When I reviewed Bernstein's Rational Expectations book a few months ago I promised readers a post discussing fixed income (bond) options for your portfolio. Specifically, there were three recommendations Bernstein made that are at least somewhat controversial that I'll discuss here.
- Buy minimal risk bonds
- Buy individual bonds
- If you must use a fund, choose an open-ended one instead of an exchange traded fund (ETF)
I'm going to discuss each of these, including pros and cons in turn, then you can decide what you want to do with your bond portfolio.
Keeping Bonds Short-Term and High-Quality
Bernstein, like Larry Swedroe, has been an advocate of taking minimal risk with the bond portion of your portfolio for a long time. The theory is to take your risk on the stock side, where it can be taken more efficiently. Here's what Bernstein says:
Critically, your riskless assets should retain their value in a crisis. Corporate bonds, in particular, have a modest amount of stock-like behavior and can see price falls independent of the rise or fall in overall interest rates. Municipal bonds can also behave this way, and if you're depending on either corporates or munis for liquidity during a crisis–precisely when you're likely to want or need it the most–you may have to take a substantial haircut to realize it. Tax-sheltered investors should keep almost all of their fixed-income assets in government guaranteed securities: Treasury bills, and notes and CDs. And while taxable investors should own at least some municipal bonds, they should still hold a fair dollop of Treasuries and CDs as well….At present, very low rates might make you consider using….Short term [bonds rather than intermediate bonds.]
The alternative argument is to look at long term returns. Both longer-term bonds and riskier bonds (corporates, junk, even P2P loans) have much higher long term returns. Taking a look at the Vanguard site, we see the following 10 year annualized returns for various asset classes:
- Short term treasuries: 2.70%
- Intermediate term treasuries: 4.51%
- Long term treasuries: 5.93%
- Intermediate term munis: 4.06% (federal tax-free)
- Intermediate term corporates: 5.20%
- Intermediate term junk: 6.57%
As can be clearly seen, the more term and credit risk you take, the better your long-term returns. So how do you reconcile a recommendation that seems to suggest you accept lower returns? Well, there are two good reasons to accept what seem to be lower returns. The first is if you actually might need to sell some of this stuff in a crisis to live on. You only get those higher returns if you DON'T sell. Secondly, Bernstein would argue that you must look at portfolio performance as a whole, rather than as individual parts. In a crisis, a liquid, high-quality bond is very helpful to the overall portfolio. Not only does it give you an asset that is liquid in case you need to live on it, but it is also an asset that has likely risen in value. In 2008, even Vanguard's relatively high quality intermediate corporate bonds lost 6.1%. But the intermediate treasuries were up 13.5%. Since a crisis is the time to sell bonds and buy stocks, you're a lot better off selling bonds that have appreciated, rather than bonds that have depreciated less than your stocks in order to buy more stocks. This effect may overcome the effect of the higher long-term returns of lower quality bonds on your portfolio, resulting in higher overall portfolio returns, which is what really matters.
The recommendation for short term bonds is simply because they are far less volatile and retain their value much better in an environment of rising interest rates. That wasn't the case in 2008, but would have been in 1973-74 when both stocks and bonds underperformed cash.
So who can take on additional bond risk in order to get those higher long-term returns? Generally, a young, accumulating investor with a secure job. This is because this investor doesn't have to sell his bonds in order to live and his savings to portfolio ratio is still quite high, so he can simply rebalance the portfolio with new money. Personally, I do a little of both. I hold a very safe bond fund (the TSP G fund) which essentially gives intermediate treasury yields while taking T-Bill risk. I also hold TIPS, which are quite safe from both a credit perspective as well as an inflation perspective. However, I also hold Peer to Peer Loans, which are the ultimate in high credit risk since they are essentially unsecured loans to the financially inept, primarily for their high returns (12% a year over the last 3 years for me personally.)
Individual Bonds Are Better Than Bond Funds
Bernstein is also a huge fan of individual bonds rather than bond funds, but this recommendation grows out of the prior one- to basically only hold treasuries. He readily admits that if you do choose to hold corporates or munis that you DO use a fund to achieve adequate diversification.
