Safe Stuff - Bond ETF Alternatives

[powersuitrecall]

It's been about a year since I ditched my FA and threw everything into a simple Canadian Couch Potato portfolio.  As of now, my safe component is made up of:

• XRB (Real Return Bond Index) @ 10%
• VAB (CDB Aggregate Bond Index) @ 25%

I'm wondering if there is a way to achieve greater diversity.  Are there any other long term vehicles that can act as a stabilizing force in a portfolio? REITs? Preferred Shares?

What do you use and why? 

Note that these are tax sheltered accounts (RRSP/TFSA/RESP), but I'd love to hear tax efficiency angles as well, as soon I'll have no choice but to open a non-sheltered account (mustachian people problems).

[FI40]

I do not use anything else for safety. I think stocks and bonds provide enough diversification, plus keeping it simple is valuable to me.

In your stock allocation, you probably own several REITs there already. Make sure you have a really good reason for doubling up on them - why do they deserve more than their market cap weighting?

Preferred shares are a more difficult market in which to invest. You pay higher fees on the ETFs, and picking them yourself is difficult as you need to read each prospectus very carefully. You could pay an advisor or mutual fund to pick them for you but I thought we liked low fees.

I choose not to have real return bonds as well. I used to work for a pension fund and they bought as many real return bonds as they could regardless of price just because it matched their liabilities. They are a huge player in that market. When you have big players ignoring their usual risk/return decision in buying something, the price typically gets inflated and the expected return from those might be a little lower than from vanilla government bonds. You get your long term inflation protection from stocks anyway.

Yep for those reasons stocks and plain bonds are fine for me. You could add short-term bonds or cash in a savings account if you want less volatility or less risk to rising interest rates.

[powersuitrecall]

Thank you, FI40, for a very thorough answer. 

In your stock allocation, you probably own several REITs there already. Make sure you have a really good reason for doubling up on them - why do they deserve more than their market cap weighting?

I had originally considered ZRE (BMO Equal weight REIT), but was smitten by what JCollins had to say about REITs enough to ignore them as a separate purchase. As a novice investor, it certainly helps to hear essentially the same thing again.

I choose not to have real return bonds as well. I used to work for a pension fund and they bought as many real return bonds as they could regardless of price just because it matched their liabilities. They are a huge player in that market. When you have big players ignoring their usual risk/return decision in buying something, the price typically gets inflated and the expected return from those might be a little lower than from vanilla government bonds. You get your long term inflation protection from stocks anyway.

This is an interesting perspective.  The only reason I decided to add XRB was because the older CCP Global Portfolio had a small weighting.  As a novice, when I see a different ETF I think "ah! diversity is good!".  I will reconsider this holding.

You could add short-term bonds or cash in a savings account if you want less volatility or less risk to rising interest rates.

Since VAB (Aggregate Bond) contains a combination of short term and long term bonds, the addition of VSB (Short Term Bond) would only be required if one felt rates would rise faster than what is currently projected / priced into the current valuation?

[FI40]

I choose not to have real return bonds as well. I used to work for a pension fund and they bought as many real return bonds as they could regardless of price just because it matched their liabilities. They are a huge player in that market. When you have big players ignoring their usual risk/return decision in buying something, the price typically gets inflated and the expected return from those might be a little lower than from vanilla government bonds. You get your long term inflation protection from stocks anyway.

This is an interesting perspective.  The only reason I decided to add XRB was because the older CCP Global Portfolio had a small weighting.  As a novice, when I see a different ETF I think "ah! diversity is good!".  I will reconsider this holding.

Yeah they're definitely interesting products, worth looking into more closely. Definitely don't take my word for it alone!

You could add short-term bonds or cash in a savings account if you want less volatility or less risk to rising interest rates.

Since VAB (Aggregate Bond) contains a combination of short term and long term bonds, the addition of VSB (Short Term Bond) would only be required if one felt rates would rise faster than what is currently projected / priced into the current valuation?

Good question - I guess so? I know CCP recommends just having VAB. It's not even that long duration, I think about 7 years or something, so this is nitpicking on my part. I only have shorter term bonds, but I'm not completely convinced it's the right call (it has certainly been the wrong call in the past two years). I guess I'm trying to time the bond market a bit, but I feel that a big reason the bonds are in the portfolio is that if the stocks lose value, then I'll be able to sell the bonds and buy more stocks. With long term bonds, I'm worried about a scenario where rates rise too fast, which simultaneously tanks the stock market and long term bonds. I miss out on rebalancing. Short term bonds have much less interest rate risk.

There are great reasons to just buy a broad based bond fund and forget it though. It's simpler, which is awesome, and you aren't stuck with the decision of when to cash out of your short term bond fund. You may be happy with the amount of short term bonds in there anyway. I'm talking myself into it as I type :)

[powersuitrecall]

Garth posted the following recommendation buried in today's post: http://www.greaterfool.ca/2015/06/21/the-deceivers-2/

Assuming 35% of a portfolio is "Safe Stuff", here is the breakdown:

7% - Government Bonds
4% - Corporate Bonds
3% - Real Return Bonds
3% - High Yield Bonds
18% - Preferred Shares
5% - Cash

Thoughts?

[thedayisbrave]

I'm wondering if there is a way to achieve greater diversity.  Are there any other long term vehicles that can act as a stabilizing force in a portfolio? REITs? Preferred Shares?

What do you use and why? 

Hah.. I would definitely NOT use REITs for their "stability" factor... a REIT is a stock.  All you have to do is look at how it's been performing over the past year or so to see how volatile it can be.  It'll offer diversity if you don't have any yet, and may smooth the volatility of your whole portfolio (since it's not highly correlated to either stocks or bonds) but arguments are surfacing that REITs are becoming more and more correlated to stocks.

Why exactly are you looking for bond alternatives? Long term bonds are actually less stable and will drop in price when interest rates go up... not really a huge deal if you hold until maturity, but if you're looking at something super safe and stable, I'd look at short term bonds.  I've also seen some places that offer 5 year CD's for 2.25% which is not bad either, it offers principal protection and even if you have to access early, with the 6 month interest penalty for pulling money out it still comes out about the same as a bond fund return (just paraphrasing what I've read on other forums - check out Bogleheads.org).  I'm not familiar with the Canadian funds you've posted but if they are bond funds they seem fine.  If you put bonds in your taxable account, depending on your tax bracket it may be more beneficial to hold tax exempt bonds, but again I don't really know how those work in Canada.

Personally, I keep enough cash around (1+ years expenses) so that I feel perfectly comfortable being 100% equities.  But I'm also 25, so YMMV.

[powersuitrecall]

Why am I looking for bond alternatives?  I suppose I just want to make sure I've got my bases covered. I was really just curious to see what others did.  Garth (above) has 18% in preferred shares, and that seems kinda risky to me ... still lots of volatility there (right?).

For my own situation, I'm settling on a simple cocktail of Gov't / Corp Bond ETFs.  KISS applies here I think.

[Heckler]

I use 20% VAB for long term buy and hold RRSP and 10% VSB for lower risk, shorter term TFSA savings i might need to cash in in the next couple years (but hopefully not).

[Heckler]

With bonds, once you've gone with a very diversified fund like VAB, the only thing you can diversify more is Duration.  Thus VSB.