Bond Allocation

[kenepp1]

I plan to RE in the next year at age 62. With my wife's retirement, plus my SS giving us 50% of what we need, I am thinking I don't need the standard 40 to 50% of my investments in bonds. I still would allocate the other assets. I still have a house payment, but it is low. Inputs?

 

[mickeyd]

Hey Kenepp1,

I suggest that you review your asset allocation. If pensions/ss will provide you with a larger cash flow than you previously thought, perhaps you may wish to increase your equities position.

You mention the "standard" 40 or 50% bond allocation. I do not know of any standard allocation in either
stocks or bonds, as everyone has a different need and, if we are held to a standard, many of us would not be properly allocated.

Asset allocation is an issue for you alone to finally decide, depending on your situation.

 

[azanon]

To reduce risk, i'd consider another option besides bonds right now, if it were me.  Right now, bonds arnt that attractive with interest rates as low as they are, and with them rising.  Interst rates really have only one way to go.  When the prime rate rises 1%, bonds drop 10%.  In this situation, your principal may decrease faster than you can earn interest.

 

[Cut-Throat]

To reduce risk, i'd consider another option besides bonds right now, if it were me. Right now, bonds arnt that attractive

Please tell us the other option

 

[charlie]

Hey kenepp1,

IMHO, you should set a stock/bond mix that will give
you the return you need to cover your unfunded
expenses for the time period that you need, with a
withdrawal rate that gives you a high probability
of success. FIREcalc is a good tool to give you a
feel for the correct mix. If you are in the accumulation
phase, then 110- your age is a good place to start
your stock allocation.

If you have a low tolerance for stock market fluctuation,
and can cover your needs with a low stock allocation,
then by all means do what lets you sleep at night.

Personally, at age 70, I use a 60/40 stock/bond mix
because I need to take the risk and can handle the
volatility, thank God.

Cheers,

Charlie

 

[charlie]

azanon,

I hate to be picky, but the amount a bond changes
depends on its maturity date. For example, a
bond fund with an average duration of 2 years will
change 2% for every 1% change in interest rates.
A fund with a duration of 5 years will change 5%, etc.

BTW, rising interest rates are not all that bad if you
reinvest your dividends. Eventually, the increase in
interest rate will offset the loss of NAV. Another way
to look at it is that a fund's duration is the length of
time it would take the fund to recover the initial loss
of NAV due to a rise in interest rates.

That having been said, IMHO at least a 1% rise in
interest rates has already been discounted by the
market. That's why you saw a recent rally in long
term bonds on fear that the economy may have
peaked.

Cheers,

Charlie

 

[azanon]

Looking at the LBA Bond Index, bonds have eared 0.30% since the end of June for the last 12 months preceding (dont have July data on me).  Not so hot.  The rates were steady, then climbed during that period.  Conversely, the two years previous rates dropped quite a bit, and as one would suspect, bonds did quite well.

Correction noted; yes i should have said long-term bonds.  Still, since bonds essentially make money by the rate they pay, and from interest rate changes that sometimes work in their favor, i'd personally try to avoid them when a good portion of its change is almost certain to go south (due to the prime rate likely to climb again).

What would i pick?  Short-term US Treasuries.  Again, i see the main purpose here (in this environment) to preserve principle and offset the stock risk.  Seems it defeats that purpose if you're buying intermediate term or long-term bonds now.

 

[db]

kenepp1,

Putting Charlie's response another way, I would determine how much I plan to draw from my portfolio annually, then keep some number of years of that amount in fixed income assets. I use 10 years. If you plan on a 4% draw, that works out to about a 60/40 split; 3% a 70/30 split. Of course, you can increase or decrease the number of years, depending on your sensitivity to the risk of selling equities in a down market. The interaction between the number of years and the withdrawal rate will drive the equity/fixed income split.

db

 

[ESRBob]

Kenapp,
An alternative approach that I follow is to break away from the simple 'Stock/Bond' dichotomy to something that is "Stock/Bond/Other". In the Other category I put the following: (you may choose differently)
Private Equity, Commodities, Commercial Real Estate, Oil and Gas, Market Neutral Hedge Fund and possibly Precious Metals (I don't have precious metals but many do -- they reduce short term volatility but have poor long run returns).

If nothing else, this exercise will cure you of following simple Stock/Bond ratios which the investment community so loves us to stay stuck in. After all, every one of them involves a traded security (pretty much).

One thing you can do in your Other category is take on illiquid investments which pay well but don't let you bail out on short notice (e.g. owning a bit of a medical office building is my favorite), or owning directly in oil and gas wells (haven't had the guts for it myself, but lots of smart people do this). The beauty of these investments is that they will tend to correlate only loosely with the stock and bond markets, helping you reduce overall volatility in your portfolio. Gillette Edmunds makes a pretty persuasive case for this in his early retirement book.

