Rebalancing into VG Fixed Income

[nun]

As of October 2009, I had almost no money in CDs and all my fixed income investments consisted of bond funds. Since then, I have loaded up significantly on CDs. My current CD portfolio will pay 4.62% interest for at least the next 7 years. But it is becoming harder to find good rates on CDs.

Currently I am adding money to equities but, on the fixed income side, I am building up my cash position so that I can take advantage of the swoon in munis and/or promotional CD offers at PenFed.

You must have got some of those good FCU rates, are they jumbo?

 

[Chester_A._Riley]

Is the caution to have money to be spent within five years in cash, CDs, etc still valid?

 

[LOL!]

Is the caution to have money to be spent within five years in cash, CDs, etc still valid?

I personally do not believe that it was ever valid. That's just too long a time to be in cash.

I think it depends on what you are going to use the money for and what the consequences are if things do not go well.

If you need to pay a tax bill in April, then cash is a good place since the consequences are not pleasant. But if you need a down payment for a house in 5 years, that's a pretty flexible number and time, so a short-term bond fund or even some equities is OK. The consequences of not meeting a goal are benign: Wait to buy a house or buy a smaller house. Plus you can get less risky when the goal is closer and you have a clearer time point or value point.

 

[FIREd]

You must have got some of those good FCU rates, are they jumbo?

Yes I was able to catch some good rates (some were promotional) while they lasted. No jumbos.

 

[chinaco]

Many are asking the same question... what to do?

Don't forget the old adage... "Don't Fight the Fed"... even though the sayingis most commonly associated with the stock market.

Till the Fed is done manipulating rates on fixed securities...This is it. They want you to take more risk.

I shortened durations on bond funds we control (except those in balanced mutual funds). We are holding a stable value fund, short-term bond fund, a little in TIPs (just in case inflation kicks up)... and probably too much in MM.... we are about half MM and half (stable value fund, short-term bond fund, a little in TIPs).


When rates increase (timing being the variable)... there is no question about what happens to the pricing of bonds.

I have been thinking about investing some taxable fixed money in munis. I am watching to see if they continue to drop in price and get overdone.

 

[nun]

I shortened durations on bond funds we control (except those in balanced mutual funds). We are holding a stable value fund, short-term bond fund, a little in TIPs (just in case inflation kicks up)... and probably too much in MM.... we are about half MM and half (stable value fund, short-term bond fund, a little in TIPs).

My bonds are intermediate term (5 year duration), but I did get out of Gov debt and into more corporate debt, I'm not touching Munis with a barge pole

 

[nun]

I personally do not believe that it was ever valid. That's just too long a time to be in cash.

I can see holding 5 years of expenses in CDs/cash in retirement as a buffer against market down turns.

 

[Gone4Good]

TBM has similar yield to a 5 year CD but has consistently produced returns over 5%, so for money I don't need for 5 years I'd go with TBM.

I wouldn't count on 5% returns going forward. With a starting yield of 2.7% and a duration of 5 it may be mathematically impossible to generate 5% average annual returns over the next five years.

 

[Lsbcal]

I wouldn't count on 5% returns going forward. With a starting yield of 2.7% and a duration of 5 it may be mathematically impossible to generate 5% average annual returns over the next five years.

One should remember that real return is what counts, not nominal. Should inflation kick up you might want some protection -- short term bonds, TIPS, etc.

 

[wolf]

FD (NUN):

Sounds like I did what you did. Locked in some 4% 7yr CD's last year.

Also, managed to get the "Reservation" 5 % 10 yr CD's. January 2011.

Penfed C.U. at times has great rates. Usually in Janury.

Really tough now, all CD rates seem to be extremely low.

I agree with " OP ", and am going thru the same thought process, when my other CD's mature this year.

Unless you want to take on a greater risk, (equites), you have to settle for lower interest rate returns. (CD's).

 

[veremchuka]

i don't have a crystal ball but here's what i would like to do, we'll see how this pans out!

i have 75% of my total fixed income portfolio in the gnma fund at vanguard. i have kept about 40% of the total portfolio in my 401k mainly as i was younger than 59 1/2 when i retired and figured i could take distributions if i needed to vs the roll over ira and it's penalty prior to 59 1/2. i would like to exchange the gmna fund into intermediate term treasury fund but i don't want the nav loss in the itt if i did it now so i could put the entire 401k into the stable value fund, last year the return was 3.45%. this would have me at the present 65/35 allocation and i would not suffer any nav loss. after say 2 years i'd hope interest rate would have risen enough to make the itt fund a better buy re the nav and then i'd roll the 401k to vanguard and reallocate to 50/50 or 40/60 and put that into itt and maybe tips if the yield is better than today.

we'll see...

 

[LOL!]

I can see holding 5 years of expenses in CDs/cash in retirement as a buffer against market down turns.

I don't see how that helps. It may be mentally comforting, but it really doesn't help your portfolio out any differently than having 5 years of expenses in short-term bonds.

