Author Topic: Portfolio rebalance-bonds  (Read 1314 times)

muskrat

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Portfolio rebalance-bonds
« on: December 27, 2024, 08:58:09 AM »
I'm currently rebalancing my portfolio and have decided to increase my bond position.  In the past few years I have not invested much in bonds due to the low yield (90-10 stock/cash-high yield money market funds.)  I have 10 years until retirement and have a high risk tolerance.  Does anyone have recommendations for bond funds? I've looked at PDI, LQD, VTEB, etc.  I would like to find one that has a yearly return over 6% and not be as heavily correlated to the market.

Wintergreen78

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Re: Portfolio rebalance-bonds
« Reply #1 on: December 27, 2024, 09:43:21 AM »
The classic 60-40 portfolio used intermediate duration bonds, and many people (me included) use US government bonds for bond portion of their portfolio. If you expect 6% returns from bonds, you will need to buy risky bonds.

This site has a good look at lots of portfolios, and each has some discussion of the bonds used in each: https://portfoliocharts.com/portfolios/classic-60-40-portfolio/#allocation

ChpBstrd

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Re: Portfolio rebalance-bonds
« Reply #2 on: December 27, 2024, 10:48:48 AM »
The best I can do, aside from absolute junk, is agency bonds (farm credit banks and home loan bank GSE's). But even here you'd have to take a lot of duration risk to even approach 6%. And they're generally all continuously callable, so you can't lock-in an assured amount of income in the distant future.

Examples (CUSIP, maturity, yield to worst)
3133EPS30     1/8/2044     5.975%     Farm Credit Banks
3133ERM32    12/19/2039  5.901%    Farm Credit Banks
3130B4EY3     1/2/2041     5.900%    Home Loan Banks

However you might want to limit exposure to agency bonds, until it is clear that the ruling party is not going to privatize them at the expense of their credit-worthiness.

There are also some A-rated corporate bonds with yields in these ranges, but you're still looking at maturities 20+ years out.

25161FU22     9/30/2044     5.946%    Deutche Bank
976826BK2     10/15/2044   5.901%    Wisconsin Power
29364WAV0    1/15/2045     5.880%    Entergy Louisiana
48130CWW1   12/23/2044   5.801%    JP Morgan

I would caution against overextending on risk just to hit an arbitrary 6% number. The market is paying what it's paying, and if you find a "bargain" like perhaps some of the names above, it merely reflects that the market knows some things about the issuer that you do not.

If you want to see the consequences of over-extension, look at the roller coasters investors in extended-duration bond funds like TLT, ZROZ, and EDV have been riding. EDV, for example, is down 10% over the past 6 months. That's a lot of volatility for a yield just over 4%. Don't try to tell these investors treasuries are "risk-free"!

For all these reasons and more, I prefer to control risk using options. This requires some education to do correctly, but the firmness of one's upsides/downsides and the mathematical certainty of counter-correlation is to me a superior way of controlling risk than chasing bond yields.

That said, I did make $100k this time last year when yields were soaring despite imminent rate cuts. I went all into high-duration bonds and funds just as the fever broke and rates started heading down amid falling inflation. The 30y rate went from about 4.75% in late November 2023 to about 3.95% in early January 2024. I sold at the bottom in rates, AKA the top in bond prices, in late December through early January. So I'm not permanently against bonds or anything - I just don't see a justification to run that same play right now.

Another possibility, if you absolutely must hit 6%, is to incorporate some high-yielding preferred stocks with yields above 7%, like TRTN/PRC, MAA/PRI, ET/PRI, or OZKAP to raise the average yield of your asset allocation to income producers. Two caveats:

(1) Preferred stocks ARE NOT BONDS. They are often riskier. In the event of bankruptcy you'd probably get nothing. Plus they can often suspend dividends. Some are not even cumulative. Some are callable. Research the terms that are specific to each preferred stock issue on https://www.quantumonline.com/. Also understand that preferreds can tank just like stocks, but lack their upside potential, and are near-impossible to hedge with options. Thus they fail as hedges to a mostly-stock portfolio.

(2) As with bond yields, if you spot a high-yielding "bargain" it is because the market is incorporating information you are unaware of. Keep your position sizes under control and think through worst-case scenarios.