Unless your account size is tiny, it makes no sense to own a Treasury or government-bond fund, since you can buy these securities at auction and hold them at no cost. The same goes double for TIPS…you can, with a little effort, tailor a ladder…If on the other hand, you hold a TIPS fund, not only do you pay unnecessary fund fees, but there will likely be periods when you will be forced to sell these securities at disadvantageous prices, as happened to many investors in 2008-2009. Much as I love Vanguard's low fees, there's almost no reason to pay them even a penny for their TIPS and government-bond funds….The only bond funds you should own are open-end municipal and corporate bond funds (to the extend that you do own these two asset classes.) The reason for this is simple. Without a great deal of effort and expense, the individual cannot put together a well-diversified low-expense mix of municipal or corporate securities.
The counter argument, of course, is that it is really convenient to use a bond fund, and they don't cost that much anyway. For example, the Vanguard TIPS fund charges just 20 basis points (10 if you have at least $50K in the fund.) That's hardly a huge drag on returns. If you're putting $20K into bonds every year for 30 years and you earn 2.8% instead of 3%, you only end up with $33K less (about 3.3% of the total.) Not exactly life changing. If we're talking about something like $100K, 20 basis points is only $200 a year. That might just be worth it to avoid the hassles of having to keep track of treasury auctions and dealing with brokerage accounts, not to mention avoiding the cash drag issue (although to be fair, the fund also has cash drag, but probably less than you.)
Many investors consider buying treasuries directly through the appropriately named government website Treasury Direct, only to discover that they can only do it in a taxable account. Since treasuries, and especially TIPS with their phantom income issues, are generally held in tax-protected accounts, especially by those in a high tax bracket, this turns the investor off from holding TIPS individually. However, you can purchase TIPS and other treasuries at auction in your IRAs (and possibly even 401(k)s) at any of the main brokerages, often for no fee at all.
The bottom line? Once you have a decent sum of money (which I'd define as between $100-500K in treasuries,) and assuming you're willing to deal with a little bit of hassle, buy individual treasuries instead of using a treasury bond fund. But stick with a fund for other types of bonds.
Don't Use Bond ETFs
Perhaps the most interesting of Bernstein's recommendations was that if you use a bond fund you should choose an open-ended version, rather than a bond ETF (exchange traded fund.) Here is his explanation:
I highly recommend that you avoid all ETF bond funds. To understand why, I'll need to explain some of the trading mechanics involved. An ETF, unlike an open-end fund, trades throughout the day at a discount or premium relative to the net asset value of the underlying shares. In most cases, the spread between the two is minimal because shares can be created and liquidated by independent agents: “authorized participants” who buy up the securities underlying the funds and bundle them into ETF shares that are then delivered to the fund company….This mechanism works well with stocks, which are highly liquid, but not with bonds, which are not. There is, for example, only one commonly trade class of Ford Motor Company stock. By contrast, Ford has a range of bonds of varying issue dates, coupons, and maturities. Since there are so many more individual bonds than stocks, the bonds can be highly illiquid. During a financial disturbance, when liquidity becomes even thinner and most corporate bonds trade only “by appointment” the authorized participant mechanism fails, often at considerable disadvantage to the shareholder. The open-end fund holder, who can always buy and sell at [the end of day price], has no such problem.
I confess I had never considered this issue with bond funds before, and I find his argument compelling. However, this issue is far less important with a treasury bond ETF, since those securities are far more liquid than corporate or municipal bonds. It would have to be a pretty terrible crisis to run into a liquidity issue with the treasuries that make up treasury bond ETFs.
Making Changes
So what am I going to do with all this information? Very little, and what I am going to do, I'm going to do slowly. I intend to continue to hold the TSP G fund as a major part of my bond holdings. This is a major reason I didn't roll my TSP money elsewhere when I left the military. While it is a bond fund, the expenses are incredibly low at 2 basis points a year, and these particular treasury instruments cannot be bought individually anyway. I also intend to continue to hold TIPS as a major part of my bond holdings. However, for the last couple of years I've been holding these as the Schwab Bond ETF in my 401(k). I'm getting close to the point where I think it makes sense to buy the individual TIPS, so will probably gradually convert my ETF shares over to individual TIPS. I plan to continue to hold P2P Loans as a small part of my fixed income portfolio. At this point, I expect higher returns going forward from those than I do from my stocks, and my portfolio is still small enough that I could really use the growth. My lifetime capital to investment capital ratio is still quite high, so I can afford to take that type of risk through a crisis.
What do you think? Are you going to change your fixed income strategy based on this information? Why or why not? Do you use bond funds or individual bonds? Do you use open ended up funds or ETFs? Do you take significant risk with bonds, or keep them short and high-quality? Comment below!
