Individual Bonds - Are they a better alternative today?

[DawgMan]

I have to admit, I have always ignored investing in individual bonds and stuck with short and intermediate bond funds/ETFs. I have subscribed to the ballast theory as well as the KISS method. As I start pulling from my investments for the first time in 2022, I am wondering if exchanging some/most/all of my bond fund allocation with laddering 1 through 5 year individual bonds is a better and more dependable approach, especially with a higher likelihood of increasing interest rates. While I subscribe to the total return/rebalance approach, my thought is by laddering a min of say 5 years of annual living expenses and holding them until maturity, I will arguably have predictable income for each period of 5 years looking forward, without some of the negative fluctuation in pricing/total return I have today in bond funds/ETFs. I am a definite novice when it comes to bond laddering strategies, but would be curious to hear how those of you who subscribe to a bond laddering approach implement it? How do you decide on the types of bonds (i.e. corporate, treasuries, ratings) and any experiences in defaults? Oh, and am I really just splitting hairs and should I stay with my funds/ETFs?

 

[bloom2708]

It can be much harder to sell individual bonds. Bonds with good rates can be called at any time. I would stay the course with Total bond index or Int-Term Treasury index.

My grandma had a bunch of Lehman Brothers bonds. They paid a nice rate until they didn't. My parents had Edward Jones and they still own some remnant individual bonds. It has been difficult to get bids on several. The opposite of simple.

 

[Dtail]

The concept that holding individual bonds to maturity in an increasing interest rate environment is better than holding bond funds is not necessarily accurate.

 

[disneysteve]

It can be much harder to sell individual bonds.

Which isn't a concern if you hold them to maturity.

Bonds with good rates can be called at any time.

Not exactly. When you buy a bond, it clearly states if it is callable and when. And you will be quoted the yield to maturity as well as the yield to worst which is the rate you'd realize if the bond got called at the first possible call date. So you always know upfront exactly what you're signing up for, or at least the range from worst to best yield that you will receive (assuming the issuer doesn't default).

 

[njhowie]

If you are a novice and don't have the desire to spend a good amount of time/effort learning about investing in individual bonds, then I would say to steer clear, and just go with the easy approach of a fund.

If you've gained a good understanding of individual bonds, how to evaluate them, how the market works, what is a bargain and what is garbage, then I personally believe that the small fry retail investor can easily do just as well as any bond fund with less risk and lower cost.

 

[Freedom56]

If you've gained a good understanding of individual bonds, how to evaluate them, how the market works, what is a bargain and what is garbage, then I personally believe that the small fry retail investor can easily do just as well as any bond fund with less risk and lower cost.

You should be able to do better than bond funds. This my performance on my taxable buy and hold bond holdings at Fidelity vs the Bloomberg/Barclays Bond Index:

---------------1-Month 3-Month- YTD---- 1-Year---- 3-Year-- 5-Year
Joint WROS +0.24% +1.06% +5.01% +7.52% +9.14% +5.63%

Bloomberg Idx-0.87% +0.05% -1.55% -0.90% +5.36% +2.94%

The trick is avoiding problem companies and sectors and timing your purchase of individual bonds (i.e. buying when funds are selling).

 

[jazz4cash]

Yeah but

I decided to use individual bonds instead of bond funds about 6 yrs ago and I’m very glad I did.

If you are starting out now, in addition to the learning curve, you may find the current offerings to be unattractive. Buying into a bond fund you might get benefit of good purchases by mgt when values were better.

Using a bond fund for income seems risky if cannot ignore NAV. You can get whipped around when the market shifts and forces mgt to sell.

Buying individual bonds can take a fair bit of work esp if you are trying to fill a significant position. I sat for years wishing I could find something to buy and got lucky for one week right at the start of COVID.

Fidelity has a bond ladder tool you could try or other brokers probably have similar. Also call the bond desk at Fido or any broker and ask for help.

Market seems to shift around and favor certain segments from time to time. Muni bonds were a value segment for quite a while but that could be changing now. Check the thread on muni bonds/funds for good insight.

It seems like we small fry investors can glean the crumbs of offerings that are too tiny for a bond fund Mgr to be bothered with and I believe that’s how individuals can beat the pros.

