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Bond index funds ( to bond fund or not)
Old 04-09-2019, 02:22 PM   #1
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Bond index funds ( to bond fund or not)

In my 401k there is a Bond index fund that I have been putting 20% in. My goal is to have an 80/20 asset allocations. Would I be better off going 100% in stocks for 401k and get my 20% outside the retirement account using treasuries and CDís? Also are Bond fonds in general not that safe.
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Old 04-09-2019, 03:15 PM   #2
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My understanding, which I put out there with willingness to be corrected where I'm wrong:

Bond funds are more volatile, which does not necessarily mean less safe. Fund managers do not tend to hold bonds to maturity, and the buys and sells will make the price jump around. The net result turns out to be the same (less any fund fees and choices on bonds), but a bond fund may have a bumpier ride. If you put away $100K and need that full $100K plus a little gain in 6 months, a bond fund can't guarantee that for you. The volatility takes away short term safety.

With individual bonds and CDs, you get your rate locked in and most people tend to hold to maturity, which means you are guaranteed that rate and return of capital. Is that really safer? If inflation takes off on you, you have reduced buying power, so it's not risk free, it's just less volatile. Those are two different things. Of course you can sell an individual bond early, but you may get a gain or take a loss based on the current rates vs. rates of your bonds, so you start getting the volatility that a bond fund has.

An advantage a bond fund has is diversity. If you only have a small number of individual bonds, one default can really hurt, and there goes your safety. Treasuries and govt insured CDs of course should not lose your money. With that safety you give up some investment return.

If smoothing out the highs and lows of the stock market is part of your goal, I *think* holding individual bonds, treasuries and CDs work better because bond fund values can jump around without being correlated to the stock market. I'm still trying to work that out, and whether I really care about short term smoothing.

An argument I've heard against a bond index is that unlike a stock index which invests larger shares in larger (and presumably more successful or more stable) companies, a bond index will invest more in companies that issue more bonds, which may be a sign of needy companies that are relying on outside capital. I'm not sure to what degree that's true, but it makes some sense and I bring it up for discussion.

As far as asset placement goes, for tax efficiency, bonds, CD, etc that are taxed at regular income are better in a 401K/tIRA.

That's my take. Fire away.
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Old 04-09-2019, 06:32 PM   #3
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I like bond funds and I believe bond index funds that track the AGG are quite safe - they hold high quality bonds and tend to appreciate when stacks fall, so they make a nice diversifier against stock funds.

What some people object to with a bond fund is that the value fluctuates daily with interest rates. Individual bonds do as well, but some people ignore that as they are only concerned with the interest paid and hold the bond to maturity.

Also, the interest paid out monthly varies with a bond fund. Some people are looking for a predictable income stream from bonds.

But these issues do not bother me. I’m looking for total return and rebalancing. Bond funds provide broad diversification and instant liquidity for rebalancing.
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Old 04-09-2019, 06:40 PM   #4
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Originally Posted by audreyh1 View Post
I like bond funds and I believe bond index funds that track the AGG are quite safe - they hold high quality bonds and tend to appreciate when stacks fall, so they make a nice diversifier against stock funds.

What some people object to with a bond fund is that the value fluctuates daily with interest rates. Individual bonds do as well, but some people ignore that as they are only concerned with the interest paid and hold the bond to maturity.

Also, the interest paid out monthly varies with a bond fund. Some people are looking for a predictable income stream from bonds.

But these issues do not bother me. Iím looking for total return and rebalancing. Bond funds provide broad diversification and instant liquidity for rebalancing.
Where's the like button? This is exactly how I view my 40% bond allocation held in total US bond index funds. They spit out some cash every month, the NAV goes up and down some but in a much tighter band than stocks (at least in my investing lifetime). They are liquid. And right now I have to sell some total stock and buy some total bond because this runup so far in 2019 has put my AA a little out of whack.
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Old 04-09-2019, 11:11 PM   #5
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Could someone give examples of Bond funds that track the AGG ?

I have managed to buy a few CD's at the brokerage, but it's certainly not as easy as buying stock/etf's.
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Old 04-09-2019, 11:52 PM   #6
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From a tax efficiency viewpoint, you would be better off with bonds in your 401k and stocks in your taxable account.... qualified dividends and long-term capital gains get preferential tax rates of 0% or 15% for most people, depending on your taxable income level.

Bond funds are generally quite safe.
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Old 04-10-2019, 04:01 AM   #7
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What some people object to with a bond fund is that the value fluctuates daily with interest rates. Individual bonds do as well, but some people ignore that as they are only concerned with the interest paid and hold the bond to maturity.

Also, the interest paid out monthly varies with a bond fund. Some people are looking for a predictable income stream from bonds.
For me, it's more the latter - it's not about the value fluctuating daily at all. What individual bonds provide over bond funds is certainty - certainty in the amount of interest, and certainty that on a specific date, the bonds will have a guaranteed value. With a bond fund you get no certainty or guarantees.

