Recent retirement-US Treas. Bond fund to decrease portfolio risk?

[Zona]

Sorry if this is a question that has been asked before. I’ve searched the forum for “treasury default”, “IEF”, and “bond fund default” but I didn’t see any recent discussion that would answer my question.

I no longer work and DH has just finally retired this year at age 50 (so I think now I can officially call us “retired”!) During our accumulation phase, we have been pretty much 95/0/5 mostly S&P etfs (SPY)/bonds/cash. We had already decided to add a bond or “safe” component and are working our way through reading the ERN Safe Withdrawal series to learn more about it. But because we’ve never owned bonds or bond funds we wanted to understand more about how to hold them, do we want to do a glide path, hold individual bonds, or hold a bond fund like IEF, etc. For our age, risk profile, planned withdrawal rate (3.25%), and long time horizon we were thinking to start moving to a 75/20/5 asset allocation. We were considering IEF (iShares 7-10 year treasuries etf) for the 20% simply because it seemed easier for us to manage and understand. We have not yet pulled the trigger and still need to sell SPY shares in order to at least move out of 95% equities. We would be making any changes in DH’s IRA, so there wouldn’t be any tax consequences to start.

My questions are:
1. I just got caught up on the news that secretary Yellen is warning about the possible default. Not trying to discuss politics, just trying to understand if bond funds would behave the same as individual bonds in such a scenario. I understand that individual bond values go down if there’s a default, would this be the same for the value of a bond fund? Would it be prudent to just sell the 20% and move it to cash for now?

2. We know we probably should have thought about this and made the financial moves before DH retired, but hindsight is 20/20. Really all we are looking to do is find a low-risk vehicle to keep a “safe” portion of our assets to hedge against sequence of returns risk. Would a cd ladder be a better tool for now, and is that something that we would want to hold in an IRA?

I have learned so much from all of you since I joined this forum, so thanks in advance — all thoughts and opinions would be much appreciated!

 

[Koolau]

In my case, I know little about individual bonds, so I own most of my bonds in a mutual fund (happens to be at Vanguard, but Fidelity and others receive decent marks here.) I don't generally like managed funds, preferring index funds. The exceptions are Wellesley (60/40 IIRC) and Wellington (40/60 IIRC) at Vanguard. These more or less do the rebalancing of equities and bonds for you. They have tended toward very good track records over the years as well. I've owned both and am satisfied with them.

Right now seems a bad time to hold cash or start a CD ladder. Inflation has picked up and cash and "cash-like" investments may be hurt.

Some folks are into I-bonds (but lots of issues - check recent threads) and TIPS (same deal - check around). Both are "designed" to deal with inflation.

Yeah, I agree that you are too aggressive - even at your young ages. BUT YMMV.

 

[Zona]

Thanks for the reply, Koolau. Yes, ideally we would have been buying 20k/yr in I-bonds for the past decade or so, or buying into TIPS. But we kicked the can down the road every year because we didn’t understand bonds, but we could kind of wrap our heads around how our index etfs worked, so we just kept letting it build in SPY. Now we are looking to move 20% of our holdings into something less volatile. I’ll look into the vanguard Well* funds you recommended (I know many forum members hold them, and like them) but I had hoped to simplify future rebalancing by just holding shares of the “bond” asset class individually. Again, thanks for giving me something to think about with those funds.

Edit: the facepalm emoji I used did not convert correctly

 

[VanWinkle]

Hi Zona!! i think you are on the right path to de-risk your portfolio at this time. I keep my bond portion in my IRA in a total bond index fund from Vanguard(Fidelity and Schwab have similar funds) It is over 50% in government bonds and also has some investment grade corporates. This keeps it simple for me as I am only looking for ballast in bad equity times. Don't reach for return with bonds as safety is the most important thing with this asset.

Just my 2 cents worth.