I personally don’t have the patience, resources or analytical ability to find more better deals, but I’m learning thanks to the experts here. I am more or less novice also but these are my impressions. I encourage feedback from the pros.

 

[pb4uski]

I have to admit, I have always ignored investing in individual bonds and stuck with short and intermediate bond funds/ETFs. I have subscribed to the ballast theory as well as the KISS method. As I start pulling from my investments for the first time in 2022, I am wondering if exchanging some/most/all of my bond fund allocation with laddering 1 through 5 year individual bonds is a better and more dependable approach, especially with a higher likelihood of increasing interest rates. While I subscribe to the total return/rebalance approach, my thought is by laddering a min of say 5 years of annual living expenses and holding them until maturity, I will arguably have predictable income for each period of 5 years looking forward, without some of the negative fluctuation in pricing/total return I have today in bond funds/ETFs. I am a definite novice when it comes to bond laddering strategies, but would be curious to hear how those of you who subscribe to a bond laddering approach implement it? How do you decide on the types of bonds (i.e. corporate, treasuries, ratings) and any experiences in defaults? Oh, and am I really just splitting hairs and should I stay with my funds/ETFs?

One option that is sort of in between is to do a ladder of target maturity bond ETFs.

A target maturity bond ETF invests in a portfolio of bonds that all mature is a stated year so it is like owning a piece of that bond portfolio. At the end of the target year all the bonds mature and are converted to cash and there is a terminal distribution of the amount in portfolio.

Invesco Bulletshares and BlackRock iBonds are the two major providers.

A 5-year ladder of investment grade bonds would yield about 1.3%. See https://www.invesco.com/bond-ladder/ or https://www.ishares.com/us/resources/tools/ibonds

I owned some of the Bulletshares in the past. One thing I noticed is that the return in the terminal year was low because bonds mature throughout the year and the proceeds are invested short term until the terminal distribution in December... but I just sold my Bulletshares near the beginning of the maturity year rather than waiting until December.

 

[thefist]

If you are interested in learning about and buying individual corporates,
I’d recommend this service http://www.BondSavvy.com.
Read his intro material and blog. Very educational. I like the conference calls about 6 to 8x per year and the detailed buy or sell guidance.
He has stated many times recently that this is a Very tough environment for buying bonds. So guidance is useful.
Some good info on the flaws with bond ladders, bond funds, and shortcomings of credit ratings.
I can pass along a referral code if you’re interested.

 

[yhoomajor]

I have done both. I generally lost money (or broke even with 1-3% return) when I was invested in Bond funds. There are several nuances with bond funds. They do lot more trading (often times locking in losses passed on to bond fund/etf holders).

Now I have a pool of several individual bonds. There are risks with individual bonds as well (some bonds can default and it DOES happen).

All in all - I've made money with individual bonds (and still do as interest rolls in). Not so much with bond funds. Just my 2 cents.

 

[Montecfo]

Bond funds versus individual bonds?

Each approach has advantages and disadvantages. It is truly a mixed bag.

I admire Freedom56 who is very active in individual bonds. Personally I prefer actively managed funds for diversification, flexibility and to manage duration and take advantage of professional management and scale.

But I may decide to do individual bonds at some point.

 

[njhowie]

Personally I prefer actively managed funds for diversification, flexibility and to manage duration and take advantage of professional management and scale.

Professional management of an actively managed bond fund takes fees for their services...those fund managers don't come for free or low cost. Fees on actively managed bond funds routinely run over 1%/year. In a low interest rate environment like we have now, fees over 1% in a bond fund is a huge portion of what they can generate in returns.

As a result of the scale you desire, bond funds are required to buy in bulk, and likewise unload in bulk. In the current environment, where so much money is flowing in to the market, with demand high for bonds paying low yields relative to risk, they are forced to pay up and are generally unable to get attractive pricing. The individual investor has the flexibility to pick and choose. He/she isn't looking for the bulk purchases/sales as the fund is. For actively managed funds to outperform an individual investor who knows what he/she is doing requires taking higher risk. This generally shows in the fund having its share of lower quality and junk bonds, employing leverage, or over trading. The actively managed fund is required to buy and sell based on capital inflow and outflow, not necessarily when it is the most opportune time (as the individual investor has the luxury of doing). As Freedom56 points out - this is where he excels.

