Bond Alternatives if Inflation is here to stay?

[DawgMan]

I know bonds get banged around here quite a bit and you have those, like me, who have made peace (although, continue to question) that bonds are a ballast and then others who have punted bonds in this low yield/inflationary risk environment. Over the last few years I have continued to simplify my generally 60/40 AA with a mix of equity (i.e. small/large/foreign growth & value) funds and mid/short term bond funds. I do have a smidgeon of preferreds & REIT funds. As a TR investor, I took a peek at my YTD total returns of my short & mid term bonds and they are returning 0% & -2.5% respectively, with preferreds hovering around 1%. This is all without any big Fed action. This has me scratching my head wondering if my bond allocation will still act as a ballast for the foreseeable future?? Should my bond allocation start including more inflationary hedges such as more REIT holdings, commodities, gold, other?? Should I allocate more into my HY Savings account as interest rates rise as part of my ballast? I have a little bit of new $$ I was going to throw into my fixed allocation, so I am having a hard time throwing it in bonds... hence, the impetus of this post.

As always, I will probably just stand there and do nothing!

Is it DIFFERENT this time What say you?

 

[njhowie]

As a TR investor, I took a peek at my YTD total returns of my short & mid term bonds and they are returning 0% & -2.5% respectively, with preferreds hovering around 1%.

Are you investing in bond funds or individual bonds?

"Total return" on my individual bonds is up like clockwork - for all maturities. I do/will not invest in any bond fund.

I have a little bit of new $$ I was going to throw into my fixed allocation, so I am having a hard time throwing it in bonds... hence, the impetus of this post.

As always, I will probably just stand there and do nothing!

Is it DIFFERENT this time What say you?

If you don't already have a treasury direct account and purchasing $10k/person/year in your household, consider doing it now. Guaranteed return on I-bonds is high right now and should inflation and/or interest rates head higher, so too will the guaranteed return. Current yield through year end is 3.54%, and that is free from state taxes. This would fall into your fixed income allocation.

 

[Dash man]

Investment grade corporate and taxable municipal bonds with 2-7 years maturity set up in a ladder is my approach.

 

[audreyh1]

I just don’t sweat my bond funds. Most of them I’ve held since 1999/2000 when inflation was much higher. As stocks go up I buy more. As stocks drop, which usually coincides with a drop in interest rates as well, I sell bonds to buy stocks. Rinse and repeat.

 

[JRon]

I have invested more in REIT’s than bonds lately. Any bonds are individual short term only bonds.

 

[DawgMan]

I just don’t sweat my bond funds. Most of them I’ve held since 1999/2000 when inflation was much higher. As stock go up I buy more. As stocks drop, which usually coincides with a drop in interest rates as well, I sell bonds to buy stocks. Rinse and repeat.

That is my most likely action, however, the thought of mixing in some alternatives as mentioned, arguably as further diversification, has crossed my mind. Increasing my REIT allocation in particular was a thought as perhaps a permanent part of my AA. Maybe 5% out of fixed to further diversify. Just banging around ideas.

 

[disneysteve]

I second the recommendation to branch out from funds to individual bonds. I've just started doing that myself this year. With an individual bond, you have a set rate. As long as you hold it until maturity (or call date if callable) you know exactly what your return will be. It doesn't matter what happens to interest rates.

 

[Montecfo]

I have reduced duration in my bond funds and invested in some alternatives, such as the Merger Fund (MERFX) 2.4 pct YTD and a closed end floating rate bank loan fund (FRA) +2.6 pct YTD, to combat low rates primarily though there is also some inflation protection.

I have some REITSs also as part of my equity portfolio and looking to add more. Also added oils to my equity portfolio over past 6 months.

If we do get high inflation, most equities equities will not be spared, FYI.

 

[tizod]

And I'd look into preferred shares, as these can be income that stays regardless of the external environment. Just gotta look at what you want, and there is much written on how to pick and what to look for. But things like NMK-C are, IMHO, a CD and pay 3%. Don't rise or fall with inflation, but good fixed income that would likely never be called. Nudge risk up a bit for higher ROI, of course.

 

[ERD50]

I second the recommendation to branch out from funds to individual bonds. I've just started doing that myself this year. With an individual bond, you have a set rate. As long as you hold it until maturity (or call date if callable) you know exactly what your return will be. It doesn't matter what happens to interest rates.

While this is true, doesn't it all come out in the wash over the long run?

Sure, a bond fund drops when interest rates rise, your bond does not. But that bond fund is also replacing the maturing bonds with bonds at a lower price and/or higher interest rate. Which is pretty much what you do with your individual bonds, but for the fund it happens regularly, which probably smooths everything out.

