Bonds?

[billy]

I'm getting close to retirement, about a year out, and my plan has been right now to buy total bond market VBTLX, but bonds haven't been behaving normally since things are not normal obviously, The feds are not helping, should I be switching to just savings account? My current plan is three buckets, stock, bond, cash.

[shinn497]

It depends on what your goal is. Bonds have lower volatility but lower returns. Over the long term, and I am assuming you are investing for the long term if you are here, time averages away the volatility of stocks, and the greater returns of stocks means your portfolio is more viable long term.

That being said, if you want a cushion for a few years to cover essential expenses, and you what that to remain non volatile, than it doesn't matter what investment, be it fixed income or cash equivalent, to choose. The time horizon is too short to matter. On a side note, a savings account IS a bond account if it is any kind of savings account with a good interest rate (greater than 0.4% right now). The bank invests that account in bonds to make the difference.

[mistymoney]

I was also trying to venture into bonds this year.....I bought in....then I sold.

As you mention - bonds are not functioning quite as they have in the past as a hedge. given arguments about the value of bonds when interest rates rise or fall, and the historically low interest rates now, I opted to not do bonds.

Thinking of doing dividend stocks and cash instead.

[billy]

Ya mistymoney, I think I'll stop at 1.5 y. worth living expenses and the rest cash as the feds are forecasting near zero interest rate for another 1.5 y. I believe. It appears either way, inflation is going to beat me up with bond/cash position. Well it could be worse, at least it's unamerican for the feds to do negative interest rates. 

[ChpBstrd]

Yea bonds are scary because convexity at these very low interest rates means their prices are extremely sensitive to changes in interest rates. The consensus is the Fed has complete control over interest rates due to their practically unlimited QE/QT firepower. However, the same Fed has also indicated they're willing to let things run hot for a while rather than fretting about quarterly inflation like they did for several of the past years as inflation failed to even reach their 2% target. Play with Excel a bit to understand the implications of a 1% rate change on trillions of dollars worth of treasuries with 10+ year durations. The Fed's choice is to either hit their inflation target or spark a financial crisis, so their "run hot" talk is empty chatter. We'll have a repeat of 2009-19, with barely-positive inflation, low rates, and possibly more rounds of QE/QT to keep inflation under 2%.

That doesn't mean a smooth ride. Treasury holders will still lose to inflation, and will fail to benefit much from another financial crisis. Long-duration holders will be severely damaged if inflation peeps even a little. We'll also have more taper tantrums and inflation panics that will rock equities, because everyone knows our vulnerability to inflation right now.

In such an environment, cash, rather than bonds, might be worth holding for its option value. I.e. cash gives one the option to buy low when the next correction hits, and that is worth paying the price of the maybe 1-1.5% spread between cash yields and likely future inflation (a spread that isn't much better for bonds). If the spread were any larger than that, you'd want to be in cash anyway!

[MustacheAndaHalf]

On Vanguard's portfolio page for VBTLX, it shows the "Average Duration" is 6.7 years:
https://investor.vanguard.com/mutual-funds/profile/portfolio/vbtlx
Every 1% rise translates to a 6.7% loss, and each drop of 1% is a 6.7% gain.

That means if the Fed raises rates 0.50%, VBTLX is expected to change by:
6.7 * -1 * 0.005 = -0.0335, or a loss of 3.35%.

Right now bond yields are at historic lows.  If bond yields remain the same, you can collect 1.1% interest a year with VBTLX.  If rates go up, that gain is wiped out pretty quickly.  Being at historic lows, large drops are very unlikely.

I sold out of my bond funds back in April, and have held cash since.  But my equity earnings more than cover for any bond yield I would have earned.  In your situation, I might find the bank paying the highest yield, and park some cash there.

[cool7hand]

I often post about how the wife and I include bonds in our portfolio. We use the All Seasons (aka All Weather) Portfolio designed by Ray Dalio of Bridgewater. It is a low volatility portfolio that has performed wonderfully for us since about 2014, including during Covid. We rebalance quarterly during low volatility and monthly since Covid began. It has been back tested by multiple websites. Give it a look and see if that might work for you!