VW

 

[big-papa]

At the end of the day, bond funds hold bonds. Just like you can. The main difference is that bond funds are buying/selling bonds all the time before they mature. Oftentimes, when an individual purchases individual bonds, they're holding them to maturity and they will know from day 1 exactly what the income stream looks like. If one doesn't hold them to maturity, then they're subject to the same market forces that bond funds have if one sells before maturity.

I hold an intermediate treasury bond (FUAMX), I-bonds and a duration matched TIPs ladder formed by holding 2 TIPs funds in differing proportions. FUAMX and my TIPs funds are held in my IRA.

On the inflation side, if I had to do it over again, I would have started earlier and would only hold I-bonds. The main downsides to them vs TIPs that affect me are the limited amount that can be purchased per year. I like the fact that taxes are deferred until maturity/redemption. Plenty of websites out there that explain the pro/cons of each of them, but I do like the fact that the Ibond rate can't go negative, which TIPs certainly can (and are at the present time). For me they will be used as part of an inflation adjusted income stream when I turn 70. Because of purchase and redemption restrictions, they're not really well suited for rebalancing in and out of like bond funds are.

Your mileage certainly will vary...

Cheers

 

[Dtail]

Hi Zona!! i think you are on the right path to de-risk your portfolio at this time. I keep my bond portion in my IRA in a total bond index fund from Vanguard(Fidelity and Schwab have similar funds) It is over 50% in government bonds and also has some investment grade corporates. This keeps it simple for me as I am only looking for ballast in bad equity times. Don't reach for return with bonds as safety is the most important thing with this asset.

Just my 2 cents worth.

VW

+1 conceptually.

 

[pb4uski]

+1 if you desire simple "ballast".

There are three main things to consider with bonds... yield, credit risk and interest rate risk.

These days, yields are low, credit risk is uncertain and interest rate risk is high. I'll take BND etf as an example. The yield is pretty good... 1.4% portfolio yield less .035% ER is a net yield of 1.365%... and and SEC 30-day yield of 1.31%... but is also less than the Fed's 2% inflation target not to speak of the current rate of inflation.

Credit risk is pretty good with all bonds held by the fund investment grade or better and 65% full faith and credit "risk-free" US government bonds. I'm not worried that of a US government default though there will be political jousting before the debt limit is increased.

Interest rate risk for BDN is pretty high, with a duration of 6.8 years. What this means is that if interest rates increase 1%... so the yield increases from 1.365% to 2.365% that the bonds in the fund would decline in value by 6.8% and it would take 6.8 years for the fund to recover that value. On the flip side, at least in theory, if interest rates are being increased that means that the Fed believes that the economy is doing well and that bodes well for your 75% in equities.

I'm not picking on BND... the same risks and rewards would apply to any broad based bond fund.

Another thought.... what is your withdrawal ratio ("WR")? What is it after any pensions and SS start? There is an argument to be made that if your WR is low... meaning that your retirement is very well funded... that you don't really need bond as ballast at all. For example, a 3.75% WR has a 96.7% success rate for a 30 year time horizon with 100% equities but if the WR is 4.0% then the success rate drops to 93.4%... but if you have a 4% WR and a traditional 60/40 portfolio then it increases the success rate to 95.9%.

Another possible strategy is to put together a CD or bond ladder. Below is a 8-year ladder of Bulletshare Target Maturity Corporate Bond ETFs (portfolios of corporate bonds that all mature in a specific year). The yield-to worst is 1.31% with a 4.71 year duration and 97.5% of the portfolio is investment grade. That is a credible alternative to BND... similar yield, a little more credit risk but much lower interest rate risk.

https://www.invesco.com/bond-ladder/

 

[mrfeh]

I have learned so much from all of you since I joined this forum, so thanks in advance — all thoughts and opinions would be much appreciated!

You will be holding this fund for decades. Stop worrying about what will happen the next few weeks; it is not relevant.

