advice on adding bonds to the stache for FI in 5-7 years

[pigpen]

Hello,

After reading with great interest for the last couple of months, this is my first posting to this fine forum. I have a question about adding bonds to my investments that I'm hoping to get some advice on. And if anyone has any other thoughts on my situation, please chime in.

In early December, we will be paying off the last of our mortgage, which means that we will have some extra money each month to invest. Since I've only recently begun to think about investing in terms of FI and early retirement, I'm also trying to reexamine my investments in general through that lens. There are too many variables right now for us to predict an FI date with confidence, but 5-7 years is probably pretty close.

Age: 43 (me), 40 (my wife)
Time until FI and semi-retirement: 5-7 years -- but will continue to bring in at least a little income through freelance work
Current Investments: Me -- $90,000 in Roth and 401k -- around 93% stocks, 7% bonds; My wife -- $65,000 in Roth and 401k -- all in T Rowe Price 2040 target date fund (currently approx. 90% stock, 10% bond) -- Cash: $50,000 (around $20k to be used to finish off the mortgage)

Tax-advantaged account options: In my job, I can contribute to both a 401k and a 457 plan. If I understand correctly, I will be able to withdraw funds from the 457 without penalty after leaving my job, so it's likely that we would be depending on some of these funds while we wait for the funds from a Roth ladder to become available. My wife can contribute to a 401k. We can also contribute to a Roth.

Question 1: I'd like to increase the percentage of bonds in the mix to around 20-30% (in the form of a bond fund -- I have Vanguard Total Bond Fund (VBTIX) as well as multiple Vanguard target date funds available in my work plans). I keep telling myself, however, that putting money into bonds under current market conditions is buying high and that I should wait until interest rates start to increase again. Am I overthinking it? Trying to time the market when I shouldn't? I just opened the 457 account, so I was thinking that I might just start contributing at the desired stock/bond allocation (80/20 or 70/30) and keep doing so until I leave the job.

Question 2: Does an allocation of around 15% Intl., 15% Small cap, 50% large cap, 20% bonds sound reasonable given our timeframe?

Question 3: Any opinions on target date funds in general? All of my wife's money is in one right now, but I don't think she'd be against changing that.

Thanks for any thoughts that anyone has.

Pigpen

[foobar]

1) Interest rates might not go up substantially for 20 + years. See the 40s/50s for an example of that. You are not going to make big money in bonds these days but the odds of losing more than 10% or so over 3 years is pretty low also. 5 years out, you need to be thinking about bonds even though they suck as an investment right now. If you were 10 years out, you might be able to talk yourself into skipping htem.

2) Good enough. Personally I go 25,25,30 but it really doesn't matter. It is pretty unknowable who is going to outperform over the next 20 years.

3) They are ok (assuming a good one like vanguard. Some of them are really pricey). You pay a bit more than handling the rebalancing your self but they handle the rebalancing are for you. And if your in favor of a glide path, they do that also.

[Dodge]

1.  When interest rates in crease, so does the yield.  If you're buying and holding, I wouldn't worry about it personally.  Here's a thread with more info:

So do we care more about change in bond price or bond yield?

2.  Vanguard's white paper on this recommends 30% of your equities should be international:

Considerations for investing in non-U.S. equities

3.  They are best for people who don't want to be bothered with rebalancing, or who might be tempted with market timing.  If these aren't concerns for you, having the funds be separate has many advantages:

http://www.bogleheads.org/wiki/Vanguard_LifeStrategy_funds

[pigpen]

Thank you both for the help. I especially enjoyed the bond price vs. yield discussion link -- although it made my head hurt a little.

[Gin1984]

How much do you spend annually?  Was your mortgage THAT huge?  Why do you think you can retire in 5-7 years with only about $200K?

[foobar]

1.  When interest rates in crease, so does the yield.  If you're buying and holding, I wouldn't worry about it personally.  Here's a thread with more info:

So do we care more about change in bond price or bond yield?

If you thought that bonds were going to be 5% in 5 years would you be better off making something like 0% nominal by investing in total bond or would you be better off making 2.5% by buying some CDs for 5 years? If you put it that way buying bonds doesn't seem like a great idea. You do lose money when rates go up. If it is enough to keep you up at night is another issue.