Firm believer in individual muni bonds for the last 40yrs until proven that a muni bond fund is better
I own corporate bond funds and hi yield as part of a well diversified portfolio and sleep well
And I have heard over the last 10yrs or so that rates have to go down as I was buying 10yr cds at 5%
yup right now 10 year CD is like 2.5%
Although short term bonds are certainly less volatile and retain their value better in a rising interest rate environment in the short term, is that really true over time periods greater than the duration of the bond fund? Larry Swedroe recommends a 10 year treasury ladder (or it’s proxy, an intermediate treasury bond fund) because of the better returns over the long term. As Taylor Larimore says, when experts disagree, it probably doesn’t make much difference. Whether short term or intermediate term treasuries do better in a financial crisis will depend on whether the crisis is a deflationary or an inflationary crisis.
I own an intermediate treasury fund and a short term corporate fund (both ETFs) in a 2/3, 1/3 ratio, approximating the total bond market. I like to have the two funds so in a crisis the rise in value of the fund due to the treasuries is not limited somewhat by corporate bonds which will likely not move or fall a bit, as will occur in a total bond fund.
I agree that the ETF issue is not a problem with treasury funds. This issue is only a problem when you are selling in a crashing market, not likely to be the case with the bond market when stocks are falling.
I dont know if I am doing it right or not, but sure is convenient. I have roughly 15% in bonds and 15% in cash. Cash is basically emergency fund or if stock market crashes to put more in. Most of my bonds are in Vanguard Total Bond Market Index Fund Institutional VBTIX and some TIPS Vanguard Inflation Protected Securities Fund Institutional VIPIX. I am only 40, w net worth around 2 Mil, and plan to work another 20-30 years. I really dont add much to my bonds, so i started at 22% and its going down as I keep adding money to my other index funds.
Its nice to have information in this article, but I still dont know what to do with it.
My plan was to, when my bond ratio falls around 10% to beef it up by either converting some 401K target date funds into the above bonds I have or start buying some Munis in taxable, and pray I am doing the right thing.
Don’t your target date funds have a bond component to them?
Are you comfortable with your risk? What I mean, the less bonds you have, the higher the potential loss in your portfolio. If you are down to 15% bonds, another 50% crash of equities will cause Yoyour portfolio to drop 42.5%. Can you confidently say you are OK with that possibility.
Me personally as my net worth grows I have less need to take risk and increase my bond holdings. I am 40 years old, currently 30% bonds and looking to increase to 40% over the next 3 years.
A net worth of $2million now will likely be $8million or more by the time you are 70 just by shear growth alone (no further contributions.) Do you really need to take on more risk?
Target date funds only have 10% bond in them since they are have far away dates, so they dont add much, and I am down to 15% bonds while considering my entire portfolio.
I guess I will never be comfortable losing any kind of money, but I know when the markets took a downturn recently this year (around 13%), I kept on putting extra money in it. Have they kept going down, I would have kept putting more. Only problems sleeping I had was my toddler having nightmares.
I wish net worth of 2 Mil meant I had 2 Mil in investments. Its more like 1.3 Mil in markets + 15% cash + house and rental worth (after debt). Who knows how fast it will grow and what surprises lurks in healthcare. But I do want to take some risks while job and income are steady and I keep living below my means
Wow, I had no idea the Vanguard 2040 fund only has 11.5% bonds. When did that happen? 2040 would be for a 40 year old. Where did age in bonds, or Age-10 in bonds go. This isn’t even close. That really bothers me and also why I invest in the individual funds and make my own asset allocation. 70/30 sits well with me today.
On another note, 15% cash of a 1.3 Million portfolio is almost $200K. You actually add that to your bond portion of asset allocation. Unless of coarse the whole thing is your emergency fund. Anyways. If you have 15% cash and 15% bonds then you are at 70/30.
Personally I think $200K in cash is way way way way too much cash. Our jobs are very secure being physicians, plus if we are in private practice, billing lags by a few months. Even if you stop working, you should have collections rolling in for a few months. Also, if you stop working at some point, your income will be lower and therefor your tax burden will also be lower therefor you don’t need as much money to live X months. I used to have $100K as my emergency fund. which was overkill and a big drag on returns. I figure if I have enough cash to replace a roof and water heater, or buy a car if need be or live for X months without working, I am fine.
