The Interest Rate Dilemma

[eytonxav]

With interest rates at historical lows (uncertainty of how long this will last), how would you allocate investments into the fixed income portion of the portfolio, if you were currently planning to roll a 401K into an IRA?  Also does the allocation metric of using your age to determine % of fixed income in portfolio make sense for a conservative growth type portfolio (presently 54, also want to be able to sleep at night)?

Bonds (which ones) %?
Inflation protected (tips, etc)%?
Stable value %?
Other %?

A large portion of my current 401K is in a company managed conservative fund, but I want to roll over to IRA for more investment choices and access to money for college use without penalty, however, the thought of bond funds and rising interest rates makes me nervous.  Some advisors have said short - intermediate term bond funds should not be a concern, while other advisors make this look like a doomsday scenario if rates rise.

Also, are there any modeling tools that will show you how specific investment products combined in a portfolio would perform over time?

Doug

 

[Cut-Throat]

I am currently wrestling with this same sort of dilemma. Recently I sold off a lot of stock and have the money sitting in my IRA collecting 1/2 percent of interest.

I don't want to go into bonds for the reasons you mentioned. I have decided (for the moment) to leave it in cash, because I believe that there are potential opportunities on the horizon.

I think the market is way overvalued, as we are not creating jobs. A big crash is a possibility in the next year or two. Also interest rates could be headed up which does not bode well for the market or bonds.

If these events happen, cash would be nice to take advantage of lower prices in the stock and bond markets. The worst thing that will happen to me is that I'll hang on to my principal (which is better than I have done for the last 3 years)

 

[dory36]

We've been looking at the same thing as well. [We shifted some to stock funds during the past 2 years, to try to prove that you can't time the market. ]

I'm thinking of putting some into rental residential real estate, now that we'll be in one place and can manage it.

Dory36

 

[thebacchus]

We have done quite well in the rental market in the last couple of years. My personal preference is to manage the properties ourselves.

We look for distressed commercial properties and residential foreclosures. We find that we can make these cash flow easily and gain some quick equity after some minor repairs. You need not be handy. While we handle many repairs ourselves, we have assembled a team of licensed professionals that perform side work for tasks we do not want or have time to complete.

Most of our time is spent on reasearch of the market and available properties, not a whole lot on actual management.

Best Wishes,

TheBacchus

 

[Alec]

Doug,

Have you looked at alternatives to bond funds for your IRA? Could you ladder CDs and/or 5-year Treasury notes and just hold them to maturity? You can also buy individual TIPS inside your IRA if your IRA provider allows it (I think Vanguard does). The only thing is that you have to hold the individual bonds to maturity to avoid loss of principle.

Short and intermediate funds should not get hammered (like can happen with stocks) if/when rates but they will decrease roughly equal to the duration for every percentage point rates rise. Remember that when rates rise, if you are reinvesting those dividends, they will be reinvested in new bonds at the higher interest rates. So, in the long run you will actually make out better if rates rise than if rates do not. Only thing is that for some people they consider the long run only a couple of years off.

As for "your age in bonds", I think that is really a phrase that is used way too often. It would certainly work if everybody had the same tolerance for risk, and the same need to take risk. Obviously everyone is different. For what it is worth, I was looking through Bernstein's "The Intelligent Asset Allocator" last night and came across this rather rough measure for risk tolerance:

I can tolerate losing _____% Recommended percent of
of my portfolio in the course portfolio invested in stocks
of earning higher returns

35%....................................80%
30%....................................70%
25%....................................60%
20%....................................50%
15%....................................40%
10%....................................30%
5%....................................20%
0%....................................10%

- Alec

 

[eytonxav]

Alec/et al, Thanks for the feedback. Absolutely, I am looking for alternatives to just a straight mutual fund bond play. Until the interest rate future looks a little clearer, I was thinking of staying with a combination of short term bond fund, tip fund, stable value fund and a small percent of a high yield bond fund. If interest rates move up, I would then probably add intermediate term bond fund. I was thinking of a mix like this until I saw Alec's risk chart:

20% stable value
15% short term bond
15% tips
5% high yield

Does this type of mix make sense? Maybe also need to move another 5% from equity to fixed income.

Doug

 

[rwwoods]

I just parked most of my taxable cash in a money market account at ING Direct at a 2% interest rate. WOW! Well, at least it's better than money market funds and most short term bond funds. Unfortunately, I expect these low rates to stay around for another 6-12 months.

 

[eytonxav]

RW, Do you essentially get check writing priviledges with ING or are there restrictions on withdrawals? Any other fees?

Doug

 

[Alec]

Doug,

I believe you said that you will be doing this inside an IRA. What stable value fund will you be using? If it is one of the "principle protected funds", I'd think twice. They usually carry hefty fees (like 1%). That usually signals (to me at least) that it is set up in the manager's best interests (to make them money at the expense of the investor), and not in the investor's best interest. If it is a stable value fund inside a 401(k), that's different as they usually have much lower fees.

I think there would have to be a very significant rise in interest rates for a short-term bond fund to lose a lot in one year. If the yield is 2.5%, the duration is 2.5, and interest rates rise 1% in a year, you should about break even if reinvesting dividends. So, if your only option of a stable value fund is one of those PP funds (with expense around 1%), you could probably substitute something like Vanguard's ST corporate.

The chart I listed is only a very rough estimate of what Bernstein thinks people should be considering. For example, if you found that your risk tolerance was in line with 60% bonds in the chart, and you had only 20% bonds, then you may have a problem. But 5% off here or there shouldn't make that much of a difference. Remember that HY bonds are part equity, so I wouldn't count all of them (5%) as fixed income. Perhaps only 1/2 (2.5%).

- Alec

 

[eytonxav]

Alec, Right, I was looking at rolling my 401K into an IRA so that I have more investment choices. The stable value funds I was considering are Scudder Preservation Plus Income and PBHG Capital Preservation. Morningstar had a nice write up on these funds and they believe the costs will come down as these funds expand outside the world of 401K where they are normally found. Laddering CDs, bonds, etc may be a good way to go, but I will need to investigate setting option up within an IRA.

It appears that you don't feel that a short term bond fund is anything to lose sleep over, given that yields could also temper share erosion, so maybe it would be OK to stick to durations that are 3 yrs or less?

Thanks for all the input, this site is great to have members that have experience in all these different investment areas and are also good devils advocates/sounding boards!!

Doug

 

[ShokWaveRider]

I am also struggling with this. I get 2.23% with my local Credit union in CDs, only insured for 100k but what can you do? That is for 3 months only, Over $1m. I keep telling myself I am waiting for rates to go up. But I CANNOT afford to loose anything. My 401K is making over 4% still in Stable Value so it stays there.

Ian

 

[rwwoods]

DFW, ING Direct links your MMA to your bank account - e.g., checking - and all deposits and withdrawals are performed by electronic transfers. There are no fees whatsoever unless your bank charges for electronic transfers. You can learn more at their site, http://home.ingdirect.com/.