I suggest you use a total bond fund, like VBTLX or FXNAX.

https://www.bogleheads.org/wiki/Bogleheads®_investing_start-up_kit

 

[Koolau]

Thanks for the reply, Koolau. Yes, ideally we would have been buying 20k/yr in I-bonds for the past decade or so, or buying into TIPS. But we kicked the can down the road every year because we didn’t understand bonds, but we could kind of wrap our heads around how our index etfs worked, so we just kept letting it build in SPY. Now we are looking to move 20% of our holdings into something less volatile. I’ll look into the vanguard Well* funds you recommended (I know many forum members hold them, and like them) but I had hoped to simplify future rebalancing by just holding shares of the “bond” asset class individually. Again, thanks for giving me something to think about with those funds.

Edit: the facepalm emoji I used did not convert correctly

Heh, heh, one minor correction: I never "recommend" anything since I'm not a professional. I own or have owned both Vang. Well*s. I like what they did for my portfolio. YMMV

 

[Zona]

Don't reach for return with bonds as safety is the most important thing with this asset.

Yes, VW thanks for saying this so succinctly -- we need to keep in mind that we are doing this to decrease volatility in that portion of our portfolio, not chase return.

On the inflation side, if I had to do it over again, I would have started earlier and would only hold I-bonds. ... Because of purchase and redemption restrictions, they're not really well suited for rebalancing in and out of like bond funds are.

Yes, "past Zona" could have done "current Zona" a big favor by starting earlier and buying the limit on iBonds for the past decade! Thanks for the very good layman's explanation of the difference between bonds and bond funds. I did look briefly into iShares iBond ETFs. What I liked was that I could build my own iBond "ladder" with differing maturities, but then again they are fairly new (this year will be the first year one of the funds "matures" - IBTA) and also they are still bond funds not individual bonds so I wasn't sure that a "fund ladder" would work the same as a ladder built with individual bonds.

 

[Zona]

Another thought.... what is your withdrawal ratio ("WR")? What is it after any pensions and SS start?

Thank you pb4uski for your thoughtful analysis and explanation of yield, credit risk, interest rate risk. Our target WR is 3.25%. This is actually more than we have ever spent in a year and our 15 years of tracking our spending includes spending on health ins & healthcare, as well as periodic big ticket/cars. That 3.25 includes a conservative projection of being in the 24% tax bracket because we will want to do Roth conversions in some years. This WR may go down a bit once SS kicks in, but that won't be for 15-20 years. We have no pensions.

Thanks everyone for giving me lots to think about, and also confirming that we are doing the right thing in de-risking some of our holdings. Since our main reason for doing this is "ballast", this morning we went ahead and started decreasing our equity exposure in DH's IRA (so far sold about 10% of our total SPY holdings). It felt good to finally lower some of our risk...we'll be buying into an intermediate treasury bond fund and will consider also putting some into a total bond fund. We'll probably hold them for decades (as mrfeh noted), but will have the flexibility/liquidity to rebalance as needed. Thanks again all!

 

[big-papa]

Yes, VW thanks for saying this so succinctly -- we need to keep in mind that we are doing this to decrease volatility in that portion of our portfolio, not chase return.



Yes, "past Zona" could have done "current Zona" a big favor by starting earlier and buying the limit on iBonds for the past decade! Thanks for the very good layman's explanation of the difference between bonds and bond funds. I did look briefly into iShares iBond ETFs. What I liked was that I could build my own iBond "ladder" with differing maturities, but then again they are fairly new (this year will be the first year one of the funds "matures" - IBTA) and also they are still bond funds not individual bonds so I wasn't sure that a "fund ladder" would work the same as a ladder built with individual bonds.

Someone will point this out eventually. But what we commonly call IBonds are actually Series I savings bonds. Ishares for whatever reason chose to call their fixed term ETFs iBonds. I'm sure nobody ever got confused by that. [emoji16]

Cheers

 

[Montecfo]

I use a range of different debt types for my bond allocation. I would tend to not purchase a fund or index mirroring the Agg (often marketed as total market funds) in this environment (due to 6.5 duration). In this market with the Fed preparing to raise rates by end of next year, I would favor shorter duration funds or even MM funds at 1 percent until the Fed begins raising.