Not that there is anything wrong with it, but for me, I do not consider my home as part of my net worth. Rentals yes, but my home is where I live. its not like I will sell off one of the rooms from my house to rebalance into stocks, or buy groceries.
PK, at what wealth point would you consider cutting down working or do you plan on going full steam for as long as possible?
Yes, the Vanguard TR funds are quite aggressive initially. That’s why it doesn’t matter which of the 4 or 5 youngest ones you pick- they’re all 90/10 basically. If you don’t like their glide path, build your own.
I don’t think $200K is too much cash. It really comes down to why you have the cash. For example, I don’t have any cash at all in my retirement portfolio. I stay fully invested. But I’ve got an emergency fund, a vehicle fund, vacation fund, money for my next tax bill, money for my next insurance bill, money earmarked for charity, money I just earned, money in checking, etc etc. I’ve had more than $200K in cash for much of the last 2-3 years and probably indefinitely going forward. I guess I’m just not comfortable investing money that will eventually go to the IRS. What happens if something happens to my income and then the IRS wants $100K? Better to have it in cash I say as it allows me to stay the course with my other investments.
Lots of docs don’t have a residual income for a few months because they’re employees. They quit and they get one more paycheck and that’s it.
I think it’s silly not to consider your home as part of your net worth. If you decide to sell and rent, your net worth just went up by $500K or whatever. If you stop renting and buy, your net worth goes down by $500K. Doesn’t make sense. I wouldn’t count it as part of your retirement nest egg, of course, unless the plan is to sell it and rent in retirement or something.
I agree w WCI, I just feel more comfortable having 200-250K in cash/emergency funds. I never thought of adding the cash to the bond side (silly of me), that does make it 30% bonds/cash. Wonder if that is accurate to consider cash like bond.
Alex interesting question about retiring. Funny thing is the answer keep changing every 5 to 10 years. At age 25, I thought I will never retire, work till disability/death. At age 30 -35 I thought around 75. At age 38, I thought retire by 70. Now I am 40 and my plans are to cut down my work by 30% at age 55 and work part time till 65-67 or 70. I already get 3 months off as vacations and if I cut down another 30% it will give me close to 5 months off in a year. I wonder if my answer will change in next few years again.
As a physician we are among top 1% income in the world/USA, I also think there is a 99% chance of my kids making less money than me. I can retire early but w 5 months off, do I really need to? why not keep doing something part time and help not my kids but generations to come? Again maybe my answer will change.
What about you Alex, what do you plan for your retirement?
I find that the less direct patient care I do, the more I enjoy direct patient care. Also when I work less, the days I work I am a much better clinician as well.
My goal is to go part time at some point in the future or transition my work to something less clinical. I would love to still be able to work for many many years to come. But definitely not full time. I hope to be able to cut down significantly by the time I am 45.
On another note I have very little interest in leaving a legacy of trust fund grandkids. Therefor “more” money is not that important.
Like you my goals have changed as I age and watch how medicine is changing. Maybe 10 years from now I will be so fed up with how medicine works I will just call it quits. I hope that isn’t my future but who knows. Thanks to WCI I will be completely prepared for that contingency.
WCI, I completely agree with you. I actually do keep large sums of cash I never considered to pay quarterly taxes, and extra cash on hand by the end of the year incase I will owe some taxes despite the 10% safe harbor. Then I keep a few months living expenses. Everything else is invested. I might as well have bonds collecting 1.7% instead of 1% in a savings account.
Maybe I missed this in your post, but someone else with great credentials and decades of investment management experience recommends using treasuries rather than corporate bonds, too… David Swensen, the former Yale University endowment fund manager. His logic mirrors that of the other two advisors you mention.
BTW Swensen’s book, Unconventional Success, is a really profitable read for people tempted by exotic investment options.
I dont consider corporate bonds as “bond-like” as munis and treasuries, they really (at least the funds) perform quite like equities. I disagree that they are exotic, they are just neither bonds nor equities really but a mixture of both assets as far as performance goes. I dont consider corporates a buy anytime like a treasury or muni either, there are times when they will represent value and most of the time where the return isnt worth it. It can be totally avoided without any notice for most people and that performance replaced with equities.
Munis are awesome, and the universe is simply too small and illiquid to have a properly funding etf, which is too bad. Maybe one day. I think one of the reasons older generations pick stocks, and also suggest individual munis is thats the only choice they ever had and they are intimately familiar with it. Thats not the case for us, and we will likely have good versions of funds for all these things in the future.