I don't know of any way to easily demonstrate that, but the logic seems right (please correct me if you see a hole n my thinking). Also, it seems that if this was true, any price deltas would get arbitraged out by deep pockets with fast computers. Plus, just buying the bond fund and re-balancing as part of withdrawals seems easier for us lazy types. And I like the diversification.

Like so many other things, I doubt there is a big difference in outcomes to either approach, but unless I can see a clear benefit, I prefer to stick with lazy and diversified.

-ERD50

 

[ERD50]

.... Guaranteed return on I-bonds is high right now and should inflation and/or interest rates head higher, so too will the guaranteed return. Current yield through year end is 3.54%, and that is free from state taxes. This would fall into your fixed income allocation.

Just to clarify, it looks like all of that 3.54% is the inflation portion. So what you call "Guaranteed return" is the inflation component. The real return is zero. Do I have that right?

https://www.treasurydirect.gov/news/pressroom/currentibondratespr.htm

I Bond Composite Rate of 3.54% includes a Fixed Rate of 0.00%

That might still make them a good choice as part of the fixed side, but I think at one time i-bonds were offering ~ 3% above inflation?

-ERD50

 

[UnrealizedPotential]

I also hold some mortgage reits. However, while the yield is nice and I think they provide some diversification from other sectors of the market, the returns can be less than appealing at times and they can be hit hard in a downturn like most everything. Still, I have reserved a place for m- reits in my portfolio for now, if ever a smaller, dwindling amount each passing year as a percentage of my portfolio.

 

[Dash man]

While this is true, doesn't it all come out in the wash over the long run?



Sure, a bond fund drops when interest rates rise, your bond does not. But that bond fund is also replacing the maturing bonds with bonds at a lower price and/or higher interest rate. Which is pretty much what you do with your individual bonds, but for the fund it happens regularly, which probably smooths everything out.



I don't know of any way to easily demonstrate that, but the logic seems right (please correct me if you see a hole n my thinking). Also, it seems that if this was true, any price deltas would get arbitraged out by deep pockets with fast computers. Plus, just buying the bond fund and re-balancing as part of withdrawals seems easier for us lazy types. And I like the diversification.



Like so many other things, I doubt there is a big difference in outcomes to either approach, but unless I can see a clear benefit, I prefer to stick with lazy and diversified.



-ERD50

It’s my understanding that bond funds can be forced into selling if there is a panic in the market, driving the prices down. The funds have to sell bonds at fire sale prices to raise cash to pay those bailing out of the fund. This doesn’t typically happen with individual bonds.

 

[njhowie]

Just to clarify, it looks like all of that 3.54% is the inflation portion. So what you call "Guaranteed return" is the inflation component. The real return is zero. Do I have that right?

https://www.treasurydirect.gov/news/pressroom/currentibondratespr.htm

Your understanding is correct. It's 0% in real terms. However, what are CDs and other fixed income getting you today in real terms?

Based on what is being discussed in the original post, in comparison to 0% to negative 2.5% (i.e negative inflation to negative (2.5% + inflation)) , any CDs, MM, or savings accounts that are available today, etc. the I-Bonds will be significantly better.

That might still make them a good choice as part of the fixed side, but I think at one time i-bonds were offering ~ 3% above inflation?

Sure - whatever the interest rate/"fixed component" is, that's how much above inflation it pays - by definition.

And again, I-Bond interest is free from state taxes - which may or may not be important to you (it is to me).

 

[njhowie]

It’s my understanding that bond funds can be forced into selling if there is a panic in the market, driving the prices down. The funds have to sell bonds at fire sale prices to raise cash to pay those bailing out of the fund. This doesn’t typically happen with individual bonds.

Absolutely. Maybe Freedom56 will chime in, as he is the resident expert on this topic.

 

[pb4uski]

.... I do have a smidgeon of preferreds... I took a peek at my YTD total returns of my ... preferreds hovering around 1%...

1% YTD doesn't jive with my experience. My preferreds portfolio has a YTD annualized return of 6.8% according to Quicken... so a YTD increase of about 2.8%. I've expanded my holdings dramatically over the last year to about 1/3 of my total portfolio.... about 52 tickers, 46% BBB- or better, 74% BB or better (preferred ratings are generally two notches lower than senior debt) with an average yield of 5.65%.

.... If you don't already have a treasury direct account and purchasing $10k/person/year in your household, consider doing it now. Guaranteed return on I-bonds is high right now and should inflation and/or interest rates head higher, so too will the guaranteed return. Current yield through year end is 3.54%, and that is free from state taxes. This would fall into your fixed income allocation.

Another option for long term ballast is EE Savings Bonds... while the only pay 0.1% or so, they are guaranteed to double in 20 years... so if in 20 years the accumulated balance is less than twice your initial investment the government tops them up to twice your initial investment... which equates to 3.57% annual interest. However the downside is that you need to hold for 20 years to get the bonus so they would be the ballast at the very bottom of the keel and purchase are limited to $10k/person/year.

