By Dr. James M. Dahle, WCI Founder
Most of the time on this blog we talk about stuff that really matters—things like your income, your savings rate, and your overall asset allocation. However, occasionally we get into the weeds and talk about stuff that only matters a little, if at all. And maybe doesn't even have a correct answer. Today is one of those days. We're going to talk about what bond fund or funds you should hold in your portfolio.
Should You Hold a Bond Fund?
There are two prerequisite issues we need to get out of the way before we get started. The first is whether you should hold bonds at all. We're not going to discuss that today, but if you are unclear on this issue, I would recommend these posts:
The second issue to address is whether or not you should use a bond fund at all. I think bond mutual funds are a great way to own bonds. They provide:
- Professional management
- Daily liquidity
- Massive bond diversification
- Economy of costs
However, there is an alternative. You can simply own the individual bonds (or CDs) yourself. Some people like to do this because it guarantees (at least as much as whoever is backing the bond can guarantee it) that when the bond matures you will get back all of your principal and all of the interest due, at least in nominal terms. I generally think this is a terrible idea for corporate bonds and a bad idea for municipal bonds. Diversification and liquidity in both of these categories is well worth the additional (but still trivial) cost of a good bond fund. With treasury bonds a better argument can be made to purchase them individually, particularly if you are buying them in a taxable account directly without fees from TreasuryDirect. However, that's a pretty tiny percentage of investors who want to buy individual treasuries and want to buy them in a taxable account.
So before we move on, let's assume that you, like me, actually want to own bonds and actually want to own them in the form of a bond fund.
Do Bonds Belong in Taxable Accounts or Retirement Accounts?
The next issue that should be addressed is “What type of account will your bond fund be held in?” If you are going to hold your bond fund in your employer's 401(k), 403(b), or 457(b), you are going to be limited to whatever they offer in that account. Some unique employer retirement plans even have unique bond funds options that you cannot get anywhere else, such as the TSP G Fund. An IRA will give you more options, of course. If you are going to hold your bonds in a taxable account, and you are in one of the upper tax brackets, you probably want to give very serious consideration to having a large chunk (if not all) of those bonds be in a municipal bond fund—preferably one that focuses on bonds in your own state. Remember the yield of municipal bonds is federal tax-free, and if the bonds are from your state, state tax-free. If you need help deciding where to hold your bonds, I recommend this post about Asset Location. The classic teaching is bonds go in tax-protected accounts whenever possible, but at low interest rates like we have right now, it doesn't matter much and can even be better to have them in taxable.
Where Will You Take Your Risk?
Another important decision, this one more philosophical, is “Where in your portfolio are you going to take your risk?” There are basically two schools of thought here. The first is that you should take your risk on the equity side. Believers in this school of thought prefer to stick with very safe bonds in the portfolio. They may have fewer of them, or they may use a more risky asset allocation on the equity side (such as a small value tilt) to make up for it. The other school of thought is that it is okay to take some risk on the bond side too, particularly in tax-protected accounts. When choosing which bond fund(s) to use, you will need to decide how you feel about this issue. Those who fall in the first camp tend to have primarily short-term treasury and muni bonds in their portfolios. Those who fall in the second camp tend to have longer-term corporates in their portfolios, or sometimes more exotic types of fixed income like Peer-to-Peer Loans or Real Estate Debt Investments. “Risk Parity” believers are into long-term treasury bonds, although I suspect a lot of their theory relies on back-tested data from a period of time when long term bonds did particularly well. I admit my own ambivalence on the topic, which tends to be reflected in my portfolio (where I invest in pretty safe bonds, but also put 5% of my portfolio into real estate lending funds). Remember there are basically two risks in the bond world:
- Interest rate risk and
- Default risk
Interest rate risk shows up when interest rates rise, causing a drop in the value of a bond with a now lower yield than what is available on the open market at the new higher interest rate. Interest rates and bond prices are inversely correlated. Default risk shows up when a bond issuer stops making payments, or at least looks like they may stop making payments.
