Bond Funds? Question about Rational Investing

[Mr._johngalt]

That's because some bonds ARE high risk. Why would you think being 100% in bonds can't be high risk?

I don't. Just did it for the predictability (of income). Also, I'm not too
sure if they got this off my "questionaire" or if it was determined
by some internal "formula". Either way, I don't care as it wouldn't
have any impact on my investing habits.

JG

 

[Nords]

Bear in mind that Nords' views on this are a little, um, unorthodox and more than a little colored by his sizable gummint pension.

Yup.

For the rest of us, an all-equity portfolio is almost certainly a bad idea.

Someday I'd like to see a Bernstein-style comparison of the volatility & returns of two types of portfolios:
1. 80% stock/20% bond
2. 90% stock/10% cash.

 

[brewer12345]

Someday I'd like to see a Bernstein-style comparison of the volatility & returns of two types of portfolios:
1. 80% stock/20% bond
2. 90% stock/10% cash.

I don't like those portfolios either. Where are the;

Commodities
Non-USD bonds
REITs
etc.?

 

[saluki9]

Yup.
Someday I'd like to see a Bernstein-style comparison of the volatility & returns of two types of portfolios:
1. 80% stock/20% bond
2. 90% stock/10% cash.

I'm certainly NOT bernstein but I do have some fairly expensive software tools at my disposal with a lot of market data in them.

Here is the short answer from 1/1/1978 (the start of my lehman bond index data) Plugging in Treasury data from 1926 - 2006 didn't change much of anything

90/10 (cash) Month Sdev = 3.89% Monthly Ret = 1.06

80/20 (Govt Bonds) Sdev = 3.56% Monthly Ret = 1.03

60/40 Sdev = 2.84 Monthly Ret = .96


Equities = S&P 500 Cash = 3 Month Tbill Bonds = Lehman 1-30 govt index

 

[yakers]

I don't like those portfolios either. Where are the;

Commodities
Non-USD bonds
REITs
etc.?

brewer,

I expect to retire late next year and at that time I would be able to move some of my deferred compensation from the Govt TSP to an IRA. I would still keep the bulk of my funds in the TSP Lifecycle Fund which is made up of Large & small cap & total international stocks and total bond fund. There is also an allocation to a risk free short term bond fund, a great risk reducer. I am pretty much set with Vanguard so I would prefer to go with their funds. I was anticipating just using the VG Global Equity (VHGEX) to increase foreign holdings. Do you have any suggestions on how to add your suggested diversifiers to a portfolio through VG funds?
In theory I would like to add REITs, I am not a market timer (I will repeat I am not a market timer 100 times to myself ) but I find it difficult to buy into REITs at what I see as their peak. And commodities have had a good run and may be at peak, well, what isn’t?
So I already have what could be considered substantial diversification but I have this particular opportunity to further diversify.

 

[brewer12345]

brewer,

I expect to retire late next year and at that time I would be able to move some of my deferred compensation from the Govt TSP to an IRA. I would still keep the bulk of my funds in the TSP Lifecycle Fund which is made up of Large & small cap & total international stocks and total bond fund. There is also an allocation to a risk free short term bond fund, a great risk reducer. I am pretty much set with Vanguard so I would prefer to go with their funds. I was anticipating just using the VG Global Equity (VHGEX) to increase foreign holdings. Do you have any suggestions on how to add your suggested diversifiers to a portfolio through VG funds?
In theory I would like to add REITs, I am not a market timer (I will repeat I am not a market timer 100 times to myself ) but I find it difficult to buy into REITs at what I see as their peak. And commodities have had a good run and may be at peak, well, what isn’t?
So I already have what could be considered substantial diversification but I have this particular opportunity to further diversify.

Since you are just looking to "fill in" the holes in the Lifecycle fund, it shouldn't be too hard. But you will have to look beyond VG funds for some of it. I would add:

- Non-USD bonds: VG doesn't have such a fund. The best available choices (IMO) are GIM (a closed end fund) and BEGBX.
- Commodities: No VG option. Pick PCRIX or DJP (exchange traded fund equivalent).
- REITs: I would add a little (maybe 5%), using VGSIX or VNQ.
- Other: you might consider adding a smidge of alternative stuff. As a diversifier, maybe a bit of MERFX.