Illiquid investments do involve more risk, but I feel that ERs with our long horizons and no need for ready cash can first carefully research for quality and then take on risks like this if we limit any single investment to no more than say 3% of our portfolio.

ESRBob

 

[wabmester]

What would i pick?  Short-term US Treasuries.

In case it wasn't obvious, short-term treasuries are the same as t-bills, which are the stuff of money market accounts. So, you're basically saying that cash is king, which might be true if inflation weren't 2 points higher than T-bill rates.

A lot of people talk about what will happen "when interest rates rise." I can only guess that they're talking about the Federal funds rate. A common misconception appears to be that when the fed raises the funds rate, all bonds are hit according to their duration. Not so.

Duration is context sensitive. So, if a long-term muni bond fund has a duration of 10 years, that means it will drop 10% if the market rate for long-term munis goes up 1%. The federal fund rate is a driver of short-term rates, not long-term rates. So if the fed raises rates 1%, long-term munis (for example) may do absolutely nothing. As Charlie says, a lot of rate change expectations are already built in.

Ironically, the funds that will probably be the hardest hit by a fed funds rate increase will be short-term bond funds, at least initially.

 

[azanon]

In case it wasn't obvious, short-term treasuries are the same as t-bills, which are the stuff of money market accounts.   So, you're basically saying that cash is king, which might be true if inflation weren't 2 points higher than T-bill rates.

Money Market accounts can be composed of a variety of debt type instruments, T-bills being one of them.  Money Market mutual funds come in all kinds of varieties and flavors, and it is very ameteurish to equate them with T-bills.

However, I must assume since you're disagreeing with me, your default position is supporting bonds so lets compare the recent numbers shall we?   From June 03-June 04, the LBA Bond index earned 0.3% (which i stated above).  From June 03-04, T-bills paid a return of 4.29%.  Futher, bonds have far more future interest rate risk as well as the default risk whereas T-bill interest rate (change) risk is negligible and has no default risk.

BTW-  thinks for educating our audience; a short-term treasury is often referred to as a "T-Bill".

So, if a long-term muni bond fund has a duration of 10 years, that means it will drop 10% if the market rate for long-term munis goes up 1%.

Who said anything about munis.  I thought we were talking corporate.

Ironically, the funds that will probably be the hardest hit by a fed funds rate increase will be short-term bond funds, at least initially.

If you're comparing them to munis, maybe so.  but to long-term corporate bonds?  You're dreaming.

 

[wabmester]

azanon, munis were just an example of one of the many instances in which long-term rates will be and have been relatively uncorrelated to fed fund rate changes.   If you want to talk about corporate, look at high-yield corporate bonds for another class that won't be much affected by short-term rate changes.

The bottom line is that short-term rates currently have a negative real yield for the most part.   And fed fund rate changes will directly impact short-term rates.   Of course, the impact will be relatively short-lived as the short-term bonds mature and are replaced by new ones.

Long-term bonds have built-in expectations about *long-term* trends in inflation and real interest rates.   Bond traders are not stupid.   If they think interest rate changes are imminent, those changes will be priced in well before the changes occur. That's why the yield curve is so steep right now.

 

[charlie]

Hot damn I love a spirited discussion. Sometimes
we need to be reminded of things like wab's comment that long term rates and short term rates are not
necessarily in lock-step.

Cheers,

Charlie

 

[brewer12345]

Maybe this has something to do with my profession, but I tend to look at my asset portfolio as a way to hedge/offset my liabilities. Most of the short term stuff (mortgage, living expenses, etc.) I assume is satisfied by current wages. So my other liabilities are very long duration: paying for college for my 1 month old and her as of yet non-existant sibling(s), ER (to be paid out over ~40 years and doesn't start for 15 or 20 years), satisfyinf estate tax obligations, etc. When I look around for appropriate long duration assets to match these liabilities, I have a choice of everything from cash to long bonds to equities to other. Cash and short bonds are clearly inappropriate, except for necessary liquidity requirements (e.g. emergency fund). Most bonds are too short for my liabilities (treasuries don't go out more than 10 years and I am not confident of my ability to forecast a company's creditworthiness for the next 25 or 30 years). So what is left? Equities, mostly. Its not primarily to do so, but my significant mortgage is effectively a large short position on the bond market, with duration of roughtly -5 and significant positive convexity, which serves to lengthen my overall asset duration.

I will eventually start looking around at "other", but mot of these assets really require lots of specialized knowledge. As I get closer to payout and my liability duration starts to shorten, I will start rethinking shorter duration assets, but until then...

 

[cute fuzzy bunny]

*I* have significant positive convexity.

 

[Cut-Throat]

Like TH, I admit I am a Bond Idiot. The more I learn, the dumber I feel about Bonds.

Does anyone know of a good book for the Bond side of the portfoilo. (e.g. Constructing ladders, I-bonds, Savings Bonds, TIPS etc.) Strategies etc.