*functioning*…arg
I didn’t mean to suggest bonds are exotic. Sorry. Swensen’s book argues you want to have some bonds for safety… that corporate bonds and munis don’t offer much safety in a truly scary situation,… so what one does is put 30% into intermediate treasuries and TIPs (rather than the old standard of 40% into corporate bonds).
The comment about the exotic stuff was reference to his philosophy that you avoid things like hedge funds.
I dont see how one can blanket statement say that muni bonds arent or do not provide “safety”. Highly rated muni bonds have default rates only matched or exceeded by US treasury bonds, and they collect on average .67/dollar in default. They are safe. Its all relative.
Vanguards national muni fund lost a total of 6.7% from peak to trough in the financial crisis, all the while paying over a 3% tax free dividend. It may not have gained (and this was peak—>trough) but it did great and provided income during one of the countrys worst case scenarios.
It’s tough to discuss the subtleties via blog comments, but to try one more time to explain/justify Swensen’s suggestion, he says you want some fixed income stuff in your portfolio to dampen the variability but as little as possible because you really only make money in equities. His suggestion, therefore, is to dial up the safety and dial down the allocation. I.e., if you accept (and maybe you don’t but for illustration’s sake say you do) that the right allocation is 35% munis and 65% stocks, he might say, ditch the 35% in munis, substitute 30% treasuries and then (and this is where the money is) bump your stocks from 65% to 70%.
Here’s another way to understand his thinking, too…. whatever risk reduction and portfolio anchoring you can get with, say, X% in munis or corporate bonds, you can probably get with less than X% in treasuries. And then again, how you make money on this is by taking that extra amount you now have and redeploying it into equities.
The problem with munis I think in any book discussion is that they greatly depend on your income level and location (due to state taxes). On a risk adjusted basis Munis have a higher return than treasuries, in the past it wasnt as much as it is today and there is quite a large yield difference between the two while there isnt much credit difference. So, while in the past they may have been closer, they have certainly diverged. The problem here is assuming that munis are solely for dampening volatility instead of recognizing their excess return and tax free nature of such.
Your example of his totally ignores the tax implications which for munis is their main point. Treasuries have their place, equities theirs and munis as well, they are not interchangeable as their purpose is different. I still count it as overall bond mix, but one is in a deferred and the other taxable for a different purpose. I would never sell some munis and replace with equities, doesnt make sense to me. I would be increasing my risk, taxes, and changing the overall risk adjusted return of my portfolio as well as where things were for tax efficiency.
When you look at their returns (tax equivalent yields that is) the funds can actually be nearly on par on a real, real return basis (after inflation, taxes) with much much less volatility. This is the essence of risk adjusted return, and munis are in a great spot right now. Everything changes at times and they may become less in the future as they were in the past, but right now, theyre pretty great. I dont know anywhere else you can get a low volatility return of 4-8% tax free equivalent.
“…Your example of his totally ignores the tax implications which for munis is their main point. …”
I’m not ignoring the math. I get the math.
“…When you look at their returns (tax equivalent yields that is) the funds can actually be nearly on par on a real, real return basis (after inflation, taxes) with much much less volatility….”
And this makes sense, right? Investors should be smart enough to look at aftertax returns.
“…I dont know anywhere else you can get a low volatility return of 4-8% tax free equivalent….”
Here’s one option:
http://evergreensmallbusiness.com/why-early-mortgage-repayment-makes-sense-for-high-income-investors/
I like that article. I can even think of a couple more points to expand it.
Never said YOU were ignoring the math, that his example did. However in your article you claimed someone needed a municipal bond returning about 5% annually, for someone at the 50% fed/state income tax level. This is not true whatsoever. Thats a pretty achievable rate in california. In order to get 5% tax equivalent yield in a treasury would only need 3% in a muni.
You’re not “earning” anything by paying down your mortgage early and it cant be acted as if its equal to buying a MBS bond. Its not. Where do you get the 4% return from anyway and how does that relate to the mortgage paydown? What happens if a factory closes in your town? Do you still get that yield?
It assumes you lose almost all of your deduction, not an issue even for most doctors.
“and this makes sense right….” I dont get what your saying here. The point was that municipal bonds have higher returns than should be justified based on their credit, they are exceedingly safe yet not priced as such. If investors understood this more muni bonds would be bought up in such a way that decreased their yield to be on par with other securities, and making treasuries the only thing safer. They are not priced like this, so apparently investors have not done the math, or their simply arent enough high income investors to take advantage of it.
