Author Topic: Is bond duration something to consider if diversification is your only goal?  (Read 1705 times)

xander

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Hello all,

As of right now I am at 100% VTSAX in my Vanguard taxable account. However I am wanting to dip into VBTLX as a means to diversify and reduce volatility from market swings. The amount of shares I plan on buying will put my portfolio at 80/20. Currently my horizon to FI is ten years or so.

Looking under VBTLX's characteristics I see an average effective maturity of 8.3 years and an average duration of 6.1 years among it's 8000+ bonds in the fund.

Does the maturity and duration play much of a role in my 10 year outlook? I know bond prices will fluctuate with interest rates, but that's not something I want to overthink or get caught up on. The way I see it is VTSAX is the workhorse of the portfolio, while VBTLX will smooth things out as the market ebbs and flows..and keep me from doing something stupid when the market eventually kerplunks.

Is that correct mindset to have for bonds? Also if you guys have any other suggestions other than VBTLX I would like to hear them. :)

Radagast

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There is one school of thought that says for someone with a lot of time left to contribute more money and a low bond allocation (say, not more than 20%), that you should keep your bond duration long and the volatility of bonds close to stocks. In this case keep duration greater than 10 or even 20 years, but realize that these bonds will sometimes crash just as hard as stocks can do (and maybe for a lot longer), and that you are in it for the hope that the crashes will occur at different times. This is what I do.

Another school of thought is that you should match the bond market's duration, which is easy to do by owning a total bond fund. A lot of people do this, and you will have a lot of cheerleaders to help you stay the course.

Some people (Bernstein, Buffet?) say to keep duration short so you do not suffer losses on your bond side. This might make sense in many cases, but bonds with short duration seem to be losing to inflation recently and you would be better off with CD's, IBonds, or maybe Redneck Bank.

BTDretire

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 I think we all agree bonds rates are low.
So do you think bond rates will be lower in 10 years? I don't.
Do you think bond rates will be the same or higher?   I do.
 If my scenerio is correct your bond fund will be down, except for dividends added.
Do the dividends make up for inflation?
 Is the relative safety of Bonds important to you?
 If the stock market tanks and your bonds are even or higher are you going to sell and wait for the next bull?
And how is your market timing?
 Just some things to ponder.

neil

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Duration isn't a great measure of safety anyway, because you still remain exposed to years of market risk up until the day you sell.  Normally a fund will roll old maturing bonds into new issues, and as it does this it maintains the same level of exposure.  So if the duration is 10 years, you aren't protected for 10 years; if interest rates are flat for 9 and spike in year 10, you'll probably take losses.  And if you gradually decrease duration over time, you may not "recover" as duration is indicating you should - but I don't have the necessary data/understanding to know how this might function in reality.

If you really want the bonds to mature at a specific date with essentially zero default risk you are probably better off buying treasuries with the appropriate dates desired.  There is really no way to shed the short term risk of the fund approach, despite the desirable simplicity.

Personally, I don't care to make it this complicated.  Fixed income will serve some role in my portfolio indefinitely. But I have run into CD promotions that offer substantial return over equivalent duration in the last couple years.  I have 3 year CDs at 2.25% with very low penalties to break  that are substituting the role to VBTLX because both the interest and effective duration is better  So in my taxable holdings, I am carrying those and they give me some freedom to break if yields were to spike or if we choose to buy a house.

I think as long as you aren't reaching for junk bonds (which correlate too much with stocks) there are a lot of ways to carry the fixed income part of your portfolio that is effectively the same, and you can tailor that to easily fit your forward looking plans.

xander

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Duration isn't a great measure of safety anyway, because you still remain exposed to years of market risk up until the day you sell.  Normally a fund will roll old maturing bonds into new issues, and as it does this it maintains the same level of exposure.  So if the duration is 10 years, you aren't protected for 10 years; if interest rates are flat for 9 and spike in year 10, you'll probably take losses.  And if you gradually decrease duration over time, you may not "recover" as duration is indicating you should - but I don't have the necessary data/understanding to know how this might function in reality.

If you really want the bonds to mature at a specific date with essentially zero default risk you are probably better off buying treasuries with the appropriate dates desired.  There is really no way to shed the short term risk of the fund approach, despite the desirable simplicity.

Personally, I don't care to make it this complicated.  Fixed income will serve some role in my portfolio indefinitely. But I have run into CD promotions that offer substantial return over equivalent duration in the last couple years.  I have 3 year CDs at 2.25% with very low penalties to break  that are substituting the role to VBTLX because both the interest and effective duration is better  So in my taxable holdings, I am carrying those and they give me some freedom to break if yields were to spike or if we choose to buy a house.

I think as long as you aren't reaching for junk bonds (which correlate too much with stocks) there are a lot of ways to carry the fixed income part of your portfolio that is effectively the same, and you can tailor that to easily fit your forward looking plans.

I like this idea actually. So instead of bonds in my portfolio I could have CDs serving as my fixed income and achieve the reduced volatility that I seek.

Noob question: After buying a CD through Vanguard with the percentage yield and duration of my choosing, can I still add contributions on a regular basis up to the maturity date? 

Thank you for all the replies!

jadd806

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I think we all agree bonds rates are low.
So do you think bond rates will be lower in 10 years? I don't.
Do you think bond rates will be the same or higher?   I do.
 If my scenerio is correct your bond fund will be down, except for dividends added.

No it won't. I hold my bonds in the G Fund available to federal employees through the TSP. It quite literally cannot go down. The bonds have a single day duration with a similar yield to intermediate term bonds. Talk about a free lunch.

Mighty-Dollar

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You own a total stock market index fund and a total bond market index fund. There's nothing complicated about investing.