[GoCubsGo]

I've been reading and worrying about a bond "bubble" for almost 5 years now (but have stayed invested in bonds).  VBTLX is up  7.4% the past year and 5.5% on average the past 3 years.  If you sat in cash or cd's that whole time you would have left a lot of money on the table. 

I totally understand the interest rate risk but I do have a question.  Over half of VBTLX is in corporate or mortgage backed securities.  Does that mitigate some of the interest rate risk (would that corporate exposure possibly help)?  If you had a 40% allocation to bonds historically in a 60/40 portfolio, would you really put that 40% in cash earning close to nothing?    I guess there's no free ride anywhere without risk but it would sure suck to put 40% of your portfolio in a CD earning .5%.   I'm to the point in my FIRE timeline where I should be implementing a bond tent but I have definite concerns.....

[ChpBstrd]

I've been reading and worrying about a bond "bubble" for almost 5 years now (but have stayed invested in bonds).  VBTLX is up  7.4% the past year and 5.5% on average the past 3 years.  If you sat in cash or cd's that whole time you would have left a lot of money on the table. 

I totally understand the interest rate risk but I do have a question.  Over half of VBTLX is in corporate or mortgage backed securities.  Does that mitigate some of the interest rate risk (would that corporate exposure possibly help)?  If you had a 40% allocation to bonds historically in a 60/40 portfolio, would you really put that 40% in cash earning close to nothing?    I guess there's no free ride anywhere without risk but it would sure suck to put 40% of your portfolio in a CD earning .5%.   I'm to the point in my FIRE timeline where I should be implementing a bond tent but I have definite concerns.....

If the risk-free rate rises, the rate for risky debt securities will rise as well, although the spread between them may widen or narrow.

For bonds to continue returning mid-single-digits, interest rates would have to continue falling, which would put them below zero. If interest rates rise, bonds will be slaughtered. That is the risk you are paid for in a long duration bond portfolio versus a bank CD.

[MustacheAndaHalf]

I've been reading and worrying about a bond "bubble" for almost 5 years now (but have stayed invested in bonds).  VBTLX is up  7.4% the past year and 5.5% on average the past 3 years.  If you sat in cash or cd's that whole time you would have left a lot of money on the table.

I'll do your example one better: for the past 40 years, bonds have mostly had capital gains.  But those same 40 years saw gradually falling bond yields, which is why they had capital gains.  There's a 10% gap or so between the peak bond yields of the 1980s and today's yields.

Back in March, the Fed dropped their funds rate, and bond yields dropped 1%.  That's where VBTLX's gains come from: when yields drop 1%, that fund is expected to gain 6.7%.  In a recovery, it should happen in reverse: a 1% rise should cause VBTLX to lose 6.7%.  There's also a contribution from it's current 1.1% yield.

As to corporate vs treasury bonds, here's two Vanguard funds for comparison:
Vanguard Intermediate Corporate, 1.6% yield, 6.4 duration, mostly Baa quality
https://investor.vanguard.com/etf/profile/VCIT
Vanguard Intermediate Treasury, 0.5% yield, 5.2 duration, all U.S. govt quality
https://investor.vanguard.com/mutual-funds/profile/portfolio/vfitx

For about 3+ notches lower quality and 1.2 extra duration, the yield is 1.1% more.
Personally, I'm risk averse with bond funds and take my risks with equities.

[GoCubsGo]

I've been reading and worrying about a bond "bubble" for almost 5 years now (but have stayed invested in bonds).  VBTLX is up  7.4% the past year and 5.5% on average the past 3 years.  If you sat in cash or cd's that whole time you would have left a lot of money on the table.

I'll do your example one better: for the past 40 years, bonds have mostly had capital gains.  But those same 40 years saw gradually falling bond yields, which is why they had capital gains.  There's a 10% gap or so between the peak bond yields of the 1980s and today's yields.

