Fixed Allocation - Ballast or Yield Driven?

[Animorph]

I can see where anyone living on dividends/interest only would be concerned about maximizing fixed income yield. I go for total return, depending mostly on stocks for growth. so getting the last drop of yield doesn't seem like a big priorty.

For me it's pretty much ballast. I use FXNAX U.S. Bond Index Fund as my only fixed income, mostly Treasuries. Over the long term I expect it will outperform cash. I'm not concerned about short-term performance as long as it's not stock-like.

I like that I can withdraw from the bond side of the portfolio when the market is down. I like that I can rebalance and even over-balance into equities during a bear market. And it has given me some flexibility to park expense money in retirement account bonds while waiting for the new year before I incur capital gains taxes by selling in the taxable account.

 

[tdv2]

I focus on total return of the whole over the long term and don’t worry about component return. It’s how it all works together with rebalancing that matters. There are periods where any component may lose money inflation-adjusted.

+1

 

[DawgMan]

I was digging a little further from my original post trying to see what the real correlation (if there really is one to identify here) between some historical total returns between stocks, short term treasuries and intermediate treasuries, relative to the movement of the Fed Funds Rate. I was trying to get a better visual of how bond funds have acted in the past, not from a yield perspective, but from a total return perspective, and if, in fact, they did their job as a ballast. For kicks and giggles, I charted out the last 20 years (2001 - 2020 YTD) Daily Fed Funds rate (movement from Jan - Dec) and compared it to the Total Returns of a short term bond fund (VSGBX), intermediate bond fund (VFITX) and World Stock Index fund (VTSAX). See attachment...

I realize the past does not dictate the future, but a few observations/questions...
- Bonds acted as expected in down years for Stocks, particularly intermediates as they had positive returns.
- Stocks acted as expected in down years for Bonds. 2015 was flat for all 3 categories, but not negative.
- Intermediates out performed short term bonds 16 out 20 years
- From 2009 - 2016, Fed Funds rate was very low and somewhat flat, yet short term bonds were positive and 6 out of 8 years of intermediates were positive
- 2020 YTD for intermediates (7.81%), short term (4.13%) despite extremely low yields
- Other than a couple of dramatic drop years by the Fed where bond total returns were much higher as expected, difficult to see a real good pattern in other years?

So, does this make a good argument for bond funds, and more specifically intermediate bond funds, as a ballast? Or, will it be "different" this time when/once interest rates start rising again?

Thoughts?

 

[VanWinkle]

I was digging a little further from my original post trying to see what the real correlation (if there really is one to identify here) between some historical total returns between stocks, short term treasuries and intermediate treasuries, relative to the movement of the Fed Funds Rate. I was trying to get a better visual of how bond funds have acted in the past, not from a yield perspective, but from a total return perspective, and if, in fact, they did their job as a ballast. For kicks and giggles, I charted out the last 20 years (2001 - 2020 YTD) Daily Fed Funds rate (movement from Jan - Dec) and compared it to the Total Returns of a short term bond fund (VSGBX), intermediate bond fund (VFITX) and World Stock Index fund (VTSAX). See attachment...

I realize the past does not dictate the future, but a few observations/questions...
- Bonds acted as expected in down years for Stocks, particularly intermediates as they had positive returns.
- Stocks acted as expected in down years for Bonds. 2015 was flat for all 3 categories, but not negative.
- Intermediates out performed short term bonds 16 out 20 years
- From 2009 - 2016, Fed Funds rate was very low and somewhat flat, yet short term bonds were positive and 6 out of 8 years of intermediates were positive
- 2020 YTD for intermediates (7.81%), short term (4.13%) despite extremely low yields
- Other than a couple of dramatic drop years by the Fed where bond total returns were much higher as expected, difficult to see a real good pattern in other years?

So, does this make a good argument for bond funds, and more specifically intermediate bond funds, as a ballast? Or, will it be "different" this time when/once interest rates start rising again?

Thoughts?

Flight to safety tends to increase demand for government bonds. The human is fairly predictable, even if the market is not.

 

[VanWinkle]

How do you do personal mortgages in your tax-deferred portfolio?

The prior post may have made you think they were in tax deferred, but they are outside my IRA. They are part of my fixed income side of the portfolio but not tax deferred. 3% taxable is better than the bond fund yields at this time. I do not consider the mortgages to be ballast.