Traditional Funds or ETFs
Another relatively minor issue to be aware of is a problem that some bond ETFs have that traditional bond funds do not have. Basically, individual bonds (at least corporates and munis) are much less liquid than individual stocks, so the ETF creation/destruction method may not work as well as it does with stocks during a liquidity crisis. More information in this post:
Why You Should Avoid Bond ETFs
Best Bond Funds
Now that we've got the preliminary issues out of the way, let's address the point of this post—which bond fund should you actually use?
Total Bond Market
Many portfolios use a Total Bond Market Fund. This is actually terribly misnamed. While it does basically include all corporate bonds, nominal treasury bonds, and mortgage-backed (GNMA) bonds in the US, consider all of the bonds it does not include:
- International Bonds
- TIPS
- Municipal Bonds
- Junk Bonds
- Savings Bonds
If you really want a “total bond market portfolio” you'll need to own 3-5 more bond funds!
Consider the statistics (taken in July 2021) and the style box:
- Yield: 1.32%
- Duration: 6.8 years
- # of bonds: 10,138
- Expense ratio: 0.05% Vanguard Admiral, 0.035% Vanguard ETF, 0.025% FXNAX, 0.04% SWAGX, 0.06% IUSB
I think there are two key statistics to key in on here. The first is the average duration, 6.8 years. That means if interest rates suddenly rise 1%, you'll lose about 6.8% of your investment. Of course, you'll then have a higher yield (and thus a higher expected return going forward) and you will actually be ahead due to that higher yield after 6.7 years. The other important thing here is to see what the fund is actually invested in: 42% treasuries, 24% mortgages, and the rest (34%) in some type of corporate bonds. You're basically hedging your bets by owning all three of these types of bonds. This is an important fund to understand as it is so widely used. All of the “3 fund portfolio” fanatics use it. It is usually available in some form in any halfway decent 401(k) or 403(b). This is basically what the TSP F Fund is. I prefer the Vanguard admiral version, but the others listed above are perfectly fine funds.
Vanguard Intermediate Index Fund
However, when I designed my parents' portfolio 15 years ago, I didn't use the Total Bond Market Fund. I used a similar, but different, fund—the Vanguard Intermediate Index Fund. It avoids the mortgage bonds (GNMAs). The statistics look like this:
- Yield: 1.6%
- Duration: 6.6 years
- # of bonds: 2129
- Expense ratio: 0.07% Vanguard Admiral, 0.05% Vanguard ETF
Although the fund used to have a slightly higher yield and slightly higher duration than the total bond market fund, it is now very similar on both counts. The only difference is there are no mortgage-backed securities (GNMAs) in it. That means fewer bonds and less diversification. The argument against GNMAs is that when interest rates go up, you take a big hit in value (like any bond) and when interest rates go down, the borrowers refinance (pre-paying their mortgages) so you don't benefit like you would with a non-callable bond. Of course, when interest rates stay the same, GNMAs work out better since they generally have higher yields (currently 1.6% with a duration of only 2.3 years) than a treasury bond.
Basically, if you hate GNMAs, use the Vanguard Intermediate Index Fund. If you like GNMAs, use a Total Bond Market Index fund. If you love GNMAs, use the Vanguard GNMA Fund. So did I make the right decision using the intermediate fund over a TBM fund? Apparently, I did. Annualized returns over the last 10 years were 4.23% versus 3.36%. Whether that outperformance will continue going forward is anybody's guess and largely depends on the performance of mortgage-backed bonds (which only made 2.65% over the last 10 years).
Other Bond Options
There are dozens of other options out there as well. They're all even less diversified than the above two options. You can take on more default risk by using solely corporate or even junk bonds in your portfolio.
Vanguard Intermediate Corporate Bond Index Fund
- Yield: 2.0%
- Duration: 6.5 years
- # of bonds: 2083
- Expense ratio: 0.07% Vanguard Admiral, 0.05% Vanguard ETF
Vanguard High Yield Corporate Fund
- Yield: 3.7%
- Duration: 3.6 years
- # of bonds: 605
- Expense ratio: 0.13% Vanguard Admiral
The upside is higher yields, the downside is that in an equity downturn, these bonds are likely to underperform treasuries, particularly the junk bond fund as defaults rise. You can do just the opposite and just use treasury bonds.