Bond, equities, and mortgages are not apples and apples. Your home is super illiquid even compared to bonds.
While admittedly more volatile than a muni mutual fund but less so than stocks, its easy to find state specific or national muni CEFs with 6-8% tax equivalent yields (4-5+%).
I’m with Stephen with regards to the mortgage paydown. You seem to be confusing the value of the house with the mortgage. They’re totally unrelated, unless you’re planning on mailing in the keys.
Paying down a 4% after-tax mortgage earns you a 4% return on that money.
I do agree that Stephen is overstretching the mortgage interest phaseout. In reality, the Pease phaseout just acts as a 1% higher tax bracket.
Theres no requirement to pay an advisory fee either, except to make the numbers work better.
Interesting that way because his other book is all about exotic investment options!
I get you are getting your interest rate back if you pay it down (ignores inflation, opportunity cost, etc..) but who has an after tax rate of 4%, or even a pretax rate that high? You basically save yourself from that future cost, but youre not earning it really in the sense that you would be with a bond. I just dont like the idea of thinking of your mortgage as a bond, its a mortgage. With bonds (treasury at least) you are guaranteed to get your principal back. While housing is pretty good for this, it is certainly not guaranteed by any means.
Maybe someone does, if you do, REFI asap! Much better rates are available.
I acknowledge that, absolutely, I used numbers that make the explanations easier to process. As a “how to” writer, I am probably always going to make trade-offs that seem to me to enhance comprehension. Guilty as charged!
As far as the phase-outs, I didn’t write that blog post for doctors specifically but for my entrepreneurial clients. And we regularly have clients who make high incomes and have mortgages but don’t itemize because they optimize with a standard deduction. When this occurs, they get no benefit from the mortgage interest deduction (or any other deduction).
Further when this occurs, because someone with a (say) 4% rate mortgage gets no tax subsidy, he or she saves/earns $4,000 “after taxes” in interest charges if he or she pays off the $100,000 of mortgage debt. You can say that $4,000 of interest is not a return on the $100,000 investment. But it is $4,000 of cash benefit. Related to $100,000 of cash outflow.. Gosh, many people would consider it a return. (This perspective might be particularly true if the borrower will owe the debt regardless of the value of the property.)
BTW, if you want to use 3% or 2% for the mortgage interest rate, that’s fine. And then the person saves $3,000 or $2,000 “after taxes” if he or she pays off the $100,000 mortgage.
FYI, when I wrote that post (August 2014) 4% was the mortgage rate per that day’s WSJ…
This makes me think that a co-worker just got a nearly 4% mortgage on a coop loan, fixed.
I hate thinking about fixed income! I recognize the need for it as I approach retirement. I just reviewed it to do this post.
VWIUX. intemediate tax exempt. 596k. 1.49% yield. ER 0.12
VBIRX. short term bond. 50k. 1.2% yield. ER 0.1
VMMXX. prime money fund. 50k. 0.43% yield. ER 0.16
AFTEX. American Funds tax exempt bond fund. 486K. yield 1.54% ER. 0.54. Capital gain long term $47614.
Two state specific muni bonds worth 110k yielding 3.5% and 4.4%.
72k in deferred annuities purchased many years ago.
Tax protected.
VBTLX. total bond. 583768k. 2.1% yield. ER. 0.07
VTABX. world bond. 333k. 2.35% yield ER. 0.14
This is approximately 39% of my nest egg. Over time stuff gets complex.
i noticed a rather large error. VBTLX is 583768 not 583768k. Oops!
Would be nice to have an edit button. Did you kept your bond ratio around 40% or slowly increased it with time? How old are you?
I gradually increased the bond portion. I only recently added “cash” equivalents. I am 58. I am only working 3 days per week now.
You’ll find an edit button in the forums. The truth is that comments sections below blogs aren’t designed for a lot of interactive conversation. That was one reason I started the forum. Unfortunately, a typical forum post goes 12 posts and a typical blog post gets 50+ comments. Oh well.