Back in March, the Fed dropped their funds rate, and bond yields dropped 1%.  That's where VBTLX's gains come from: when yields drop 1%, that fund is expected to gain 6.7%.  In a recovery, it should happen in reverse: a 1% rise should cause VBTLX to lose 6.7%.  There's also a contribution from it's current 1.1% yield.

As to corporate vs treasury bonds, here's two Vanguard funds for comparison:
Vanguard Intermediate Corporate, 1.6% yield, 6.4 duration, mostly Baa quality
https://investor.vanguard.com/etf/profile/VCIT
Vanguard Intermediate Treasury, 0.5% yield, 5.2 duration, all U.S. govt quality
https://investor.vanguard.com/mutual-funds/profile/portfolio/vfitx

For about 3+ notches lower quality and 1.2 extra duration, the yield is 1.1% more.
Personally, I'm risk averse with bond funds and take my risks with equities.

That corporate bond comparison pretty much answered that question for me.  Thanks.  A "traditional" bond tent would have me ramping up my exposure to bonds at a massive level to mitigate SORR.  It would be terrifying if 40-60% of my portfolio was in bonds and the Fed surprised with a rate increase.   But 60% of a large portfolio in cash at close to zero makes me sick too.  It's a conundrum I'm rapidly approaching.   A thought I've been having is to buy more rental real estate, as it has proven to be very durable for me through two massive financial crises. Even though it is a lot more work than a bond fund earning 3-4%!

[ChpBstrd]

Go 100% equity and hedge using options. You can engineer a similar limited downside, low volatility, and rebalance-able portfolio as with a bond/stock portfolio, and completely dodge the interest rate risk.

[MustacheAndaHalf]

As to corporate vs treasury bonds, here's two Vanguard funds for comparison:
Vanguard Intermediate Corporate, 1.6% yield, 6.4 duration, mostly Baa quality
https://investor.vanguard.com/etf/profile/VCIT
Vanguard Intermediate Treasury, 0.5% yield, 5.2 duration, all U.S. govt quality
https://investor.vanguard.com/mutual-funds/profile/portfolio/vfitx

For about 3+ notches lower quality and 1.2 extra duration, the yield is 1.1% more.
Personally, I'm risk averse with bond funds and take my risks with equities.

That corporate bond comparison pretty much answered that question for me.  Thanks.  A "traditional" bond tent would have me ramping up my exposure to bonds at a massive level to mitigate SORR.  It would be terrifying if 40-60% of my portfolio was in bonds and the Fed surprised with a rate increase.   But 60% of a large portfolio in cash at close to zero makes me sick too.  It's a conundrum I'm rapidly approaching.   A thought I've been having is to buy more rental real estate, as it has proven to be very durable for me through two massive financial crises. Even though it is a lot more work than a bond fund earning 3-4%!

Holding 60% bonds/cash seems a bit high.  The traditional fixed retirement portfolio is 60% equities / 40% bonds, so your lower 40% figure seems more reasonable for a bond allocation.

Bond tents aren't really conventional wisdom as yet.  For example, the traditional 60/40 portfolio has known allocations - but bond tents don't.  Some start near 80%, drop to 60%, then rise back to 80%.  Others start lower - I could be wrong, but I'm not aware of a traditional bond tent allocation.

My personal "benchmark" portfolio is a boring equal split between US Total Stock Market ("VTI"), Total International ("VXUS"), and Total Bond ("BND").  I've beaten that benchmark by pushing into riskier assets that have been recovering nicely so far.  But the principle also holds in general: you should expect higher long-term returns from a higher equity allocation.  If you're worried about having enough for retirement, 60% bonds is a bad idea.  Once you have more than enough, you can stay retired with that allocation - but it's usually a slower path to a nest egg.

[Radagast]

My bonds preferences really haven't changed over the last year.
ZROZ or EDV for term risk and rebalancing, only in a tax deferred account.
VWALX for (moderate) credit risk, which is a little different than corporate equity risk, only in a taxed account.
Series I Savings Bonds for safety, and to defer taxes on interest. I don't feel rich enough to afford safety.