Vanguard Intermediate Treasury Index Fund
- Yield: 1.0%
- Duration: 5.4 years
- # of bonds: 112
- Expense ratio: 0.07% Vanguard Admiral, 0.05% Vanguard ETF
If you want to take on more term risk, you have options in each of these categories:
- Vanguard Long Term Bond Index Fund
- Vanguard Long Term Corporate Bond Index Fund
- Vanguard Long Term Treasury Bond Index Fund
If you want to take on less term risk, you again have options in each of these categories:
- Vanguard Short Term Bond Index Fund
- Vanguard Short Term Corporate Bond Index Fund
- Vanguard Short Term Treasury Bond Index Fund
It's hard to choose without a working crystal ball, and that's why most people end up with one of the first two funds I mentioned for their nominal bond allocation.
Municipal Bond Fund Options
If you are in a high tax bracket and have any significant part of your bond holdings in your taxable account as I do, you should take a look at Vanguard's excellent municipal bond funds. Pre-tax yields are obviously lower when you compare to a taxable bond fund, but the after-tax yield is usually higher for high earners. For example, I use the intermediate-term fund.
Vanguard Intermediate-Term Tax-Exempt Fund
- Yield: 0.9% (equivalent after-tax yield in the 37% bracket = 0.9%/(1-37%) = 1.43%)
- Duration: 4.3 years
- # of bonds: 12,431
- Expense ratio: 0.09% Vanguard Admiral
Lots of other options in the tax-exempt space too. If you live in California, Massachusetts, New Jersey, New York, or Pennsylvania, Vanguard has a fund just for you that will also be exempt from state taxes. If you want a longer duration, they have the Long Term Tax-Exempt Fund (duration 5.1 years). If you prefer a shorter duration, they have the Limited-Term Tax-Exempt Fund (duration 2.3 years). If that's not short enough for you, try the Short Term Tax-Exempt Fund (duration 1.0 years) or even the Municipal Money Market Fund (average maturity of 12 days). There's also a high-yield (junk) option, the Vanguard High-Yield Tax-Exempt Fund (yield 1.6%).
Inflation-Adjusted Bond Options
Most inflation-adjusted bond funds just invest in Treasury Inflation-Protected Securities (TIPS). Vanguard offers two options here. The first is the 20-year-old Inflation-Protected Securities Fund. Note that the admiral shares version of this fund requires a $50,000 minimum investment, not just the usual $3,000 investment and that the yields are REAL (after-inflation) yields, not nominal yields like all the bonds above.
- Yield: -1.69%
- Duration: 7.2 years
- # of bonds: 47
- Expense ratio: 0.10% Vanguard Admiral
If you don't like all that term risk, consider the Short Term Inflation-Protected Securities Index Fund (also available as an ETF). The minimum investment for admiral shares is only $3,000, the expense ratio is slightly lower, and the duration is only 2.5 years. The downside? A lower yield, at -1.59% real.
I Bonds (a type of savings bond) may be a good option for you. They're also protected from inflation and are currently paying 1.68% (nominal). That yield is comprised of a 0% fixed yield plus the 1.68% inflation rate. Beats the current EE bond rate of 0.10% (nominal), but those are guaranteed to at least double over 20 years (3.53% nominal). Unfortunately, those bonds really aren't practical for those with large bond portfolios built over just a few years.
International Bond Options
Vanguard currently offers four international bond funds. Its largest fund is the Total International Bond Market Index Fund.
- Yield: 0.6%
- Duration: 8.4 years
- # of bonds: 6,294
- Expense ratio: 0.11% Vanguard Admiral, 0.08% Vanguard ETF
It's pretty hard to get excited about the combination of a duration of 8.4 years and a yield of just 0.6%. Vanguard also has two emerging markets bond funds, one actively managed and one index.
The newest Vanguard International bond fund is the Global Credit Bond Fund, an actively managed fund that invests in corporate bonds in both the US and overseas. Technically, that's a “Global” (includes US) fund, not an “international” (excludes US) fund.
The Bottom Line
As you can see, there are a plethora of options and that's just at Vanguard. If your crystal ball is cloudy about the future, I would suggest choosing either the Total Bond Market Fund or the Intermediate Index Fund if you are investing in a tax-protected account and the Intermediate-term Tax-exempt Fund in a taxable account. If your crystal ball is not cloudy and you wish to bet on outperformance of some aspect of the bond market, then adjust term and default risk to your taste.