I agree on funds vs ETFs. In a bear market when you are trying to sell, the corporate or especially muni fund will have a lot of stale pricing in it as new trades to reset prices have not yet occurred. Hence, you get to sell an “overpriced” asset at NAV while the ETF trades at a discount to NAV to reflect the true price of transacting in the market. The same is true in a bull market for bonds that the full price of all of the holdings might not yet be fully incorporated into the fund’s NAV, so you get to a buy an asset for less than what it’s worth. The exception is if you were adventurous enough to buy in a credit bear market or sell in a credit bull market, you would probably get a better with ETFs. The bond ETF would trade at a premium to NAV in the bull market and a discount to NAV in the bear market, while the fund would trade right at the NAV level. So if you hold a mix of bond ETFs and bond funds from being an investor collector, you might want to buy and sell accordingly
age 66 I have 82% of my portfolio in fixed, yes BONDS, CDS, MUNIS and doing well living off the interest ONLY
awesome Ken!! I can live off dividends and interest when I pull the final trigger and completely retire.
its all about sleep the stock mkt eventually takes a big hit, possibly 40-50% but eventually rebounds
I rather not wait
Ken,
Looks like you are going to leave a massive inheritance. Was that the goal/plan?
If not, what are you going to do with all that money?
(If you don’t mind me asking.)
Exactly. I’d sleep well at night too if it looked like I was going to leave $5M+ behind, no matter what I was invested in. Different strokes for different folks.
Vanguard has a proprietary mutual fund structure that offers ETF’s as a share class of many of its funds, including bond funds. They have a patent on this structure until about 2023. I use BND which is the ETF class of their Total Bond Fund. It answers the liquidity issue that Bernstein brings up to me. Has he ever commented on Vanguard’s dual class structure?
I think BND is so huge that is liquid. I have both etfs and funds from vanguard
expect to leave the 5 mil to the wife, then kids
NEVER ever had an emergency fund, especially nowadays at 0%
that’s insanity
BE 100% invested-everything is LIQUID!
creating Wealth is all related to TIME in the MARKETS
5th grade stuff is index investing
Thank you JOHN BOGLE
It’s not all related to time in the markets. It’s also related to how much you make, how much of that you save, and in retirement like you are in, how much you spend. If you made a bunch, saved most of it, and are only spending a tiny sum of it, it doesn’t really matter how you actually invest. If you’re trying to optimize things a bit more, then how you invest can have a profound effect. But there is great wisdom is taking “how you invest” out of the equation if it wouldn’t make you any happier to spend more. For example, if you saved enough and are happy in retirement only spending a low percentage of that, then it’s perfectly fine to be 80%+ fixed income in your 60s.
I disagree that having an emergency fund is “insanity.” It isn’t about ROI. It is about financial and emotional security. If there is a 80% stock decline I don’t want to have to cash out stocks at the worst time or bonds and shift my asset allocation. Separating risky and risk-free investments clearly would be helpful to us all. The smartest money folks who have personally given me advice (Bill Bernstein, N.N. Taleb and Gilette Edmunds) have all emphasized this. I listened and benefitted from this “barbell” concept. 200K in cash is not at all unreasonable for a ER physician. I had a ER doc friend who really wished he had that much after his group lost their contract. He had to scramble and move to another less desirable city and grab the first job available.
There are other safe but yielding something assets other than cash. At some point of net worth the cash pile should be drawn down with the likelihood to need to access the full amount, like maybe the point you could retire but dont. This obviously goes down with time, and you shouldnt need the same amount at 50 as you did at 30. That makes sense. Many also have access to home equity and other means as well. Some people depending on what they own or do may have different kinds of emergencies as well and that is certainly a good reason to have an excess amount of cash on hand, a little rental empire would be cash intensive at times, etc…
You also have to think about the probabilities, what is the likelihood you use that cash for its intended purpose? I keep a preset amount of “float” in the checking account, usually a couple months of bills, but every dollar after that is in the taxable account even my accumulating tax dollars getting something but still easily turned into cash. Eventually even anemic growth will mean its way bigger than any cash earning near zero, and far beyond the needs of an emergency fund. This is in very low risk assets like muni bonds, etc…
I wouldnt put it in small caps or biotech or anything, as the point about risk stratification is super important. I am leaning more and more to less risk, more risk parity general overall views and getting good risk adjusted returns rather than risk and hoped for returns.