The reasons you give for your preference are generally applicable to those with a small (bond) portfolio, or unwilling to invest the time or effort on their own. Nothing wrong with that, just pointing out that it will not necessarily get the best returns.

Like Freedom56, I manage my own bond portfolio. My returns match my index and at significantly lower risk. The risk indicators which Fidelity provides on my holdings are minuscule relative to the indexes.

 

[DawgMan]

One option that is sort of in between is to do a ladder of target maturity bond ETFs.

A target maturity bond ETF invests in a portfolio of bonds that all mature is a stated year so it is like owning a piece of that bond portfolio. At the end of the target year all the bonds mature and are converted to cash and there is a terminal distribution of the amount in portfolio.

Invesco Bulletshares and BlackRock iBonds are the two major providers.

A 5-year ladder of investment grade bonds would yield about 1.3%. See https://www.invesco.com/bond-ladder/ or https://www.ishares.com/us/resources/tools/ibonds

I owned some of the Bulletshares in the past. One thing I noticed is that the return in the terminal year was low because bonds mature throughout the year and the proceeds are invested short term until the terminal distribution in December... but I just sold my Bulletshares near the beginning of the maturity year rather than waiting until December.

Helpful, will dig in. Thanks.

 

[DawgMan]

Appreciate all the responses. It's funny how today we (or perhaps just me) wrestle with optimizing such little yield/total return when it comes to the bond allocation. Looking at some of the quoted investment rated individual bonds with maturities from 1 - 5 years, it appears the yields are approximately .76% (1 year) to 1.6% (5 years). Sure, you guaranty these returns vs the risk of a negative or lesser total return on your bond fund/ETFs, but over a 5 year span do you really? We have all been saying interest rates are going to rise for some time, but even with some movement upward over the last 5 - 10 years, it appears funds/ETFs have not been beat up to bad. Of course, NOW, with inflation, it sure feels like we are going to see a steady increase, but what do I know.

Here are the total return results of a majority of my bond holdings over the last 5 years...

Short Term Treasury ETF (SCHO)
2021 YTD -.11%
2020 3.11%
2019 3.53%
2018 1.50%
2017 0.35%
2016 0.78%


Intermediate Bond ETF (SCHZ)
2021 YTD -1.65%
2020 7.50%
2019 8.64%
2018 -0.09%
2017 3.46%
2016 2.49%

I suppose if I believe the next 5 years will produce an average total return below a blend of the .76% - 1.6% I buy a bond ladder? If not, stay the course? Am I looking at this correctly?

 

[sengsational]

One option that is sort of in between is to do a ladder of target maturity bond ETFs.

Interesting idea. I've never liked bond funds because when the flight to cash happens, they're forced to sell low... something I wouldn't be doing with my individual bonds in ballast bucket. I'm pleased to have a stable value fund in the 401k, so that gets me around the problem, mostly, but not completely. And then there's a problem with access to individual bonds in another tax bucket, so I'm stuck with a bond fund there. But I'd be in individual bonds if I could. My somewhat uninformed opinion is that you don't have to be all that skilled or lucky to manage reasonably well. IOW, avoid making the obvious mistakes covered in the bogleheads wiki, and you're probably no worse off, and maybe quite a bit better.

 

[Freedom56]

If you are interested in learning about and buying individual corporates,
I’d recommend this service http://www.BondSavvy.com.
Read his intro material and blog. Very educational. I like the conference calls about 6 to 8x per year and the detailed buy or sell guidance.
He has stated many times recently that this is a Very tough environment for buying bonds. So guidance is useful.
Some good info on the flaws with bond ladders, bond funds, and shortcomings of credit ratings.
I can pass along a referral code if you’re interested.

A person from BondSavvy.com was presenting at a Fidelity webinar earlier in the year. He sounded okay until he brought up his JC Penny bond investments that went horribly wrong. That made be ponder, what kind of expert even considers investing in JC Penny, a failed retailer with repeat bankruptcies? I heard enough and terminated the webinar.

 

[Freedom56]

Personally I prefer actively managed funds for diversification, flexibility and to manage duration and take advantage of professional management and scale.

But I may decide to do individual bonds at some point.