[GoCubsGo]

As to corporate vs treasury bonds, here's two Vanguard funds for comparison:
Vanguard Intermediate Corporate, 1.6% yield, 6.4 duration, mostly Baa quality
https://investor.vanguard.com/etf/profile/VCIT
Vanguard Intermediate Treasury, 0.5% yield, 5.2 duration, all U.S. govt quality
https://investor.vanguard.com/mutual-funds/profile/portfolio/vfitx

For about 3+ notches lower quality and 1.2 extra duration, the yield is 1.1% more.
Personally, I'm risk averse with bond funds and take my risks with equities.

That corporate bond comparison pretty much answered that question for me.  Thanks.  A "traditional" bond tent would have me ramping up my exposure to bonds at a massive level to mitigate SORR.  It would be terrifying if 40-60% of my portfolio was in bonds and the Fed surprised with a rate increase.   But 60% of a large portfolio in cash at close to zero makes me sick too.  It's a conundrum I'm rapidly approaching.   A thought I've been having is to buy more rental real estate, as it has proven to be very durable for me through two massive financial crises. Even though it is a lot more work than a bond fund earning 3-4%!

Holding 60% bonds/cash seems a bit high.  The traditional fixed retirement portfolio is 60% equities / 40% bonds, so your lower 40% figure seems more reasonable for a bond allocation.

Bond tents aren't really conventional wisdom as yet.  For example, the traditional 60/40 portfolio has known allocations - but bond tents don't.  Some start near 80%, drop to 60%, then rise back to 80%.  Others start lower - I could be wrong, but I'm not aware of a traditional bond tent allocation.

My personal "benchmark" portfolio is a boring equal split between US Total Stock Market ("VTI"), Total International ("VXUS"), and Total Bond ("BND").  I've beaten that benchmark by pushing into riskier assets that have been recovering nicely so far.  But the principle also holds in general: you should expect higher long-term returns from a higher equity allocation.  If you're worried about having enough for retirement, 60% bonds is a bad idea.  Once you have more than enough, you can stay retired with that allocation - but it's usually a slower path to a nest egg.

Yes, I'd ultimately sit at 70/30 equities/bonds as my FIRE allocation but SORR is obviously a huge concern the first part of FIRE.  A 60/40 portfolio has a known track record, but one that opens you up to a potential SORR risk (hence flipping the allocation early in FIRE). It's those first 5 years for me that I'm going to have to squirm.  Executing  a solid cd ladder like the old days (4-5%) would solve my problems but I'd imaging if we got to that point equities would probably suffer.   I hate overthinking this stuff but the like many, the bond risk the next few years could be a huge challenge to me in early FIRE.

[Wolfpack Mustachian]

I've yet to personally see a huge benefit in bonds. To me, there's a lot of risk although it's a different risk than with equities. I believe that when I get there, I will handle it with just a cash cushion of maybe 3 years or so to be able to handle a significant drop in the stock market. Who knows, I'm still years out and may get cold feet when it gets closer but that's my feeling currently.

[MustacheAndaHalf]

...
Yes, I'd ultimately sit at 70/30 equities/bonds as my FIRE allocation but SORR is obviously a huge concern the first part of FIRE.  A 60/40 portfolio has a known track record, but one that opens you up to a potential SORR risk (hence flipping the allocation early in FIRE). It's those first 5 years for me that I'm going to have to squirm.  Executing  a solid cd ladder like the old days (4-5%) would solve my problems but I'd imaging if we got to that point equities would probably suffer.   I hate overthinking this stuff but the like many, the bond risk the next few years could be a huge challenge to me in early FIRE.

It's a big relief to hear you're aiming for 70% equities, since that's where long-term performance has come from historically.  And I agree with the last 30%, you might be overthinking the decision between bonds and CDs.  You could split the difference, and allocate 15% bonds and 15% CDs...

... and then look at something more important: your withdrawal rate.  Annual living expenses of 3% vs 5% (of your retirement) are much more significant than a decision of bonds vs CDs.