MustacheAndaHalf

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Re: Portfolio rebalance-bonds
« Reply #3 on: December 27, 2024, 08:37:49 PM »
I'm currently rebalancing my portfolio and have decided to increase my bond position.  In the past few years I have not invested much in bonds due to the low yield (90-10 stock/cash-high yield money market funds.)  I have 10 years until retirement and have a high risk tolerance.  Does anyone have recommendations for bond funds? I've looked at PDI, LQD, VTEB, etc.  I would like to find one that has a yearly return over 6% and not be as heavily correlated to the market.
Did you know "high yield bonds" are also called "junk bonds"?  They tend to crash with equities, providing equity-like risk.  The bond market doesn't offer higher yields without higher risk.

You could locate a state-specific municipal bond fund, in which case the income is exempt from both Federal and state taxes.  Personally, I prefer the diversification of VTEB, which holds municipal bonds from across the country.

Mississippi Mudstache

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Re: Portfolio rebalance-bonds
« Reply #4 on: January 03, 2025, 11:46:52 AM »
I'm also scheduled to increase my bond percentage this year. I've been 100% stocks for the last decade, so I have zero experience in investing in bonds, aside from a bond mutual fund that was a part of my first 401k package back in the early 2010s. My question is this: Is it generally going to be preferable to invest in individual bonds vs. a bond fund? I greatly appreciate the risk-diversity of stock ETFs, but if a bond ETF will wash out my expected returns, then I'm willing to bite the bullet and put my eggs into fewer baskets.

ChpBstrd

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Re: Portfolio rebalance-bonds
« Reply #5 on: January 03, 2025, 12:43:16 PM »
I'm also scheduled to increase my bond percentage this year. I've been 100% stocks for the last decade, so I have zero experience in investing in bonds, aside from a bond mutual fund that was a part of my first 401k package back in the early 2010s. My question is this: Is it generally going to be preferable to invest in individual bonds vs. a bond fund? I greatly appreciate the risk-diversity of stock ETFs, but if a bond ETF will wash out my expected returns, then I'm willing to bite the bullet and put my eggs into fewer baskets.
I think if you are primarily investing in treasuries or agencies, just buying one or two of them directly has about the same risk profile as an ETF. The only benefit of the ETF, IMO, is in keeping your duration at a certain level long term. I.e. if you buy a 20y treasury now, it'll be a 7 year treasury in 13 years, with all the associated changes in how they react to changing interest rates. A bond fund with a target duration will keep the same duration throughout.

With corporate or especially junk bonds, you are buying the fund for diversification against default risk. I.e. some percentage of these bonds will default each year, and so you don't want to buy just one or two names and hope for the best. OTOH, I've done very well for myself bond-picking over the years, and own several specific low-rated-corporate / edge-of-junk bonds.
« Last Edit: January 03, 2025, 03:59:23 PM by ChpBstrd »

Mississippi Mudstache

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Re: Portfolio rebalance-bonds
« Reply #6 on: January 03, 2025, 01:41:05 PM »
Thanks, ChpBstrd. I recall reading about the pros & cons of funds vs. individual bonds 10+ years ago when I was just beginning to save, but I'd forgotten the specifics of it since I never invested in them. Every time I've looked into bonds since then, I've been overwhelmed by the apparent complexity compared to stock ETFs, but it's time to bite the bullet and learn to pick them.

vand

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Re: Portfolio rebalance-bonds
« Reply #7 on: January 04, 2025, 11:02:49 AM »
10y US Treasury is pay around 4.5%; if you want to reach for higher yield you have to go further out onto the risk spectrum into corporates and junk, however in so doing the risk profile changes and the bonds can behave more more similarly to equities and less like Treasuries...

To reiterate, though, bonds are very poor diversifier, and gold should be your first port of call to diversify a stock portfolio...
« Last Edit: January 04, 2025, 11:08:06 AM by vand »

bthewalls

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Re: Portfolio rebalance-bonds
« Reply #8 on: January 04, 2025, 05:28:53 PM »
10y US Treasury is pay around 4.5%; if you want to reach for higher yield you have to go further out onto the risk spectrum into corporates and junk, however in so doing the risk profile changes and the bonds can behave more more similarly to equities and less like Treasuries...

To reiterate, though, bonds are very poor diversifier, and gold should be your first port of call to diversify a stock portfolio...