My strategy relies on passive bond and preferred stock funds to repeat their sell at any bid decisions when the market sells off or when they rebalance. Those low cost passive bonds are for the most part controlled by algorithms implemented by their portfolio management software. So they don't make the most rational decisions when they need to raise cash. March 2020 was a great example of what can go wrong with passive bond funds when they sold their holding as much as 60% below par only to buy the same securities back several months later above par.

 

[yakers]

My strategy relies on passive bond and preferred stock funds to repeat their sell at any bid decisions when the market sells off or when they rebalance. Those low cost passive bonds are for the most part controlled by algorithms implemented by their portfolio management software. So they don't make the most rational decisions when they need to raise cash. March 2020 was a great example of what can go wrong with passive bond funds when they sold their holding as much as 60% below par only to buy the same securities back several months later above par.

I like the idea of buying preferds on sale but do I have to wait for March 2020 events to buy? And will buying opportunities go by before I can even react?
By the time I figured out I wanted commodities they had their big run up. I need something easy to manage, getting older and DW has no interest in things financial.
BND has worked well enough as part of VBIAX, not sure of anything better without risks I don’t understand.

 

[Montecfo]

Professional management of an actively managed bond fund takes fees for their services...those fund managers don't come for free or low cost. Fees on actively managed bond funds routinely run over 1%/year. In a low interest rate environment like we have now, fees over 1% in a bond fund is a huge portion of what they can generate in returns.

As a result of the scale you desire, bond funds are required to buy in bulk, and likewise unload in bulk. In the current environment, where so much money is flowing in to the market, with demand high for bonds paying low yields relative to risk, they are forced to pay up and are generally unable to get attractive pricing. The individual investor has the flexibility to pick and choose. He/she isn't looking for the bulk purchases/sales as the fund is. For actively managed funds to outperform an individual investor who knows what he/she is doing requires taking higher risk. This generally shows in the fund having its share of lower quality and junk bonds, employing leverage, or over trading. The actively managed fund is required to buy and sell based on capital inflow and outflow, not necessarily when it is the most opportune time (as the individual investor has the luxury of doing). As Freedom56 points out - this is where he excels.

The reasons you give for your preference are generally applicable to those with a small (bond) portfolio, or unwilling to invest the time or effort on their own. Nothing wrong with that, just pointing out that it will not necessarily get the best returns.

Like Freedom56, I manage my own bond portfolio. My returns match my index and at significantly lower risk. The risk indicators which Fidelity provides on my holdings are minuscule relative to the indexes.

That's all fine. I see no reason to debate it or pick at your approach. I will say no one should pay 1 percent for a basic bond portfolio. I certainly do not. And it is results after fees that carry the day, in fact.
Focusing on expenses on an active bond portfolio is a red herring in fact. Not like passive, which I avoid anyway

Each approach has clear pros and clear cons. Everyone must choose which they prefer, but there is no one approach best for all.

 

[pb4uski]

I like the idea of buying preferds on sale but do I have to wait for March 2020 events to buy? And will buying opportunities go by before I can even react?
By the time I figured out I wanted commodities they had their big run up. I need something easy to manage, getting older and DW has no interest in things financial.
BND has worked well enough as part of VBIAX, not sure of anything better without risks I don’t understand.

No, I think Freedom likes to monitor pricing and buy the dips... like when the large instutional preferred ETFs like PFF or PGX or others are doing a fire sale when reorganizing their large portfolios and flooding the market with supply.

I'm not as patient or opportunistic as Freedom and I pretty much buy when I have funds to buy or have funds from a call or something like that.... my preferred portfolio yield is 5.25% for average credit quality of BBB-, and I'm happy with that.

 

[thefist]

A person from BondSavvy.com was presenting at a Fidelity webinar earlier in the year. He sounded okay until he brought up his JC Penny bond investments that went horribly wrong. That made be ponder, what kind of expert even considers investing in JC Penny, a failed retailer with repeat bankruptcies? I heard enough and terminated the webinar.

The JCP bond was not one I bought. It was an earlier recc before I joined, and I think I had the same general reaction as you did initially. One thing to keep in mind is that their approach is total return. So the reason to buy JCP may have been for an opportunistic call on price appreciation rather than yield. It’s been a good service so far. Not everything will be a winner, just like a portfolio of stocks (or bond fund). And if you don’t like a particular recc, don’t buy it. Some current selections have been Alphabet, Amazon, waste management, so you have a mix of quality in the selections.