 

[FIRE'd@51]

FYI, I have 25% of my portfolio in CA muni bonds. This year, I have a 5.53% capital return to date with an average 3.25% dividend on top of that. So my total return to date is 8.78% (tax free).

Realized capital gains are taxable, even for muni's.

 

[Dawg52]

Since you are just looking to "fill in" the holes in the Lifecycle fund, it shouldn't be too hard. But you will have to look beyond VG funds for some of it. I would add:

- Non-USD bonds: VG doesn't have such a fund. The best available choices (IMO) are GIM (a closed end fund) and BEGBX.
- Commodities: No VG option. Pick PCRIX or DJP (exchange traded fund equivalent).
- REITs: I would add a little (maybe 5%), using VGSIX or VNQ.
- Other: you might consider adding a smidge of alternative stuff. As a diversifier, maybe a bit of MERFX.

Brewer, I own a little DJP and just had a small cd mature. As you know, oil has had a pull back recently and wondered if now is a decent time to add to DJP? I've got a ways to go to get to a 5% allocation to commodities. Beginning to sound like a dirty market timer.

 

[Nords]

I'm certainly NOT bernstein but I do have some fairly expensive software tools at my disposal with a lot of market data in them.

Here is the short answer from 1/1/1978 (the start of my lehman bond index data) Plugging in Treasury data from 1926 - 2006 didn't change much of anything

90/10 (cash) Month Sdev = 3.89% Monthly Ret = 1.06

80/20 (Govt Bonds) Sdev = 3.56% Monthly Ret = 1.03

Hey, thanks, Saluki, I've been wondering about that ever since I finished reading "Four Pillars".

The numbers seem to imply that ditching bonds for equities & cash raises returns by about 3% while volatility goes up by about 9%.

Of course even 3.56% monthly SD may be more than most investors care to put up with.

Does "Monthly Ret = 1.06" imply a compounded annual return of [1 + 1.06%]^^12 = 13.5%? Yikes.

 

[brewer12345]

Brewer, I own a little DJP and just had a small cd mature. As you know, oil has had a pull back recently and wondered if now is a decent time to add to DJP? I've got a ways to go to get to a 5% allocation to commodities. Beginning to sound like a dirty market timer.

You pays your money and you takes your chances. I maintain about an 8% allocation to commodities and I am not bothered by the level of commodity prices, since i have others things that will go up when commodities drop (and vice versa).

 

[Dawg52]

You pays your money and you takes your chances. I maintain about an 8% allocation to commodities and I am not bothered by the level of commodity prices, since i have others things that will go up when commodities drop (and vice versa).

I wanted a guarantee.

 

[brewer12345]

I wanted a guarantee.

Funny, I didn't think I look like Cramer.

 

[Dawg52]

Funny, I didn't think I look like Cramer.

Hmmmm........somewhat similar.

 

[saluki9]

Hey, thanks, Saluki, I've been wondering about that ever since I finished reading "Four Pillars".

The numbers seem to imply that ditching bonds for equities & cash raises returns by about 3% while volatility goes up by about 9%.

Of course even 3.56% monthly SD may be more than most investors care to put up with.

Does "Monthly Ret = 1.06" imply a compounded annual return of [1 + 1.06%]^^12 = 13.5%? Yikes.

Yep, thats a geometric compounded annualized return.

Let me know if there is anything else you want to see, I can plug them in pretty quickly.

 

[JohnEyles]

- Non-USD bonds: VG doesn't have such a fund. The best available choices (IMO) are GIM (a closed end fund) and BEGBX.

FWIW, Morningstar has an article of int'l bond funds right now titled
"International Isn't Just for Equities". After reading the article I bought
some LSGLX (Loomis Sayles Global Bond).

 

[yakers]

Thanks brewer, those were some good funds and more importantly, thoughtful. I will check back in a year when I actually have to make a decision but I expect I will at least add some VGSIX as it neatly has a negative corelation with my other holdings so even though it may be high it could do what it is supposed to do in my "portfolio". The other ideas I will have to see how I would hold them (IRA trading account at VG?) I closed my Quick & Reilly account after a short and slightly successful trading experience.

 

[brewer12345]

The other ideas I will have to see how I would hold them (IRA trading account at VG?) I closed my Quick & Reilly account after a short and slightly successful trading experience.

I believe that VG will happily set you up with a brokerage account.