 

[cute fuzzy bunny]

Its a darn moving target too. I was just warming up to the idea of lousy returns on ibonds and tips, and ran across an entire raft of experts who claimed both were awful ideas and they're buying EE bonds.

I'm just gonna stick with the short term corp, what the wellington peeps are buying in my wellesley fund, and if interest rates pick up, I'll have another look at ibonds, tips and the total bond market fund.

The 3.5% returns on the intermediate term california muni fund are starting to look good to me too.

 

[unclemick]

Also the book should cover convexivity - something else I vaguely remember I don't understand.

 

[unclemick]

On second thought - after using web crawler - I remember why I stick with bond funds. Convexity can lie in peace.

 

[haha]

Most bonds are too short for my liabilities (treasuries don't go out more than 10 years and I am not confident of my ability to forecast a company's creditworthiness for the next 25 or 30 years).

Brewer, I don't understand. Since equities are the longest duration of all, and since all debt is senior to equity, how can you feel confident buying equity, if you don't feel that you can assess long term credit worthiness? If the concern isn't credit worthy, surely the equity must be even less predictable.

Mikey

 

[wabmester]

Brewer, congrats on the little girl.  Ours just turned 16 months, and she's an absolute blast.

TH, try a low-carb diet to take care of that positive convexity problem.

Cut-Throat, try a book called simply "The Bond Book."  I haven't read it myself, but I've heard nothing but praise.

UncleMick, I've only heard of convexity as it applies to mortgage-backed bonds.   IIRC, negative convexity means duration will extend as interest rates rise due to the dearth of refinancing activity.   So, mortgage-backed securities get hit harder than you'd expect when rates rise.

And, yeah, mortgages are like shorting long-term bonds, but they come with a free put option.

 

[cute fuzzy bunny]

F--- low carbs diets!

I'm low fat, mostly vegetarian. I like the variety of veggies and grain products. Especially around here...there are still a few dozen types of vegetable products I havent even tried yet. Had Chayote squash as a side dish tonight. Nice...kinda like a cross between summer squash and zuch.

The preponderance of posterior isnt so bad. I'm just trying to regain my 21 year old proportions and finally coming to terms with the fact that it aint gonna happen.

I liked being in the 190-200 range. At 240 I feel positively porky. Maybe I should just look into ways to increase my height a few inches rather than reducing my diameter.

I actually lost 20lbs when I went back off the mostly meat diet, but I put it back on when the wife began demanding huge quantities of meat products at the beginning of the pregnancy. I believe I characterized it as jabba the hutt yelling "bring me steak and eggs for breakfast!". Except she's WAY prettier than jabba the hutt.

I just hate it when I rub the expectant mother to be's tummy and cheerfully burble "baby!" and she pokes mine and says "food baby!". Its worse when she stands there holding her hand on it and says "I think I felt it kick!"

Mortgages also have a call option. I've got a 140k in HELOC I can employ anytime I want to. In the meanwhile, I've got a quarter mil in the frickin short term corp fund scraping out a match to inflation. I wish I had another mortgage to pay off with that money for double the return.

 

[wabmester]

F--- low carbs diets!

I'm not an expert on nutrition, but I play one on TV (err, I mean, I studied biochem at one point in the last millennium).

Here's a pretty non-controversial hypothesis: if you have high triglycerides in your blood stream, your carb intake is probably responsible for much of your rotundity. A simple blood test will tell you whether it's worth checking into. Mine were outrageously high for years. I cut out sugar and starch (including pasta, starchy veggies, etc) for a few weeks, and my triglycerides fell to a normal level, and I dropped about 10 lbs.

It's all about liver function and insulin. Your body cranks out insulin in response to high blood sugar. This works fine when you're a youngster, but if you have continuously high blood sugar (i.e., consume lots of carbs), eventually your cells are awash in insulin, and they become resistent (you start losing insulin receptor sites).

Eventually, this can lead to diabetes, but before you get there, you just start converting the carbs to triglycerides all day, which eventually get stored as fat after they're done blocking your arteries.

Aren't you glad the concept of "off-topic" doesn't exist here?

 

[gayl]

Went to an investment 'seminar' yesterday re: bonds. Schwab is advising that we stick to shorter terms, ie: 2-3 yrs, to somewhat guard against interest rate increases. Then they proceeded to tout their short-term fund paying 2.2% per annum. Then they went on to talk about barbells vs laddering. Guess I need a book, as all I came away with is that I do better in the 457 General Acct (paying 5.5% this year) then I'd do in bonds. I know the 'experts' advise bonds in the portfolio, but when I can get such returns with the general acct, can you give me a reason why I should switch?

 

[Cut-Throat]

as all I came away with is that I do better in the 457 General Acct (paying 5.5% this year) then I'd do in bonds. I know the 'experts' advise bonds in the portfolio, but when I can get such returns with the general acct, can you give me a reason why I should switch?

Do you know what kind of investments are in your Acct that are paying the 5.5% return?