Muni bonds and rebalancing

[ZiziPB]

I have posted on this topic before but I am still struggling with the decision on how to invest my bonus money this year.  I have $36K cash in my taxable to invest right now.  My overall portfolio is somewhat out of balance at this point - I would like to be at least 20% bonds, but am around 16% now.  If I invest $36K in bonds, it will bring me to about 22% in bonds which I would be fine with for now.

But I have two concerns: first, I don't want to invest in a tax inefficient vehicle in my taxable account (33% fed marginal rate and 6.5% state income tax).  Second, I am concerned about the effect the rise in interest rates will have on bond funds. 

So I've come up with two options: one would be to invest $36K in muni bonds (specifically I'm looking at Fidelity's FTABX (long term tax free bond fund with 0.47% expense ratio) and FICNX (CT specific muni bond fund with 0.48% expense ratio)).  The other option would be to invest the cash in my normal automatic investment mix of total stock index fund and international index fund, and reallocate my 401k to obtain more bonds.  The bond options in my 401k are:

HIABX - Hartford Total Return Bond HLS Fund (intermediate term 0.5% expense ratio)
Proprietary High Yield Bond Fund (.02% expense ratio)
Proprietary Stable Value Fund (.306% expense ratio)

My 401k is currently in Vanguard Target Retirement 2030 fund (which we get at .08% expense ratio), so another option would be to switch that to a more conservative Vanguard Target Retirement 2015 (same .08% expense ratio) which would result in about 23% overall bond allocation in my portfolio.

What say you?  And what of my second concern with the bond funds in rising interest rate environment???

[hodedofome]

It is true that there is more risk that rates will rise than fall. In some ways buying and holding a bond fund is really a bet that rates will stay the same or fall. However, there's no guarantee that rates have to rise. You could buy a short duration fund, convinced that rates have to rise, and 15 years later rates are still lower than when you bought in. I think the question to answer is why do you own bonds in the first place? If it's to diversify your portfolio then it has merit even if the returns aren't going to be good. It's entirely possible that bonds outperform stocks the next 10 years. Won't you be glad you had an allocation to them if that happens!

[ZiziPB]

So I guess what you are saying is that I shouldn't be trying to time the bond market ;-)  I should just decide on my allocation and stick with it.  So what do you think of my three options then? 

[brewer12345]

If the stable value fund yields at least 2%, I would buy equities in your taxable account and rebalance 401k assets into the SV fund.

[ZiziPB]

Thanks Brewer. 

The Stable Value Fund investment description:

The fund invests in stable value investment contracts ("Contracts") issued by a diversified group of high-quality insurance companies, banks, and other financial institutions, and a variety of fixed income instruments including U.S. Government and agency securities, mortgage-backed securities, asset-backed securities, corporate bonds, and interest rate futures and options. The fund also maintains an allocation to a money market fund to help meet daily liquidity requirements. Unit price, yield, and return will vary.

Performance history:
YTD (Daily)* +0.71%  1 Yr +2.42%  3 Yr +2.91%  5 Yr +3.09%  10 Yr +3.92%

Thoughts?

ETA: Would you view this a temporary allocation until the interest rates normalize or should I be looking at this as a good long term diversification tool?

[myDogIsFI]

Re: bond funds in rising interest rate environment.  Basically, you're asking "should I do market timing?"  That implies that you think you know something about the market that isn't priced into it.  Conventional wisdom, as I'm sure you're aware, is don't time the market and stick to your asset allocation.  I also hear stocks are overvalued and sure to crash.  If you believe that AND that rising interest rate thing for bonds, then you're stuck in cash and you'll never retire.

Re: putting bonds in taxable v. 401k.  One thing to consider is liquidity.  If you think you'll be drawing from your portfolio for any purchases, e.g., home down payment or car or college or whatever, it may be nice to have the munis there that you can get out easily.  If you want to get the money out of your 401k, you'd have to sell your taxable stock and re-buy it in the 401k.

I tend to think the muni bonds are pretty good option in your tax bracket.  If you are really worried about the rising interest rates boogeyman, then the stable value fund may be best for you.