 

[audreyh1]

That is my most likely action, however, the thought of mixing in some alternatives as mentioned, arguably as further diversification, has crossed my mind. Increasing my REIT allocation in particular was a thought as perhaps a permanent part of my AA. Maybe 5% out of fixed to further diversify. Just banging around ideas.

Just leave it alone and don’t mess with it. Tweaks are just as likely to make things worse as better. Just sit on your hands and follow the original plan.

 

[audreyh1]

It’s my understanding that bond funds can be forced into selling if there is a panic in the market, driving the prices down. The funds have to sell bonds at fire sale prices to raise cash to pay those bailing out of the fund. This doesn’t typically happen with individual bonds.

I’m probably buying more of the bond fund at these very moments for rebalancing, so works for me as I’m a long term investor. Temporary market panics are simply a rebalancing opportunity.

When one of my asset classes gets hit harder than others, I buy more instead of trying to avoid the hit ahead of time.

 

[VanWinkle]

I just don’t sweat my bond funds. Most of them I’ve held since 1999/2000 when inflation was much higher. As stock go up I buy more. As stocks drop, which usually coincides with a drop in interest rates as well, I sell bonds to buy stocks. Rinse and repeat.

+1

 

[Midpack]

If you don't already have a treasury direct account and purchasing $10k/person/year in your household, consider doing it now. Guaranteed return on I-bonds is high right now and should inflation and/or interest rates head higher, so too will the guaranteed return. Current yield through year end is 3.54%, and that is free from state taxes. This would fall into your fixed income allocation.

$10K/person/year is a trivial amount for most portfolios here (based on recent polls). I had TD account, but I sold off my I-bonds when they matured, not worth the accounting IMO. I'd be all over them if we could buy significant amounts...YMMV

I'm just sitting on my bond funds, as I don't see a compelling alternative, raking in the yields - better than cash at least. I did shorten duration a couple years ago. I'm a little concerned about what the NAV prices may do, but I don't have any need to sell them - probably for decades.

 

[njhowie]

$10K/person/year is a trivial amount for most portfolios here (based on recent polls). I had TD account, but I sold off my I-bonds when they matured, not worth the accounting IMO. I'd be all over them if we could buy significant amounts...YMMV

Let's not go down this path again as some folks did on the thread devoted to the topic, as it's not worth debating and polluting this thread.

 

[Midpack]

Let's not go down this path again as some folks did on the one devoted to the topic, as it's not worth debating and polluting this thread.

I noted YMMV. I wasn't hoping to debate or "pollute" anything. The recent poll made it clear $10K/person/year isn't significant to many here - simple observation.

 

[ERD50]

$10K/person/year is a trivial amount for most portfolios here (based on recent polls). I had TD account, but I sold off my I-bonds when they matured, not worth the accounting IMO. I'd be all over them if we could buy significant amounts...YMMV...

Let's not go down this path again as some folks did on the thread devoted to the topic, as it's not worth debating and polluting this thread.

I noted YMMV. I wasn't hoping to debate or "pollute" anything. The recent poll made it clear $10K/person/year isn't significant to many here - simple observation.

I'm with Midpack on this one. Geez, what he pointed out sure seems relevant, and I personally found it useful.

What's with trying to shut down discussion?

For some context, as I was reading this thread, I agreed, the ~ 3.5% current iBond rates look attractive. I like diversification, so getting some money in an inflation hedge like that has a certain appeal.

But Midpack's comments were along the line of my thinking (though I wasn't sure w/o checking) - I've worked recently to simplify my accounts. This would add another account (not a big deal, but I like simple). And at $20K/year for a couple (I assume that is per spouse?), it hardly seems worth the effort to me. Others certainly may feel differently, and that's fine - it's just my personal preference.

-ERD50

 

[disneysteve]

While this is true, doesn't it all come out in the wash over the long run?

Sure, a bond fund drops when interest rates rise, your bond does not. But that bond fund is also replacing the maturing bonds with bonds at a lower price and/or higher interest rate. Which is pretty much what you do with your individual bonds, but for the fund it happens regularly, which probably smooths everything out.
-ERD50

That may be true. I am by no means an expert on this topic. Most of our bond money IS in bond funds. I've only recently started dipping into individual bonds at least partly to get a feel for how the market works and how it differs from funds.

I do know enough to understand that rising interest rates will decrease the resale value of my individual bonds but have zero impact on the yield as long as I continue to hold them. So unlike a bond fund that has a YTD return of -2.5% as mentioned by the OP, individual bonds will always have a positive yield and I know exactly what it will be because it is a fixed amount.

 

[foxfirev5]

Wow. Some of the comments here. I know plenty of decamillionaires and can't think of one who would say that 10k is insignificant.