 

[audreyh1]

I was digging a little further from my original post trying to see what the real correlation (if there really is one to identify here) between some historical total returns between stocks, short term treasuries and intermediate treasuries, relative to the movement of the Fed Funds Rate. I was trying to get a better visual of how bond funds have acted in the past, not from a yield perspective, but from a total return perspective, and if, in fact, they did their job as a ballast. For kicks and giggles, I charted out the last 20 years (2001 - 2020 YTD) Daily Fed Funds rate (movement from Jan - Dec) and compared it to the Total Returns of a short term bond fund (VSGBX), intermediate bond fund (VFITX) and World Stock Index fund (VTSAX). See attachment...

I realize the past does not dictate the future, but a few observations/questions...
- Bonds acted as expected in down years for Stocks, particularly intermediates as they had positive returns.
- Stocks acted as expected in down years for Bonds. 2015 was flat for all 3 categories, but not negative.
- Intermediates out performed short term bonds 16 out 20 years
- From 2009 - 2016, Fed Funds rate was very low and somewhat flat, yet short term bonds were positive and 6 out of 8 years of intermediates were positive
- 2020 YTD for intermediates (7.81%), short term (4.13%) despite extremely low yields
- Other than a couple of dramatic drop years by the Fed where bond total returns were much higher as expected, difficult to see a real good pattern in other years?

So, does this make a good argument for bond funds, and more specifically intermediate bond funds, as a ballast? Or, will it be "different" this time when/once interest rates start rising again?

Thoughts?

This jives well with my personal experience over the past 20 years. And is why I continue to be quite content to use high quality bond funds - particularly intermediate bond funds. I have around 2/3 of my fixed income in intermediate bond funds and the remainder split between short term bond funds and cash.

I have been through several interest rate rising periods since 2000. They have not been a problem. I also rebalance annually, so if bonds are pushed down temporarily, I buy more. As it turns out, bond funds often have an outsized return a year or two following a poor year. Also, Fed controlled interest rates affect bond index funds indirectly. The interest rate curve is a very mobile thing, and intermediate rates can behave very differently from short and long term rates. And it keeps changing over time.

 

[DawgMan]

This jives well with my personal experience over the past 20 years. And is why I continue to be quite content to use high quality bond funds - particularly intermediate bond funds. I have around 2/3 of my fixed income in intermediate bond funds and the remainder split between short term bond funds and cash.

I have been through several interest rate rising periods since 2000. They have not been a problem. I also rebalance annually, so if bonds are pushed down temporarily, I buy more. As it turns out, bond funds often have an outsized return a year or two following a poor year. Also, Fed controlled interest rates affect bond index funds indirectly. The interest rate curve is a very mobile thing, and intermediate rates can behave very differently from short and long term rates. And it keeps changing over time.

Yup. That was my take away as well, but wanted to check my thinking with those with some retirement tenure. This seems to give me some validation to staying the course despite interest rates being effectively close to zero. I suppose if it becomes so obvious interest rates are going to march up (multiple increases in a year), pivoting to short term treasuries and cash is always an option, but then again, we have seen these predictions before.

I think I'm with you... stay the course!

 

[audreyh1]

Yup. That was my take away as well, but wanted to check my thinking with those with some retirement tenure. This seems to give me some validation to staying the course despite interest rates being effectively close to zero. I suppose if it becomes so obvious interest rates are going to march up (multiple increases in a year), pivoting to short term treasuries and cash is always an option, but then again, we have seen these predictions before.

I think I'm with you... stay the course!

With interest rates close to zero, my bond funds have appreciated quite a bit in value, and have pretty good unrealized gains at moment. So it doesn't bother me, especially as I have owned them for a very long time. I will end up buying a bit less when I rebalance. Oh wait - stocks are up even more! So I will be still be buying bonds from stocks. Well, that's OK too!

People, including on this forum, are constantly predicting an imminent rise in interest rates, but it always seems to take way longer than expected. Short-term interest rate changes really can't be predicted, nor how they might affect different maturities or different types of bonds.

 

[Lsbcal]

We know that since 1982 or so the rates have declined dramatically and bond holders have been rewarded, especially towards the long end. Yes there were periods of rate rises but the basic trend was down. But what about the rate run up from the 1950's to 1982?