If you wish to diversify into inflation-indexed bonds, either of Vanguard's options are great as are IBonds if you can purchase a meaningful amount of them. If you invest through another brokerage, be aware that Fidelity has a good TIPS fund and both Schwab and iShares have good TIPS ETFs.
If you wish to diversify into international bonds, I would stick with the plain vanilla Total International Bond Market Fund because strange things can happen with loans to emerging market governments (see Argentina and Russia for details). Personally, I don't invest in international bonds. I'm willing to give up that diversification in order to reduce portfolio complexity.
In my own portfolio, I split my bonds 50/50 nominal/inflation-indexed and my current holdings (remember bonds are 20% of my portfolio) are:
- 4% TSP G Fund
- 6% Vanguard Intermediate-term Tax-exempt Fund
- 10% Schwab TIPS ETF
What do you think? If you invest in bonds, what funds do you use and why? Comment below!
Thanks for this. I suspect many white coat investors find this topic very confusing. For example, I was speaking with my pharmacist friend who does a lot of trading/investing and he knew nothing about bonds at all. Something about the topic feels intimidating.
With regards to a tips fund, I assume this should be in a tax protected account?
Yes, putting TIPS in a tax protected account avoids the phantom tax issue. But they are state and local income tax free.
TIPS newbie here. Poster asked “tax-protected” and you replied “taxable”.
Can you clarify ? Should TIPS go in a RETIREMENT (tax-protected) or TAXABLE account?
My error. Thanks for correcting. Will fix.
I’m seeing that often the Vanguard ETF version is cheaper than the Admiral Fund version.
So what are the advantages of holding the Admiral version if it is more expensive?
If you prefer funds instead of ETFs, that’s the advantage.
What’s the difference between a fund and an ETF?
Do you think a fund is better?
Thanks
An Exchange Traded Fund (ETF) is traded during the day. A traditional mutual fund is traded only at 4 pm. The differences are minimal and neither is necessarily “better.” More info here:
https://www.whitecoatinvestor.com/mutual-funds-versus-etfs/
How in the world can the Vanguard (20 year old) Inflation Protected Fund yield 1% real when every TIPS issue out there short of 30 years is negative yielding real?
Good question. It was -1.3% or something 6 months ago and today they’re reporting -1.69%. So I have no idea where I got that 1% from when I updated this post this weekend just before publication. I’ll fix it.
Another nice feature of I Bonds is that the taxes on the interest are not paid until you cash them, unlike TIPS where they have to be paid annually. This makes I bonds a good option to buy while you are accumulating assets and can then cash them when retired and your tax bracket is (hopefully) lower. As pointed out, the big issue is the limitations on buying them: $10k per person per year plus up to an additional $5k per year that can purchased only with tax refund dollars. Still, over time they can be accumulated to provide some low risk capital for retirement.
Thanks for what you do!
A timely post for me as I’m summarizing asset classes for my residents.
I’m currently in vanguard’s total world bond ETF (BNDW) in our retirement accounts. It’s a composite of the total bond index and total international bond index. The returns haven’t been anything to write home about but the diversification in one product has been useful for me.
In our taxable account, we’re in the intermediate tax exempt bond fund.
Regards,
Psy-FI MD
Find the cheapest intermediate bond fund (muni or taxable) you can, invest in it and stop worrying. Problem solved.
Jim- I have a question regarding bond funds. Is there some sort of penalty for selling the bond fund “early” before the average duration of the bonds in the fund or does that really only apply to individual bonds? I’m guessing no- for example VCADX (Vanguard Admiral California Intermediate Muni Bond Fund) has no redemption fee.
No redemption penalty with most funds. It’s possible to lose money, of course, but that’s not a penalty.
There is no penalty for selling an individual bond early either. The market plus the transaction costs will determine what you get for it, but there is no penalty.
Depending on what you paid for it and what you receive when you sell, you may have a taxable gain, requiring you to pay income taxes.