[ZiziPB]

Yes, I figured this was some form of market timing ;-)

I am planning to retire in about 4 years and will be drawing from my taxable portfolio then.  I am not planning any big purchases before that time that would require liquidity.  I have a solid emergency fund in a liquid CD in case of the unexpected.  Somehow, having lived through a couple of market crashes, stock crashes don't bother me much.  I believe the markets will eventually recover.  But I have a definite fear of high inflation and manipulation of interest rates since that is outside of the market.

[myDogIsFI]

Sounds like you're in good shape.  I'd go with the stable value fund in your position.  You'll probably have no need for the munis when you retire and it'll protect you from interest rate risk on the bond funds.

[ZiziPB]

Thanks for your input!  And I like your screen name - my cat is not FI but she is definitely RE ;-)

[brewer12345]

Thanks Brewer. 

The Stable Value Fund investment description:

The fund invests in stable value investment contracts ("Contracts") issued by a diversified group of high-quality insurance companies, banks, and other financial institutions, and a variety of fixed income instruments including U.S. Government and agency securities, mortgage-backed securities, asset-backed securities, corporate bonds, and interest rate futures and options. The fund also maintains an allocation to a money market fund to help meet daily liquidity requirements. Unit price, yield, and return will vary.

Performance history:
YTD (Daily)* +0.71%  1 Yr +2.42%  3 Yr +2.91%  5 Yr +3.09%  10 Yr +3.92%

Thoughts?

ETA: Would you view this a temporary allocation until the interest rates normalize or should I be looking at this as a good long term diversification tool?

You should be able to see a current yield for this fund, but the YTD suggests it is over 2%.  Stable value funds are essentially zero risk for the plan participants and are a nice stand in for bond funds and money market funds, especially when interest rates are very low.  It would be a permanent allocation for me unless bond yields were a good deal higher yielding and/or the yield curve inverted.

[beltim]

Thanks Brewer. 

The Stable Value Fund investment description:

The fund invests in stable value investment contracts ("Contracts") issued by a diversified group of high-quality insurance companies, banks, and other financial institutions, and a variety of fixed income instruments including U.S. Government and agency securities, mortgage-backed securities, asset-backed securities, corporate bonds, and interest rate futures and options. The fund also maintains an allocation to a money market fund to help meet daily liquidity requirements. Unit price, yield, and return will vary.

Performance history:
YTD (Daily)* +0.71%  1 Yr +2.42%  3 Yr +2.91%  5 Yr +3.09%  10 Yr +3.92%

Thoughts?

ETA: Would you view this a temporary allocation until the interest rates normalize or should I be looking at this as a good long term diversification tool?

You should be able to see a current yield for this fund, but the YTD suggests it is over 2%.  Stable value funds are essentially zero risk for the plan participants and are a nice stand in for bond funds and money market funds, especially when interest rates are very low.  It would be a permanent allocation for me unless bond yields were a good deal higher yielding and/or the yield curve inverted.

I agree with brewer that the stable value fund looks like the best deal.  I would, however, check to see if there are any holding requirements - some stable value funds require you to hold shares for 5 years or so.

[ZiziPB]

Thank you all.  For some reason I cannot find yield information for it, just the performance info I posted which is termed "average total returns".  Not sure if that is the same as yield.
   
As to restrictions, the only restrictions I can see relate to direct exchanges with the HLS Fund and a money market fund we have - basically, you need to have your money in another investment class for at least 90 days between such exchanges.  It doesn't seem t0o restrictive.

[ZiziPB]

Thank you all for the helpful input.  I have read up some more on stable value funds and can see that it is in fact a good option that will most likely address my concerns.  So I put in an order to reallocate a portion of my 401k and also adjusted the allocation of my future contributions to utilize this investment option in order to achieve my desired AA.  Next step is to invest the cash in taxable which I will do in the next couple of days.

I am so grateful that I found MMM and this forum last year.  I have since instituted an automated investment program through my brokerage account, increased my HSA contribution to the max, dropped unneeded but expensive life insurance and significantly increased my 401k contributions (always maxed in the past but now I am also contributing after tax dollars which I can convert to Roth 401k after a couple of years).  My spending is still pretty high but I am now very happy with my savings and investments, so I feel great overall.   Thanks to all again!