Personally I have accepted that if I am lucky I will get about 0% real from my bonds for the next 5 years and if I am unlucky I might have a 1-2% loss.  At this point I am buying them as a hedge against an overvalued market more than as an investment and I am gambling that liquidity I get by doing that will make it a win over buying CDs and the interest rate risk I am taking is still better than keeping the money in a money market fund. I also accept that the odds of me being right are about 50/50 at best.

[pigpen]

Foobar -- Yes. That's a good of looking at it. I think I also need to do a little bit more reading on the topic. Going to get a copy of the Intelligent Asset Allocator at the library today, actually.

Gin1984 -- The mortgage wasn't that huge, but we've been paying a fair amount extra against the principal and also holding back a little extra in cash each month that will now be directed every month into better investments. Expenses are approximately $25k-$30k per year. Plus my wife and I both have pensions that will add income of somewhere in the neighborhood of $25-30k/year (2014 dollars) to the mix when we hit 60. We also plan on continuing to earn something all along. The plan is really more for a take the lower paying job you really want style retirement than a pina coladas on the beach sort of thing.

[Gin1984]

Foobar -- Yes. That's a good of looking at it. I think I also need to do a little bit more reading on the topic. Going to get a copy of the Intelligent Asset Allocator at the library today, actually.

Gin1984 -- The mortgage wasn't that huge, but we've been paying a fair amount extra against the principal and also holding back a little extra in cash each month that will now be directed every month into better investments. Expenses are approximately $25k-$30k per year. Plus my wife and I both have pensions that will add income of somewhere in the neighborhood of $25-30k/year (2014 dollars) to the mix when we hit 60. We also plan on continuing to earn something all along. The plan is really more for a take the lower paying job you really want style retirement than a pina coladas on the beach sort of thing.

Then, I would not add many bonds.  If your income covers your expenses I would have less than a year of expenses in bonds.

[DrF]

In your situation this is what I would do:

401k up to match for you and wife > MAX out 457 > MAX out Traditional IRAs (if eligible) otherwise MAX out 401ks > MAX out Roth IRAs (if ineligible for Traditional) > add anything leftover into a brokerage account.

Since you seem like you will have additional income streams during retirement you can be a bit more aggressive IMO. 70-80% USA (total market), 10-20% International, 10% Bond.

Way to go with your Mustachian spending habits!!

[pigpen]

Thank you, Dr. I could probably figure this out if I thought about it, but why contribute to a traditional IRA before a 401k?

[wtjbatman]

Thank you, Dr. I could probably figure this out if I thought about it, but why contribute to a traditional IRA before a 401k?

People usually suggest that when you have a 401k with high fund fees. With your IRA you are investing your money in (hopefully) low fee funds like index funds. Many people don't have that option with a 401k.

[DrF]

Thank you, Dr. I could probably figure this out if I thought about it, but why contribute to a traditional IRA before a 401k?

That step is pretty interchangeable (Traditional IRA vs remaining 401k). It sounds like you have good options in your 401k, so do what you want there. Importantly, if your income is above the Traditional IRA limits then see if you can bring it down enough to qualify by maxing out your 457 and 401k first (make sure you are doing pre-tax into both, some 401k accounts have Roth options - don't do that).

Hope that helps!

[VirginiaBob]

On question 3, I used to be in Vanguard's Target funds a long time ago, but now I am re-allocating manually.  Once you hit admiral fund status, the savings start to become significant (for example VFINCX .17% vs 0.05% expense ratios).  Doesn't seem like much, but let's say you invest for 50 years out of your life.  That works out to over 6% of fund costs.

[pigpen]

Great -- thanks for the advice, everyone.

[Holyoak]

Once you hit admiral fund status, the savings start to become significant (for example VFINCX .17% vs 0.05% expense ratios).  Doesn't seem like much, but let's say you invest for 50 years out of your life.  That works out to over 6% of fund costs.

Hallelujah!, and I love my all "admiral" accounts with VG...  Also love playing with this handy cost calculator...  Good Lord, every time I see 401k's, 403b's, clown mutual funds/advisers with 2+ % fees/loads, I wince, especially after just a few years.

https://personal.vanguard.com/us/insights/investingtruths/investing-truth-about-cost

Just see what a HUGE difference there is between say .5% to 1.5 or 2%...  UNREAL!  Gotta love VTSAX @ .05%, loosing only 1.4% to fees after 25 years; 43% are lost @ 2%!