Aside from treasuries, most bonds are VERY illiquid compared to stocks, generating a significant bid/ask spread. That’s a penalty of sorts and a good reason to own a bond fund instead of individual bonds.
Hi Jim, quick clarifying question: I’ve heard from an old hourly-based financial advisor that my family should “use equities to invest in companies (and to invest internationally), and to keep our bond funds strictly to short and medium term U.S. treasury funds.” So this year we thusly started out with 12.5% in a VSBSX and another 12.5% in VSIGX (two Vanguard treasury-only index funds). This year, both have essentially changed 0% in value and lost real dollars to inflation. Have you heard of this “treasury only” strategy for bonds? We’re a doing-pretty-well 41yo family—does it make sense for most doctors like us to diversify and add some corporate (or mixed) bond funds?
Thanks so much!!
-underinformed ER doc Brad
Sure. For a long time all my bonds were essentially treasuries and even now are either treasuries or high quality muni bonds in my taxable account. The idea is to take your risk on the equity side, not the fixed income side. Remember the purposes of bonds in your account…to provide ballast when stocks sink.
There are two schools of thought here and very reasonable people have been arguing about the merits of both schools for decades. Your advisor obviously leans one way, but when you become informed enough to start wondering if that is right you have to start asking yourself if you still need an advisor!
Great column. The main disadvantage for me of the Total Bond Fund Index (VBTLX) is that it often underperforms other Vanguard intermediate bond funds. So I have a mix of short and interemdiate bond funds so that if one category takes a dive, the others may not and can be used for RMD purposes (all are in my IRA). VBILX, VSBSX, VSGDX are my choices.
Excellent summary of all the options.
One comment — For I-Bonds issued from May 2021 through October 2021, the current rate is 3.54%. The 1.68% rate quoted in the article was the rate prior to May. The 3.54% rate will be adjusted in November, it’s possible it could go up.
Laddering I-Bonds is a great way to beat inflation and be 100% safe. The downside, of course, is that a couple can only invest a maximum of $25,000 per year ($10,000 for you, $10,000 for your spouse, and $5,000 via tax refund)
Thanks for the update. You’re right that the article was written before May.
Hi Jim, great post as always. I am 100% equities but 5 years before I retire am planning on adding bonds to de-risk my portfolio to 60/40, and I have listened to Frank Vazquez’s Risk Parity podcast where long term treasuries seem to be the best ballast for the equity portion of your portfolio given these bonds are the most non-correlated to stocks. Is this true? doesn’t long term treasuries increase inflation risk, making it less ballast in times of risking inflation? you mentioned that the risk parity folks are using data at a time when long term treasuries were doing well. Does their data not include the high inflation of the 70’s/80’s? Also, what do you think would be the bond fund to use if you want the bonds to be ballast to your stocks?
In the past it’s true, but the risk parity argument heavily relies on past data that to me seems unlikely to repeat, thus I don’t own any long treasuries. Yes, long treasuries are the most at-risk asset class in an inflationary state.
I prefer relatively safe, relatively short-term bonds. My portfolio has very short treasuries (G fund), medium TIPS, and medium munis.
Thanks for this helpful article! For those of us using Fidelity or other brokerages, are there Intermediate-term Tax-exempt Funds or ETFs you would recommend? I’m also wondering what tax bracket would you consider to be high enough to warrant using a tax-exempt bond fund vs a non tax-exempt in a taxable account? If there is a lower tax bracket that you would consider using non tax-exempt bond funds in a taxable account, what would you use?
I’m a big fan of Vanguard bond funds and thus Vanguard bond ETFs such as VTEB. At Fidelity you can buy FTABX. iShares offers MUB. Schwab offers SWNTX but don’t think I’d buy it at Fidelity.
If you’re going taxable bonds, you could use the Fidelity Total Bond Market Fund, the iShares TBM ETF, or any of the Vanguard ETFs.
As far as what tax bracket you should change from one to the other, you just have to do the math as the relationship is almost constantly changing. As a general rule, the top 3 tax brackets should usually be using tax-free bonds in taxable.
Here’s how to do the math:
If taxable yield * (1-marginal tax rate) > tax free yield, then do taxable. If not, then do tax exempt.
