality preferreds and limiting each position to 0.625% of the total.

ETA: 56 positions in total.
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Old 11-22-2023, 02:33 PM   #9
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Thanks.

The laddering only makes sense with these sorts of ETFs that only purchase bonds of a given maturity and then fully distribute/disband the ETF when that year distributes.

Your point on diversification is interesting. I'm curious, roughly how many positions do you hold?
I had 200 bonds not too long ago, but have that now is down to 146. I could easily whittle that down to less than 100. I have several million dollars in the ladder. The largest position is less than 3%.

The number was driven more by my desire to reinvest maturing funds right away. So I had positions of $5000/$10,000 which is really unnecessary and doesn’t provide any real value. I now try and make positions much larger in size.

Fidelity will warn of concentrated positions and not just regarding a single issue. At one time I had a bunch in Colorado healthcare related munis and they noted that to me. It was a good heads up.
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Old 11-23-2023, 09:08 AM   #10
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Thank you both. Very helpful.

I would need to start taking much larger positions to keep the total positions manageable.

A while back I started buying individual CD/Muni bonds with "new" money ... which meant very small purchases. Which I then diversified into smaller purchases.

LOL.

My Schwab account is now a sea of $3k - $25k positions. I've seen the error of my ways. I need to simplify this.

That's why I'm leaning to the Blackrock iBonds ETFs. But perhaps I could just take larger, individual positions.
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Old 11-24-2023, 07:07 AM   #11
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Personally, would never buy a bond fund unless it was a defined-maturity fund. Learned that the hard way through BND at Vanguard and a few others that were promised to be "great for retirees!" I've gotten out of as much of that as I can, even at a loss. Fund managers have to keep buying bonds in the bond funds, even if they are crap low returns.

YMMV
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Old 11-24-2023, 08:27 AM   #12
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Originally Posted by COcheesehead View Post
I had 200 bonds not too long ago, but have that now is down to 146. I could easily whittle that down to less than 100. I have several million dollars in the ladder. The largest position is less than 3%.

The number was driven more by my desire to reinvest maturing funds right away. So I had positions of $5000/$10,000 which is really unnecessary and doesn’t provide any real value. I now try and make positions much larger in size.

Fidelity will warn of concentrated positions and not just regarding a single issue. At one time I had a bunch in Colorado healthcare related munis and they noted that to me. It was a good heads up.
Hi just curious how large your typical bond positions will be in the future. I have larger positions around 100k (approx 10 percent of portfolio) but thinking that may be to high/risky?
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Old 11-24-2023, 08:34 AM   #13
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Hi just curious how large your typical bond positions will be in the future. I have larger positions around 100k (approx 10 percent of portfolio) but thinking that may be to high/risky?
I don’t want anymore $5000-$10,000 positions. I would would like to target $50,000 - $100,000. My largest right now is 2%-3% and I have two like that.
If your large positions are AA or AAA you have nothing to worry about. If they are BBB- or lower, that’s another story.
Keep in mind though that larger positions may have to be sold off in smaller lots if you want to liquidate prior to maturity.
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Old 11-24-2023, 08:45 AM   #14
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Do MYGAs count on a Fixed income latter? If so, I just applied for a 7 year at 5.55% with an A++ company.

I already have a 5 year.
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Old 11-24-2023, 09:42 AM   #15
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We're considering how to manage our rolling bond ladder to get compounding benefits and income. I buy 4%+ coupon bonds, and CDs where a portion of the interest dropped into the settlement will get reinvested for compounding and a portion for income. Our ladder is in a tIRA so we can figure out without tax concerns how to get the best returns. A no-brainer if it's in the Roth. We have some CDs in the taxable, but only a small portion. Most of our taxable are stock funds.

CDs and treasuries are simple interest so to get compounding benefits, they have to be managed following predictions about future interest rates. We're DIY so I'm paying attention to inflation and what the Fed will do (in theory).
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Old 11-24-2023, 10:11 AM   #16
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I donít want anymore $5000-$10,000 positions. I would would like to target $50,000 - $100,000. My largest right now is 2%-3% and I have two like that.
If your large positions are AA or AAA you have nothing to worry about. If they are BBB- or lower, thatís another story.
Keep in mind though that larger positions may have to be sold off in smaller lots if you want to liquidate prior to maturity.
Got it Thanks!
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Old 11-24-2023, 11:12 AM   #17
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Do MYGAs count on a Fixed income latter? If so, I just applied for a 7 year at 5.55% with an A++ company.

I already have a 5 year.
They count in my fixed income ladder along with CDs, treasuries, and bonds. I was planning to buy another MYGA 5yrs at 5.95% from an A rated insurer but at the last minute I bought an annuity provider’s A rated bond 10yrs >6% because buying a MYGA takes weeks and It’s another account to hassle with.
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