Much of the above occurs as a result of the fact that bond funds have an objective, targeting some duration - maybe it's a long-term bond fund, maybe short-term, maybe intermediate. The duration is going to remain fairly constant - the fund never matures, it's always got a target duration. With individual bonds, they mature and you get your money back at maturity. Should you decide to cash out of the bond fund, at the time you sell, you're selling the equivalent of a bond still with X years to maturity. When your money is in the bond fund, think of it as continually rolling over a bond to another of the original duration. That's not what I'm looking for.
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Old 04-10-2019, 05:45 AM   #8
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Could someone give examples of Bond funds that track the AGG ?

I have managed to buy a few CD's at the brokerage, but it's certainly not as easy as buying stock/etf's.
AGG is an ETF
https://screener.fidelity.com/ftgw/e...type=sq-NavBar
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Old 04-10-2019, 05:57 AM   #9
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In my 401k there is a Bond index fund that I have been putting 20% in. My goal is to have an 80/20 asset allocations. Would I be better off going 100% in stocks for 401k and get my 20% outside the retirement account using treasuries and CDís? Also are Bond fonds in general not that safe.
People generally hold bonds/bond funds for two reasons
1. As an uncorrelated asset to stocks. For this purpose, many people use bond funds. As an uncorrelated asset, it can smooth out the year-to-year volatility vs, holding 100% equities. Depending on the percentage of bonds chosen, the amount of smoothing will of course vary, along with the associated reduction in long term returns of a portfolio. In the very short term it can go become anti-correlated, such as 2008/09. But bond funds could just as easily be (and have been) correlated to stocks during times of financial stress, especially when considering inflation. As others have mentioned, most index bond funds target a very specific average maturity - meaning that they're buying and selling bonds before maturity all the time. Number of years maturity, years remaining till maturity, interest rate at the time of purchase, and interest rate of any new bond it replaces all go into factoring the NAV of a bond fund at any given time.
2. As a source of income. For this purpose, many people purchase individual bonds and hold them to maturity where they have 100% knowledge of the nominal returns along the way, if holding nominal bonds. If, at any point, one decides to sell before maturity, then the same forces at work in a bond fund will apply here. Likewise, if one is purchasing an already existing bond from somebody. If the money isn't needed at maturity, people often build a bond ladder and use the proceeds to purchase new bonds that mature N years in the future - rinse and repeat. Plenty of sources out there on how to build a bond ladder.

As far as bond "safety", the answer is "it depends".
Treasury bonds are backed by the full faith and credit of the US government. You or a mutual fund buys a treasury bond, then the return is known and guaranteed. That doesn't mean that market forces as I described above won't move the value around if holding a bond fund or if you want to sell a bond early. Corporate and Municipal bonds can't make that claim.

Then there is inflation. When you buy a nominal bond, the interest rate is set for the life of the bond. If inflation rears its ugly head, as it did in the 1970's, then you could easily lose money, in an inflation adjusted sense. They didn't exist back then, but TIPs and Ibonds fill a roll for inflation protection, with the price of protection being that the interest rates are lower than nominal bonds during times of low/stable inflation.
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Old 04-10-2019, 06:11 AM   #10
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From a tax efficiency viewpoint, you would be better off with bonds in your 401k and stocks in your taxable account.... qualified dividends and long-term capital gains get preferential tax rates of 0% or 15% for most people, depending on your taxable income level.

Bond funds are generally quite safe.

Can you explain or elaborate on this? Bonds gains are taxed as capital gains if the seller does not hold them to maturity right? Not sure how that shakes out when investing in a bond fund as opposed to holding individual bonds.



My initial thinking was as much stocks in the 401k as possible. OP is a young dreamer so presumably has a long time horizon. Stocks over time will grow more than bonds. 401k shields all capital gains taxation of whatever is in it so you want whatever is going to grow the most (and potentially be subject to the most capital gains taxation) to be inside there.
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Old 04-10-2019, 06:37 AM   #11
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Can you explain or elaborate on this? Bonds gains are taxed as capital gains if the seller does not hold them to maturity right? Not sure how that shakes out when investing in a bond fund as opposed to holding individual bonds.



My initial thinking was as much stocks in the 401k as possible. OP is a young dreamer so presumably has a long time horizon. Stocks over time will grow more than bonds. 401k shields all capital gains taxation of whatever is in it so you want whatever is going to grow the most (and potentially be subject to the most capital gains taxation) to be inside there.
Capital gains in a 401k or tIRA are taxed at ordinary rates when withdrawn and do not get capital gains tax rates.

In a taxable account, bond interest is taxed as ordinary income... higher rates... 10-12% vs 0% for lower income people and 22%+ vs 15% for higher income people.

While it is true that bond LTCG are taxed the same as stock LTCG, bond LTCG tend to be more modest than stock LTCG so stock LTCG get a larger benefit from lower rates.

For example, VTSAX was $20.87 on 4/9/2009 and closed at $71.53 yesterday so it has a capital gain of $50.66 (242%). OTOH, VBTLX was $10.07 on 4/9/2009 and closed at $10.64 yesterday so it has a capital gain of $0.57 (6%).

