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I see bond funds as a nice stabilizing force within the overall retirement portfolio. They act to reduce volatility. I see them as one element of an overall balanced portfolio.
My portfolio is designed for a longer time horizon, 30 years in retirement, and takes my risk tolerance and very long term goals into consideration.
Your plans may be different from mine.
The portfolio design I have developed uses low cost index funds for stocks and low cost bond funds. The following breakdown of asset classes is used to guide the portfolio construction, as
my target allocations:
• 55% stocks / 45% bonds and cash. This is close to an optimum compromise between volatility and growth over time.
• Stocks are divided to 70% US-based and 30% foreign to minimize volatility. See the Efficient Frontier diagram below.
• 80% of the US-based stocks are in the Total Stock Market fund, and 20% are placed in a Small-Cap Value fund, to try and take advantage of the Fama-French Three Factor Model.
• Bond funds are split roughly half in an Intermediate Term bond fund, half in a US Treasury Inflation Protected Securities (TIPS) fund, and a cash reserve. The TIPS find is exempt from state tax, and is held in a taxable account. The Intermediate Term bond fund is subject to state and federal taxes, and so is sheltered from taxes in an IRA account.
• If additional Intermediate Term bond funds are needed, and the IRA is full, put this allocation into a State Intermediate Term Tax-Exempt bond fund in a taxable account.
• About 5% of the portfolio should be in a cash reserve. This is drawn upon monthly over the course of a year to provide our monthly spending money and cover irregular annual expenses. Cash may be in a money market fund or for funds not needed for over a year, in a short term bond fund.
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Given this portfolio design, and allowing for a shift in value before needing rebalancing of up to 25%, I have the following allocations worked out using low expense Vanguard funds. Holding limits as minimum to maximum values of the entire portfolio are in parenthesis.
• Cash - Vanguard Prime Money Market Account 5%
• Vanguard Intermediate Term Bond Fund (VBILX) 20% (15% - 25%)
• Vanguard Inflation-Protected Securities (VAIPX) 20% (15% - 25%)
• Vanguard Total Stock Market Fund (VTSAX) 30.8% (23.1% - 38.5%)
• Vanguard Small-Cap Value ETF (VBR) 7.7% (5.78% - 9.63%)
• Vanguard FTSE All-World Ex-US ETF (VEU) 16.5% (12.38% - 20.63%)
This was developed as part of
my overall
Investment Policy Statement.
I recommend that everyone investing for some future goals develop such a statement, and pull it out every time one is planning on making a significant change, just as a little reminder.