Here’s an example using today’s yields for me in the 37% bracket.
BND yield is 4.9%. VTEB yield is 4.1%.
4.9% * (1-37%) = 3.1%, which is less than 4.1%, so I’d do tax exempt. But if I were in the 12% bracket then
4.9% * (1-12%) = 4.3%, which is more than 4.1, so in the case I’d do taxable.
22% and up should do tax exempt right now. But next month it might be 33% and up. It just varies over time.
Hi Dr. Dahle,
I have been poring through your website and Bogleheads, but am still confused about bonds vs bond funds even after going through the Bogleheads wiki. Individual bonds — that I can wrap my head around. You pay a principal, get a coupon semi-annually, until the bond matures and you get back your principal (or you sell it in the meantime) and I understand zero-coupon bonds too. The duration for an individual bond also makes sense and how the value of the bond changes with changes to interest rates etc.
With regards to bond funds/ETFs, I can’t figure out how to interpret duration. If I buy Vanguard’s BND, it says yield to maturity is 4.3% and average duration is 6.6 years. How the heck do I interpret that if the ETF is composed of 10330 bonds, which are constantly being bought and sold? On Bogleheads, they say that if you keep the ETF until the average duration, then you have recouped the cost of a potential decrease in the price. Does this mean, with regards to the BND ETF, that if the Market Price is $74 today and it drops to say $70, if I hold for 6.6 years that I will get the difference in dividend payments cumulatively?
I held AGG last year which decreased in value substantially and I panicked and sold. I am trying to get back into bond investing, and I can’t get over the idea that the safest option is to buy short-term individual treasuries and hold them to maturity. On Fidelity, I just bought some 13-week T-bills at a rate of ~5% just as a short-term investment.
What do you think?
Thank you so much for your work and all that you do. It is truly amazing!
If rates go up and the value of the bonds in the fund falls such that your share price falls from $74 to $70, remember that those bonds now have a higher yield. So they’re paying more than they would. When does that higher yield make up for the drop in price? In 6.6 years. After that point you’re coming out ahead with higher interest rates.
It’s fine to buy individual treasuries. I wouldn’t do that with corporates or munis though. What you absolutely do have to do, however, is fix your bad investing behavior. Selling because something went down in price is a major boo-boo. You only have to do that once late in your career to torpedo your whole financial plan.
When the price of bananas and gasoline and shrimp goes down do you buy more or less? Why are stocks different? Those bonds were a better investment at the lower price than they were at the higher price you bought them at. Yet you want them less. There’s no logic there, just emotion. Get rid of that in your investing if you want to be successful. If you can’t do it on your own, hire help here: https://www.whitecoatinvestor.com/financial-advisors/
Thanks for the great explanation. So to reiterate, even if the price of the bond fund decreases, it doesn’t mean that the expected return decreases, as the yield of the bonds in the fund increases and so dividends increase. So…for a LONG-TERM investor, one really shouldn’t worry about day-to-day fluctuations in the bond fund price as long it is kept for the average duration? I guess that’s the motto of Bogleheads anyways…
And, thanks for the reality check. I’m 31 and just graduated from EM residency last year. I had previously all my investments in stock (100%) with no bonds. With regards to my worry with bonds, I think it’s because I had the more simple view that “if the value of stocks go down, then the value of bonds will go up” so at that time, I was very surprised to see both stocks and bonds both lose value. Now…I know better.
That’s pretty much right. Stocks and bonds have a correlation of zero. Meaning their returns have little to do with each other. But their correlation is not -1. Bonds don’t always go up when stocks go down.
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I have FIDELITY Long Term (FNBGX) & Intermediate (FUAMX) & TM (FXNAX) TREASURY BOND INDEX FUNDs, bought in different batches over 2-3 years or so. At the time the yield looked decent but over time they are all in negative (-10 to -36%). I was trying Buy & Hold, hoping that it will provide some hedge, but alas. Can someone guide me here as to what is the best case scenario would be? ….. hold ’em? Sell ’em?? :((
Dude, definitely hold ‘em ! sounds like you’re nowhere near retirement and don’t need to draw the money, so why sell? Just wait till they bounce back. if you do need the money, then draw down from the intermediate treasuries, as those likely took less of a hit.