 

[mathjak107]

All of that may be true mathjak but for us fund buyers the Vanguard TIPS fund has beat the Vanguard Bond Fund 7 out of the last 10 years and that is why (aside from the inflation protection) that it is part of my bond portfolio.

well last year tips had an aberation , this year fidelity inflation proof securitie are flat. most intermediate term funds are up around 2.5-3% with longer term up even more.

the past is no indicator of the future as they say and i dont trust the manipulation of that index.

 

[wabmester]

i dont trust the manipulation of that index.

Oy. It's good not to trust your government, I guess. But the CPI-U calculation is 100% transparent. You can go see for yourself exactly what comprises the basket of goods, what their weights are, how the prices have changed, etc.

Furthermore, the treasury is bound by law to protect TIPS owners from any changes in how the index is calculated. If it changes, TIPS investors will either continue to use the old index or will otherwise be compensated for the change.

Paranoia has its place, but the bond market tends to be smart about these risks....

 

[JohnEyles]

the penalty in interest you give up in economic climates like now for the inflation insurance is toooooo high too.

Folks. I've been wondering and thinking about these TIPS for awhile. The return
of inflation plus 2.375% doesn't seem so appealing (but of course it's the "safe"
portion of your portfolio - hopefully the equity allocation has far better returns).
However, if you do a simple withdrawal spreadsheet, you find that inflation plus
2.5% is really good enough for a 4% SWR over 40 years **IF** the return is
flat (consistent from year to year). Of course, this is what TIPS gets you, the
consistency. So it seems pretty appealing to me. But how do you make this
work in real life, since you obviously must get some of the principal out in order
to actually withdraw 4% ?

To see how this might work, I've put together a spreadsheet that shows laddered
5-year TIPS, staggered a year apart. The PDF is attached here (I'm not quite
sure how to make the XLS file available if folks wish to mess with it themselves.
I trimmed it a bunch so it'll fit on one page, so the basic parameters for the run
below are 3.5% inflation, nestegg $100K, inflation-adjusted withdrawal of 3.75%,
and a TIPS coupon of 2.375%. I'm making simplifying assumptions, such as
the coupon rate will be the same on all TIPS purchased til the end of time, that
inflation will be a flat 3.5% until the end of time, that TIPS mature and are
purchased (at auction) on December 31 of each year, and that they are always
purcahsed at par value. It'd be nice to random vary inflation and TIPS cost, but
my Excel kung-fu is not strong enough at this point; I think it's fair to say that
such variations would not be as devastating to portfolio survivability as variations
in return are to an equity portfolio.

The basic prescription is: At end of 2006, five TIPS of 1-5 year maturities are purchased
by equally dividing the lump-sum minus the year-2007 payout. At the end of each
subsequent year (starting with 2007), one of the five TIPS will mature. Take the
proceeds, plus the year's accumulated interest from all five TIPS. Set aside the next
year's payout and buy a new 5-year TIPS with the remaining amount.

As you can see, this 3.75% payout lasts almost 40 years. At some point, one of the
maturing TIPS fails to cover (together with the years interest on all 5) the payout for
the coming year; but of course, the other 4 can be prematurely liquidated to eke
out another year or so. (There's a little built-in pessimism for algorithmic convenience -
the paid out interest isn't earning any return while it's waiting to be spent the following
year, and the current year's payout is set aside at the end of the previous year and
earning no interest). Interestingly, I can vary the inflation number fairly wildly (1-6%)
and the payout time remains almost identical - so I guess the TIPS works as advertised !

A 4% payout lasts about 35 years. A 5% payout last about 25 years.

Please don't think I'm trying to hijack this into a SPIA debate, but the TIPS
ladder IS a sort of self-annuitization. How does it stack up against a SPIA (for me) ?
Currently, Vanguad/AIG quote represents about 4.2% for a 53yo male. That's
inflation adjusted life-only. To be fair, I should compare against SPIA with a
guaranteed period; a 30-year guarantee cuts the payout down to 3.78%, nearly
the same. The TIPS ladder has the huge advantage of being able to end the annuity
and get my principal out at any time - although this could be very disadvantageous
if interest rates are high when I might want to do so. Also, the TIPS is a bit more
secure, being guaranteed by the USA rather than AIG, and with no 10% cap on
CPI adjustment.