As an example, suppose your expenses require a 4% withdrawal from your portfolio. 5 years of expenses would then be 20% of your portfolio. If short-term bonds dropped by 10%, then that 20% in short-term bonds would drop your portfolio by 2%. If you had cash, you would not have that 2% extra drop in your portfolio. If your portfolio is set up such that an extra 2% drop in your portfolio is gonna make or break you, then something else is wrong.

In the meantime, did those short-term bonds create more income than cash to overcome any drop? I think the answer is yes. These can't be junk bonds though. They have to be investment-grade short-term bonds and Treasuries.

Cash is a drag on your portfolio.

 

[Gone4Good]

One should remember that real return is what counts, not nominal. Should inflation kick up you might want some protection -- short term bonds, TIPS, etc.

The nice thing about the CDs I own is that it only cost 2 months interest to get out of them. So while I'm taking treasury credit risk and enjoying significantly better than treasury (and 5-yr TIPS) returns, if interest rates go up, I can reset to higher market rates at an insignificant cost.

 

[nun]

I don't see how that helps. It may be mentally comforting, but it really doesn't help your portfolio out any differently than having 5 years of expenses in short-term bonds.

As an example, suppose your expenses require a 4% withdrawal from your portfolio. 5 years of expenses would then be 20% of your portfolio. If short-term bonds dropped by 10%, then that 20% in short-term bonds would drop your portfolio by 2%. If you had cash, you would not have that 2% extra drop in your portfolio. If your portfolio is set up such that an extra 2% drop in your portfolio is gonna make or break you, then something else is wrong.

In the meantime, did those short-term bonds create more income than cash to overcome any drop? I think the answer is yes. These can't be junk bonds though. They have to be investment-grade short-term bonds and Treasuries.

Cash is a drag on your portfolio.

I agree that 20% would be too much in cash, but I'm frugal and have rental income so 5 years of expenses is closer to 10% of my investments. The CDs would be held in taxable accounts and their main purpose would be to buffer against interest rate rises, market down turns, and provide spending money.

With this buffer I'd just have the rest of my fixed income in TBM, maybe some intermediate term corporate and TIPS all in tax deferred accounts.

 

[Gone4Good]

In the meantime, did those short-term bonds create more income than cash to overcome any drop? I think the answer is yes.

Not at the moment. Money held at Capital One Direct yields ~1.35%, versus 1.08% for the Vanguard ST Bond Index.

Times have changed. Safe pays more than risky in today's fixed income environment. I never owned a CD in my life until a year or two ago. But when banks are paying more on FDIC insured deposits than I can get in the market taking credit and duration risk, why would I ever take those risks to earn lower returns?

 

[brewer12345]

The nice thing about the CDs I own is that it only cost 2 months interest to get out of them. So while I'm taking treasury credit risk and enjoying significantly better than treasury (and 5-yr TIPS) returns, if interest rates go up, I can reset to higher market rates at an insignificant cost.

I assume that Ally includes the weaselly words about being able to forestall/deny early withdrawals at its discretion? If so, how do you evaluate the risk of the enforcing this? I have to assume that they have a mountain of hot money that thinks as we do.

 

[Gone4Good]

I assume that Ally includes the weaselly words about being able to forestall/deny early withdrawals at its discretion? If so, how do you evaluate the risk of the enforcing this? I have to assume that they have a mountain of hot money that thinks as we do.

That is indeed a risk with CDs, that the bank will change the rules mid-game. But the downside risk is small versus having a similar amount in a bond fund. I'm stuck earning 3-4% in my CDs for a couple of years as rates go up, while the Bond Index loses 5% for every 100bp increase in rates. I can live with that trade.

I can replicate the credit and market risk of the CD by buying a 5-yr treasury and holding it to maturity. Currently treasuries pay 50bp less than an Ally CD. So I'm getting 50bp for liquidity risk, which is a big spread in today's market. I'm also getting a low cost interest rate put which, as you point out, I may or may not be able to exercise. But the value of that put isn't negative, and from today's perspective, it isn't zero either. So in exchange for illiquidity, I'm getting 50bp per year and an interest rate put option with some positive value. I suspect that put option has negative convexity, so I wouldn't plan on waiting until the Fed Funds rate hits 5% before trying to exercise it. I might pull the trigger as soon as cash gets competitive, which should put me at the front of the line, but I'll evaluate that when the time comes.

** Just looked, and when I bought my CDs the spread was more like 150bp to treasuries, so the deal has gotten worse. Still good, but not as much of a home run as it used to be.

 

[Gearhead Jim]

Please, start another thread for the CD discussions. I'm already at my personal limit for them, just looking at different Vanguard FI choices.

Well, I'll admit to one other possibility:
We bought a new Toyota Camry for DW this last Spring. Normally, I would pay cash; but Toyota was offering 5 yrs/1.9%financing and we took that. With just over 4 years to go, I wonder if my FI will earn much more than that, just paying off the loan might be an option. My guess is that for the next year or two, it'll be almost a wash. For the final 2-3 years of the loan, FI will probably be significantly above the 1.9%
Aren't you impressed with my ability to forecast interest rates?