Also, I tend to favor corporates since we are in a rapidly growing economy.

Once we get into a more normal environment I would look at intermediate corporates and possibly treasuries.

If you have time to accumulate some ibonds, that does not seem crazy here in my view.

 

[OldShooter]

Boring I know, but I'll again point out that volatility is not risk. Risk is Theranos, GE, Sears Holdings, Worldcom, etc. where the value of the investment can and has gone to zero (or close) and stayed there. Every market dip in history has been followed by a recovery. That is a very different thing than a real loss.

Where volatility meets risk is SORR. I would use the word "insurance" or the word "protection" for segregating the funds necessary to protect against this risk. To me "ballast" has the connotation that one is strictly trying to reduce volatility. That can certainly be done, but at a significant (IMO) cost in portfolio yield.

@Zona, I think you can start to answer your own question by understanding the concept of "buckets." That can be a useful way of viewing a portfolio, just as AA is useful. Search will provide you many threads with debates on this, many arguing that buckets and AA are an either/or. For me, they are both useful viewpoints on our portfolio. There are also plenty of internet articles on buckets.

 

[Koolau]

Someone will point this out eventually. But what we commonly call IBonds are actually Series I savings bonds. Ishares for whatever reason chose to call their fixed term ETFs iBonds. I'm sure nobody ever got confused by that. [emoji16]

Cheers

I'm glad you cleared that up for me. I guess I knew that (our) I-bonds are actually Series I savings bonds, but did not realize there was an Ishares ETF called iBonds. Could be (well, WAS) very confusing. Thanks again.

 

[kevink]

Your original question was about using the IEF intermediate-term Treasury fund to offset your large equity holdings. For sure we're in an unprecedented low-interest rate environment right now but historically ITT's in the ~5 year duration range have represented the risk"return "sweet spot." IEF stretches out the duration, as does BND (Vanguard Total Bond Market ETF) and as TBM includes a lot of corporate bonds it also doesn't offer the downside protection during stock market meltdowns of a pure Treasury fund. When comparing yields make sure to take into account that Treasuries are state tax exempt, BTW.

Good paper on Treasuries vs. Corporates on this FA's site:

https://jonluskin.com/wp-content/uploads/2020/09/Dec2017_Contributions_Luskin.pdf

As for the cash side of things, iBonds at this point are flat-out the best cash AND bond holding you can have - with the obvious caveat that the 10K per person per year purchase limit may make them barely worth the bother in many cases. A really great primer on them - the best I've seen - was just published:

https://tipswatch.com/2021/09/26/i-bond-manifesto-why-inflation-linked-savings-bonds-can-work-as-part-of-your-emergency-fund/

Can't go wrong with some combo of an ITT fund (I prefer VGIT because of its optimum duration and low ER) and all the iBonds you can buy. As for % in these vs. stocks in retirement, I've always thought the rule of thumb of imagining your stock holdings losing 50% of their value in a crash and not recovering for a decade and then adjusting accordingly is a good one - especially early in retirement when sequence-of-returns risk is greatest. YMMV.

 

[Koolau]

Can't go wrong with some combo of an ITT fund (I prefer VGIT because of its optimum duration and low ER) and all the iBonds you can buy. As for % in these vs. stocks in retirement, I've always thought the rule of thumb of imagining your stock holdings losing 50% of their value in a crash and not recovering for a decade and then adjusting accordingly is a good one - especially early in retirement when sequence-of-returns risk is greatest. YMMV.

I still kick myself for not buying I-bonds earlier and also more often - before the ridiculous limits on ownership. I also like the idea of paper bonds which is all I now have. I guess I need to open a Treas. Direct act. if I'm going to jump back into buying more I-bonds. YMMV

 

[Zona]

Someone will point this out eventually. But what we commonly call IBonds are actually Series I savings bonds. Ishares for whatever reason chose to call their fixed term ETFs iBonds. I'm sure nobody ever got confused by that. [emoji16]

Count me among the formerly confused so thanks for clarifying that!