So, I think I have more or less mathematically convinced myself that a TIPS ladder
is a better idea than a SPIA - what many have been saying here for awhile. It's too
bad the coupon ain't a WEE bit higher, or it'd be a no-brainer.

 

[mathjak107]

well i dont want to start the ole cpi discussion again but for my own inflation rate the cpi -u is to low. its been toned down by about 2-3% less than living is costing me....
when somethings to high,drop it from the index or change its definition...

you know the drill!

 

[wabmester]

well i dont want to start the ole cpi discussion again but for my own inflation rate the cpi -u is to low. its been toned down by about 2-3% less than living is costing me....

Gotcha. So, please let us know the list of investments that guarantee a return relative to our individual personal rates of inflation, and we'll buy those instead.

Sheesh. The entire investment universe uses the CPI as the de facto gauge of inflation. You need to compare TIPS to nominal bonds, not to your personal expenses. If you want to use some other measure of inflation, it's up to you to convince the market to stop looking at the CPI.

 

[mathjak107]

ahhhhhhhhhhh if only we could come up with a different index..

actually i forgot who the famous economist was who came up with it but it was called the PIZZA INDEX

Supposedly it tracks a real world inflation rate.

lets see when i was a kid pizza was .15 ,im 54 , today its 1.50

by the same token ice cream too was .15 today its 1.50

the nyc subway was .15 now its 2.00


gas was .31 so i guess that should be 3.10 so we are actually getting a bargain.

 

[FIRE'd@51]

John,

I think you've done a nice piece of analysis. The 5-year ladder seems to be a reasonable way to approach the problem. By using maturing TIPS to receive your principal payments, you appear to avoid the price-risk associated with selling TIPS in the secondary market. The biggest problem I see with this approach, and I'm not sure how to solve it, is the roll-over risk as the TIPS mature. Your analysis assumes each new 5-year TIP will have the same coupon, but in reality this is not the case since real interest rates move around quite a bit. The first 5-year TIP (actually 5.5 yrs) was issued in October of 2004 and had a coupon of only 0.875%. This issue roughly coincided with the bottoming of short-term interest rates around the time the Fed began to raise rates. The most recent issue, which you plan to purchase on the reopening Monday has a coupon of 2.375%, and looks like it will be issued at a price which will give a YTM of about 2.6%. But what happens when the Fed enters it's next easing cycle and short-term rates begin to go down. Who knows what will happen to real rates. What if you have to replace a maturing 2.375% or 2.50% coupon with a 1.25% coupon? This would result in having to withdraw more principal to get your 3.75% SWR, which in turn will shorten the life of your TIPS ladder program. Of course, real rates can move up as well, so on average, it may still work out. However, your proposed methodology definitely introduces the path-dependence of real interest rates into the equation. This is a lot like a bunch of bad years in the beginning of ER messing up the program. This path dependence goes away with an SPIA, with an extra cost to the buyer, of course.

Yes, a higher coupon would be nice. I guess the buyers of the 30-year TIPS issued in 2000 with coupons of 4.25% and 3.875% are feeling pretty good now.

 

[donheff]

John,

I think you've done a nice piece of analysis... The biggest problem I see with this approach, and I'm not sure how to solve it, is the roll-over risk as the TIPS mature. ... The first 5-year TIP (actually 5.5 yrs) was issued in October of 2004 and had a coupon of only 0.875%....Who knows what will happen to real rates. ...your proposed methodology definitely introduces the path-dependence of real interest rates into the equation. This is a lot like a bunch of bad years in the beginning of ER messing up the program. This path dependence goes away with an SPIA, with an extra cost to the buyer, of course.

From your earlier posts I get the impression you are looking for an assured income stream but it doesn't appear to exist. The TIPS approach gives you unlimited inflation protection (yes, only as reflected in CPI Mathjack) with a full faith of the US guarantee but leaves substantial uncertainty about the available coupon rates as the TIPS are replaced. The SPIA gives you certainty of income up to 10% CPI with a slight degree of risk about the guarantee (e.g. likihood of company bankruptcy - state guarantee).

It looks like we need Saluki to run numbers showing the variations of expected coupon rates vs inflation rates over 10%. Since TIPS are new (aren't they?) there won't be historic coupon rates but they could probably be projected backwards by matching the ones we have against a bond index??