Here is the picture for 5 year Treasuries. This only goes up to about 2018.

Here is some data I got comparing intermediate bonds and short term bonds. Note in 1950-1982 (red circled years) short term bonds were the place to be.

So all you have to do is figure out which era we are in.

 

[audreyh1]

Sure, but you’ll notice that the FRED chart is quite volatile even during the run up. It’s not a straight line. Interest rates move up and down as there are recessions and recoveries as shown by the gray bars in the graph. If you are rebalancing annually you’ll have opportunities to buy more bonds when they are under pressure. And when stocks are under pressure, bonds usually appreciate a bit due to rate drops and help buy more stocks.

5 year rolling returns disguise the annual volatility that benefits rebalancing.

We never know where we are or where we are going to be soon, but I do notice looking at the long-term charts that initially rate rises were fairly gradual. It took over 10 years to move from 2.5% to stay above 5% and even dropped back down to 5% briefly another 5 or so years later.

 

[Lsbcal]

The Fed plans to keep rates pretty low until 2023. Then if they can I imagine rates will rise gradually. So maybe there will be a way to make bonds work whether you are longer or shorter.

 

[audreyh1]

The Fed plans to keep rates pretty low until 2023. Then if they can I imagine rates will rise gradually. So maybe there will be a way to make bonds work whether you are longer or shorter.

If it’s gradual like in 2003-2005, bond funds behave pretty well over the period. Although they were starting from higher rates back then.

 

[RobLJ]

Maybe I should post in another thread but this doesn't seem worthy.
Nonetheless, 4 years ago I invested a chunk of my bond allocation in a Zero Coupon fund (American Century Zero Coupon 2025), which expires obviously in 2025. I tend to like intermediate govt bonds as at least a 20-35% of my bond allocation.
This year it acted just as planned, going up 13% in the wake of the COVID crash.

However, the price has now matched the expected NAV/expiration value, which I take to mean what I will "earn" from here is at best yield which is going to be pitiful.
a) I'm inclined to sell, but should I? (just curious about your thoughts on the agora; the responsibility obviously is mine). I think I've gained as much as I will gain and now it is more of a short-term bond fund.
b) if so, I would like to replace it--any good candidates? At current yields is investing in US govt bonds even a good idea? Floatiing? Foreign? I suspect the US dollar drop will continue, for at least a few years, but I'm just thinking aloud (and not productively). Another possibility is just a short-term govt bond fund.
I'm not sure the small increase in yield going out 7-10 years is worth the interest rate risk.
I'm having trouble wrapping my mind around bond investment in a zero yield environment that I suspect is likely to remain for a while. I know a lot of you are smarter on this than I, but I find it a conundrum (I'm a little skeptical that intermediate US govt funds will act as much of a buffer in another crash, but negative yields are quite possible I suppose.)

 

[jimbee]

I consider my fixed allocation to be ballast, although over the last ten years, the bulk of it has returned 4% CAGR.

 

[Out-to-Lunch]

a) ... I think I've gained as much as I will gain and now it is more of a short-term bond fund.

Yes, I think those things are probably correct; you sort of "pre-collected" what you were going to get by holding to 2025, but....

b) if so, I would like to replace it--any good candidates?

Yeah, that is the rub, isn't it? Nothing notably better out there for you to switch to. Which makes sense.

So, ballast it is?

 

[RobLJ]

So, ballast it is?

Either ballast--or dead weight now.
It is quite possible that intermediate funds will continue to act as normal in a crash, but I have plenty of doubts, this time (but the most dangerous phrase is "this time is different"--even in negative yields I suppose). I still can't wrap my mind around bonds in a negative/zero yield world.

 

[ejw93]

In my taxable account I am using short term munis (SUB) for 'ballast'. If you want to beat inflation (which is a long-term problem), stocks are the only way to go (which are long-term investments).
The way I see it, Ballast will let me continue to eat when a market correction attacks the value of stocks.

 

[Markola]

I consider my fixed allocation to be ballast, although over the last ten years, the bulk of it has returned 4% CAGR.

+1. Beats a sharp stick.

 

[pn3069]

I am holding intermediate and short term bond funds in equal proportion. I bet the next move by the Fed is negative interest rates in 2021.