Try to look at your portfolio relatively where you compare those bonds to stocks. I bet overall the bonds portion didn’t fall as much as a tocks, right? Try to find solace in that fact. also, seems like you think the bond portion of your portfolio is too risky so consider buying short-term treasuries. Again though I wouldn’t sell any of your bond funds right now because the yield on them are freaking awesome! I would at least hold them for a little bit and get that juicy yield, maybe until at least the average duration, so that you psychologically made up what you invested theoretically.
Well….they’re a better investment now than they were when you bought them. But without a crystal ball, I can’t tell you what the future will bring with regards to interest rates. The rise in rates is why you lost so much on medium to long term bonds. If they drop you will get a lot of it back. If they go up more, you’ll lose more.
I’m not a big fan of long term bonds. I tend to keep my durations pretty short.
Hi Jim and everyone – Thank you for an outstanding post and all the helpful comments. I am currently debating which bond fund to hold in a taxable account as my wife and I work on allocating our assets. We currently max out our tax-advantaged accounts which contain the vanguard inflation protected securities fund in addition to a few stock index funds. In our taxable account, I’m not sure whether to use Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX) or Vanguard New York Long-Term Tax-Exempt Fund (VNYUX). We live in New York City. The yield of VWIUX is 3.4% and the yield of VNYUX is 3.8% so it seems like VNYUX would be a better option though I guess I’m a little bit weary of holding a longer term bond fund. My wife and I are almost 40. Is there a clear better option for us or is it essentially the slightly higher yield of VNYUX vs the risk of holding a longer term bond fund? Thanks for your help. Also please let me know if I’m thinking about this totally wrong.
Not a huge fan of long term bonds. Lots of interest rate risk there. I think I’d take the intermediate fund even though it isn’t NY specific. If you want to make some of your allocation to the NY fund I think that’s fine, but it feels like letting the tax tail wag the investment dog to me.
Thanks Jim!
Thanks for the great article as always. What should be done with the yield payments from your bond funds (during the accumulation phase of one’s career)? Reinvest them into the same bond fund? Hold them as cash in a money market fund ? Something else? I assume in retirement one might use the yield money to refill the short term cash buckets (if one is using a bucket strategy). Thanks!
hey Jerad, I myself during accumulation would use the yield payments to rebalance to my asset allocation. although if you just want to make it easy just have it reautomatically reinvest in the same bond fund, and rebalance with future contributions to retirement or maybe just rebalance inside your tax advantaged accounts maybe once a year. The choice is yours. I don’t think holding the yield payments in cash is wise unless it’s part of your asset allocation. You will suffer from cash drag if you don’t invest those yield payments!
Yes! in retirement the yield payments would best be used to refill short term cash buckets if using the bucket strategy 🙂
If you’re truly in the accumulation phase, then they’re going to be reinvested, not spent. Whether you do that automatically or manually is up to you. My preference is automatically in tax protected accounts and manually in a taxable account to minimize the number of lots.
In the decumulation/retirement phase the income from stocks, bonds, cash, and real estate is generally spent in a taxable account and reinvested in tax protected accounts where shares are periodically sold for RMDs and other withdrawals.
With the very poor yield of TIPs in the above article as well as the loss of TIPs value with recent inflation/interest changing market, have you thought about changing your 50:50 mix (inflation to Nominal) to being primarily I-bonds in the inflation-indexed allocation? I know your allocation is probably too large to do all i-bonds but theoretically if your allocation could be done solely with I-bonds. Does recent events change your mind regards TIPs? I am currently 70:30 total bond (because that’s in my 401k and low ER) to TIPs (in Fidelity H.S.A as I don’t want to use my ROTH for TIPs and try to use it for potentially higher yield investments like the small value tilt or REIT portion of my written financial statement), but could consider going to I-Bonds through treasury-direct.
I’m too wealthy to use I bonds for 10% of my portfolio. #firstworldproblems
But TIPS are likely the better deal right now anyway. It would have been smart to switch from TIPS to I bonds 2 years ago though if one could have. TIPS are a far better investment now than they were 2 years ago so I don’t think I’d make that switch now even if it were possible.