Also see https://www.bogleheads.org/wiki/Tax-...fund_placement

ETA: I just noticed that this is my 21,001st post.
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Old 04-10-2019, 07:03 AM   #12
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Could someone give examples of Bond funds that track the AGG ?

I have managed to buy a few CD's at the brokerage, but it's certainly not as easy as buying stock/etf's.
Here are a couple of very inexpensive intermediate duration bond index funds that track the AGG:

FXNAX - Fidelity US Bond Index Fund
VBMFX/VBTLX - Vanguard Total Bond Index Fund
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Old 04-10-2019, 07:10 AM   #13
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The index is the Bloomberg Barclays US Aggregate Bond Index (BBgBarc US Agg Bond TR USD), often nicknamed AGG or Agg before the ETF using that as a symbol was created. The ETF AGG tracks this index.

It was originally called the Lehman Aggregate Bond Index before Barclays took it over. It dates from 1973.

It is often used to represent investment grade bonds being traded in United States. Index funds and exchange-traded funds are available that track this bond index. Most bond funds are tracked against this index similarly to how the S&P500 index is used for stock funds. There are also Bloomberg Barclay indexes for short-duration and ultra-short duration bonds.

https://en.m.wikipedia.org/wiki/Bloo...ate_Bond_Index
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Old 04-10-2019, 07:40 AM   #14
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If you are investing for the long term, just pick an appropriate bond fund and don't worry about it. Andrew index fund based on the aggregate is fine. The price will move a bit,, but that isn't a problem.

If you are putting money away for goals within 5 years, individual bonds and cds make more sense because you need a certain amount at a certain time.
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Old 04-10-2019, 07:53 AM   #15
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If you are investing for the long term, just pick an appropriate bond fund....
If someone could tell me how long my term is then it would make things a lot easier.
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Old 04-10-2019, 08:14 AM   #16
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If someone could tell me how long my term is then it would make things a lot easier.
500 more years. Advances in medicine and genome stuff will allow you to transfer your mind to a suitable android container. You could live forever with proper maintenance. What is the withdrawal rate for forever?
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Old 04-10-2019, 08:16 AM   #17
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If someone could tell me how long my term is then it would make things a lot easier.
Well in the OPís case, itís their goal retirement date.

For those of us already retired, well........
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Old 04-10-2019, 08:25 AM   #18
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If someone could tell me how long my term is then it would make things a lot easier.


There are also hybrid methods. As part of my own mental accounting, I consider my nominal bond fund there only for volatility reduction. I don't wish to guess where interest rates are going, so intermediate-term bonds fit the bill. In that sense, I guess the future is always 5-7 years away.

At the same time, though, I have a TIPs pseudo-ladder set up to generate an inflation adjusted income stream to supplement SS for about 15 years once I start taking SS at age 70. Such a system was described by BobK over on Bogleheads. It's set up by using 2 or more TIPs funds of different durations such that the proportions are set to provide the same average duration as would exist with a true TIPs ladder. I check once a quarter and rebalance to match my desired duration, if needed. SS+ this ladder should cover my basic living needs. The rest of the portfolio will be for anything extra. If either of us is still kicking after 15 years, we'll consider a SPIA to carry us to the end.
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Old 04-10-2019, 08:40 AM   #19
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There are also hybrid methods. As part of my own mental accounting, I consider my nominal bond fund there only for volatility reduction. I don't wish to guess where interest rates are going, so intermediate-term bonds fit the bill. In that sense, I guess the future is always 5-7 years away.
Yeah, pretty much for my intermediate bond funds, anything longer than 5 years which my retirement portfolio certainly is, no problem.

With rebalancing Iíll be taking from the most appreciated asset anyway, so it doesnít matter if bonds have a bad year.

Funny that - 2018 looked like a bad year for bonds, but they ended up breaking even as they gained suddenly when stocks took a hard hit. Ended up trimming bonds to buy stocks in very late 2018.

If Iíd rebalance 2 months earlier, stocks would have supplied our annual withdrawal and more bond funds would have been bought. Things sure can turn quickly.
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Old 04-10-2019, 08:45 AM   #20
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Yeah, pretty much for my intermediate bond funds, anything longer than 5 years which my retirement portfolio certainly is, no problem.

With rebalancing Iíll be taking from the most appreciated asset anyway, so it doesnít matter if bonds have a bad year.

Funny that - 2018 looked like a bad year for bonds, but they ended up breaking even as they gained suddenly when stocks took a hard hit. Ended up trimming bonds to buy stocks in very late 2018.

If Iíd rebalance 2 months earlier, stocks would have supplied our annual withdrawal and more bond funds would have been bought. Things sure can turn quickly.
Yep - that's what I think most do: withdraw in the direction of rebalancing. If withdrawals are only once a year, I know some who also use rebalance bands during the rest of the year if anything gets out of whack. I suspect that's probably a pretty rare event. Even rarer if one makes withdrawals over the course of the year in the direction of rebalancing.
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