Whole life? haha
Good discussion, it is hard to get excited about bonds in a market like today. Even as a banker, I have a hard time stomaching five years at 1.25% on a US Treasury or 10 years at 1.79%. The fact with today’s market is that you lose more flexibility going long to increase yields just a little. The Two – Ten Spread (https://research.stlouisfed.org/fred2/series/T10Y2Y) is also nothing to get excited about…
Depending on portfolio size, you are better going with a local bank CD (Some are out there around 1.60-2.00% annual percentage rate on a five year term) or sitting in cash in a money market at a local bank. Local banks, in general, tend to pay more for deposits than the money center banks.
Lastly but most importantly, the key to bond and CD investing is having a laddered approach. This allows for you to move up and down with the interest rates. If you have constant maturities you are rolling into a five or ten year bucket per se, you should be able to mitigate your risk in the portfolio. You may leave some on the table but you will at least sleep better.
I’ll add inflation risk to the discussion. Since 2008, only long bonds have out paced inflation, which was 1.4% for 2015. So, currently, bonds experience interest rate risk, inflation risk, taxation risk. The short term treasuries are valuable only as dry powder when stocks crash. I pray for stock volatility.
This long quote – I apologize – from Michael Kitces amplifies Bernstein’s first comment above, and adds additional insight. Although Kitces specifically refers to his research recommending a “rising equity glide path” in retirement, his T-Bills recommendation can be applied more broadly:
“However, even with an accelerated rising equity glidepath, there is still significant exposure to bonds in the early years, and the results also show that in situations where rates are low and there is an elevated risk of rising interest rates (and associated price declines in bonds), it doesn’t pay to take interest rate risk. As a result, safe withdrawal rates in the worst inflation/rising rate environments are better with Treasury Bills than bonds, even though Treasury Bills may pay “almost nothing” at the beginning of such time periods. This suggests that in the end, while it’s appealing to generate a better return from bonds if available – and higher returns will lead to higher safe withdrawal rates – in the worst environments, compounding bond risk on top of equity risk doesn’t pay. Instead, if there’s risk to bond – e.g., equities may be volatile, and interest rates may rise – the better outcome is to own the (less volatile) bonds, dollar cost average into equities, but don’t take interest rate risk in the process. In essence, the first function of bonds is simply as ballast to stocks, and should only be a return driver when there are appealing bond returns already on the table (or to hedge truly deflationary scenarios). In fact, there is actually a negative correlation (of about -0.25) between short-term bond yields and the outperformance of rising equity glidepaths using Treasury Bills; in other words, the lower interest rates are, the better it is to use low-yield Treasury Bills (due to the risk of rising rates!).”
That may be the wisdom, but doesnt seem to be the reality case. Shorter term bonds seem riskier at the moment, longer term bonds arent moving much. If the curve flattens it will be from the short end. If you want to look at this kind of thing Japan seems to be the place to look for corollaries.
All these guys from the 70s and 80s assume rates must rise, which is most likely a bias from the times they grew up and lived, but there is no reason thats true and lots of good macro reasons it wont come back as strong as before. That period of growth from the 60s-00s was most likely the aberration, not now.
People have been wrong about bonds for over 30 years, I dont expect them to be right for any reason other than chance any time soon. Best to just pick an allocation and stick with it and not try to game or time it, as Mr. Market will be sure to do his best to cause the most pain to the most people possible.
a recent 30yr period had bonds returning 8.5% AVERAGE
john bogle age=bonds
Great information on your blog here. I’m looking at the best way to add some fixed-income into my portfolio. I’ve got 130k in Schwab mutual funds paying my advisor 1%. 70k in Roth IRA. I have got 100k in 457b. The municipal Bond guy sounded too much like a Salesman. Leaning towards treasuries but not sure where to start. What do I do?
First you write down your goals, how much you’re going to save for them each year, and what accounts you’re going to invest in for each goal.
Then you figure out what kind of return you will need given your goals and savings rate.
Then you pick an asset allocation that is likely to achieve those goals given your savings rate.
Then you choose mutual funds that will give you that allocation.
But truthfully, since you’re paying 1%, the advisor ought to be doing all this for you.
Treasuries, munis, corporates, I bonds, TIPS, CDs etc can all have their place in a fixed income allocation. There isn’t necessarily a right mix or right answer, but there probably are some wrong ones- like putting it all in Ford bonds.
With rates so low you might expect a long term return of 5% with stock/bonds; after inflation about 3%
Using corporates, hi yield corpo, preffereds, taxable/tax free munis, cds, agency bonds, etc to garner a bit more
My NJ community using these asset classes as well in 10M Reserve Fund-a bold and s somewhat aggressive approach