Any idea what best index linked bond for uk isa vand? Any suggestions would be great

Barry

vand

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Re: Portfolio rebalance-bonds
« Reply #9 on: January 05, 2025, 03:29:10 AM »
10y US Treasury is pay around 4.5%; if you want to reach for higher yield you have to go further out onto the risk spectrum into corporates and junk, however in so doing the risk profile changes and the bonds can behave more more similarly to equities and less like Treasuries...

To reiterate, though, bonds are very poor diversifier, and gold should be your first port of call to diversify a stock portfolio...


Any idea what best index linked bond for uk isa vand? Any suggestions would be great

Barry

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yr welcome

bthewalls

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Re: Portfolio rebalance-bonds
« Reply #10 on: January 05, 2025, 02:47:50 PM »
10y US Treasury is pay around 4.5%; if you want to reach for higher yield you have to go further out onto the risk spectrum into corporates and junk, however in so doing the risk profile changes and the bonds can behave more more similarly to equities and less like Treasuries...

To reiterate, though, bonds are very poor diversifier, and gold should be your first port of call to diversify a stock portfolio...


Any idea what best index linked bond for uk isa vand? Any suggestions would be great

Barry

SGLN

yr welcome

You prefer gold etc than bonds in portfolio?

Baz

MustacheAndaHalf

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Re: Portfolio rebalance-bonds
« Reply #11 on: January 05, 2025, 07:05:48 PM »
For diversification, you want uncorrelated assets, so you can rebalance when one falls - and hopefully, the other rises.  That pairing of one falling and the other rising is called "negative correlation" - they are correlated, but move in opposite directions.

From 2012 until Covid hit (Mar 2020), bonds ($BND) had a negative correlation to the S&P 500 ($SPY).  Compared to those 7+ years, gold ($GLD) had a negative correlation to stocks from 2016 until Covid-19 hit.  And while gold was negatively correlated to stocks, it became more than 0.50 correlated with bonds.  According to portfolio visualizer, bond has been a better diversifier than gold.

When the Fed hiked rates in 2022, stocks and bonds had their worse year in over a decade.  Stocks and bonds started 2022 with a 0.20 correlation, but are now 0.74 correlated as the Fed continues to keep rates high.  Arguing that bonds are not good diversifiers assumes the Fed actions will continue indefinitely - that the events starting in 2022 won't end.  Historically, that doesn't happen, so a more reasonable assumption is that stocks and bonds will return to having low correlation, and even negative correlations.

https://www.portfoliovisualizer.com/asset-correlations
https://finance.yahoo.com/quote/GLD/performance/

SeattleCPA

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Re: Portfolio rebalance-bonds
« Reply #12 on: January 06, 2025, 07:04:49 AM »
@muskrat , @Mississippi Mudstache and @bthewalls ,

Just to give you guys a different perspective on this bonds question, I think you consider using the Merton framework to think about bonds and their effect on your portfolio. This approach does a couple-three things.

1. It points you to risk-free assets as your bond choice. So for US investors, treasuries. More specifically intermediate term treasuries and TIPS. For UK investors, sorry, I don't know... but maybe the UK "sovereign debt" equivalent?

2. It suggests you're not so much using bonds as a diversifier but rather risk-free assets as an alternative to risky assets. The tradeoff in layman's terms works like this: If you can get 2.2% real return and bear zero risk, does it really make sense to invest in US stocks which sure look like they'll probably generate a 3.65%-ish real return but also force you to bear risk where return actually varies a lot from year to year. The Merton framework, BTW, provides math you can use to think about this.

3.  More concretely, the Merton framework lets you respond to rebalancing impulses/intuitions/questions with a quantitative approach. I.e., it'll suggest when you want to get adjust your allocations to bonds.

I've got links in my signature which point to a couple of calculators you can use to estimate Merton shares and super-safe withdrawal rates. The Merton share BTW is the suggested allocation to stocks an individual investor should have based on the extra return equities are expected to deliver given their volatility.

P.S. For what it's worth, the Merton share has most of the time suggested you want to have a large allocation to stocks. Maybe even use leverage. And right now, my calculations suggest the typical individual investor going all US stocks should probably have, like, 55%-ish in stocks? So 45%-ish in bonds.


bthewalls

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Re: Portfolio rebalance-bonds
« Reply #13 on: January 06, 2025, 03:05:54 PM »
Thanks for the bond query responses folks….im 100 pc stock so going to start buying some bonds plus gold for diversification