Author Topic: What Percentage of Bonds to Have  (Read 6086 times)

dalekeener

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What Percentage of Bonds to Have
« on: February 02, 2015, 08:08:52 AM »
Hello! I am 54 and was wondering at today's low interest rates does it make  a huge difference to have a percentage in Bonds if so at 54 what should mine be?

Dale

Dodge

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What Percentage of Bonds to Have
« Reply #1 on: February 02, 2015, 08:17:16 AM »
Interest rates should have no affect on your allocation to bonds. You don't add bonds for yield, you add them the reduce the volatility of your portfolio.

That being said, no one can decide for you how many bonds you should have. It's based on your willingness, need, and ability to take risk. Just knowing your age isn't enough information to determine that.
« Last Edit: February 02, 2015, 08:21:21 AM by Dodge »

FFA

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Re: What Percentage of Bonds to Have
« Reply #2 on: February 02, 2015, 09:21:09 AM »
Interest rates should have no affect on your allocation to bonds. You don't add bonds for yield, you add them the reduce the volatility of your portfolio.

That being said, no one can decide for you how many bonds you should have. It's based on your willingness, need, and ability to take risk. Just knowing your age isn't enough information to determine that.
Hi Dodge, while i agree conceptually, in practice I find it difficult to hold bonds myself currently, even despite being on the cusp of FIRE and wanting to reduce risk and increase steady income flow. I guess it depends a lot where you are, but in particular for Europeans looking at negative yields, ecb just starting an unpredictable qe policy, risk of haircuts/govt defaults, etc. I read in the FT the other day 30yr German govt bonds have returned 43% in the past year and yield is below 1% for the first time ever. Defensive assets are not supposed to behave like this. Japan is in the same category for a long time.

I read a Buffett article the other day where he was saying bonds are supposed to be for risk free returns but now their priced for return free risk. He wrote that 3 years ago and it seems to me much worse now.

In Australia my home country, you can still get bank deposits at 4% and these are govt guaranteed up to 200k. For my case, that seems a much safer place than bonds too. These are floating rates not fixed, but at least I know my principal is guaranteed and will not take a hit if interest rates suddenly start rising from the current 50 year historical lows.

I guess it might be different if you've had a bonds allocation long term and continue to rebalance it. But for people looking to add bonds right now to their investment mix, I personally think there are some reasons to pause and consider the timing, risk versus reward, and eventual normalization of unconventional central bank policies.

PencilThinMustache

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Re: What Percentage of Bonds to Have
« Reply #3 on: February 02, 2015, 10:56:22 AM »

In Australia my home country, you can still get bank deposits at 4% and these are govt guaranteed up to 200k.
[/quote]

can you open a savings acct for me in Australia? ;)

DrF

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Re: What Percentage of Bonds to Have
« Reply #4 on: February 02, 2015, 12:12:30 PM »
why not do long term corporate bonds then?

LQD

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Re: What Percentage of Bonds to Have
« Reply #5 on: February 02, 2015, 12:55:40 PM »
People talk about yield and portfolio stability but the fact of the matter is that the value of bonds can (and do) go up the exact same way that an equity index does.  Bonds won out over equities many times in the past few decades.  So, it's not yield or dividends per se--it's that when the bonds have exceeded value expectation on a given year you can siphon that money off into the equity portion of your portfolio when they're doing not so well.  Buying low.  Vanguard's Bond Index VBMFX is up what?  3.3% this year?  That's not too bad. I'm Canadian so I use a different bond index, but it's at 4.6% already this year.    It's nice to have a suddenly bond-overweight portfolio to rebalance $10K from them into equities when the latter are feeling sick.

Winners rotate.

Dodge

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Re: What Percentage of Bonds to Have
« Reply #6 on: February 02, 2015, 01:01:13 PM »
Interest rates should have no affect on your allocation to bonds. You don't add bonds for yield, you add them the reduce the volatility of your portfolio.

That being said, no one can decide for you how many bonds you should have. It's based on your willingness, need, and ability to take risk. Just knowing your age isn't enough information to determine that.
Hi Dodge, while i agree conceptually, in practice I find it difficult to hold bonds myself currently, even despite being on the cusp of FIRE and wanting to reduce risk and increase steady income flow. I guess it depends a lot where you are, but in particular for Europeans looking at negative yields, ecb just starting an unpredictable qe policy, risk of haircuts/govt defaults, etc. I read in the FT the other day 30yr German govt bonds have returned 43% in the past year and yield is below 1% for the first time ever. Defensive assets are not supposed to behave like this. Japan is in the same category for a long time.

I read a Buffett article the other day where he was saying bonds are supposed to be for risk free returns but now their priced for return free risk. He wrote that 3 years ago and it seems to me much worse now.

In Australia my home country, you can still get bank deposits at 4% and these are govt guaranteed up to 200k. For my case, that seems a much safer place than bonds too. These are floating rates not fixed, but at least I know my principal is guaranteed and will not take a hit if interest rates suddenly start rising from the current 50 year historical lows.

I guess it might be different if you've had a bonds allocation long term and continue to rebalance it. But for people looking to add bonds right now to their investment mix, I personally think there are some reasons to pause and consider the timing, risk versus reward, and eventual normalization of unconventional central bank policies.

Everyone knows (well almost everyone) not to market time the stock market.  The bond market is no different.  My standard "market-timing bond" response is below, but I'll add one more chart, just for fun :)

You might not see it, but this is market timing.  Ignore the noise, the news reports, and the doomsday articles.  You can't guess where the market will go next.  Let's review what happened to bonds the last time interest rates soared:



Interest rates spiked pretty high from 1975 through 1981 (the peak).  Let's see what happened to intermediate term bonds during this time (orange line):



A $10,000 deposit grew almost 60%!

This is why we say ignore the noise.

------

Now let's look at another point on the chart, the two decades from 1950-1970, where interest rates tripled from their record low.  What happens to bonds then?



Unfortunately Morningstar's Intermediate bonds graph doesn't start until 1955, so I added "High Yield Bonds", a category which should be more negatively impacted by a rise in interest rates.  Looking at the chart, we see:
  • High Yield Bonds more than tripled during this time.  With a $10,000 deposit growing to $31,775.33
  • Intermediate Bonds more than doubled during this time, despite not starting until about 1955.  A $10,000 deposit grew to $23,435.50

If savings accounts are giving you 4% in your country than bonds are likely giving more.  Indeed, Vanguard's Australia Bond index has a  5% yield currently - http://etfs.morningstar.com/quote?t=VAF&region=aus&culture=en-US


Dodge

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Re: What Percentage of Bonds to Have
« Reply #7 on: February 02, 2015, 01:04:39 PM »
People talk about yield and portfolio stability but the fact of the matter is that the value of bonds can (and do) go up the exact same way that an equity index does.  Bonds won out over equities many times in the past few decades.  So, it's not yield or dividends per se--it's that when the bonds have exceeded value expectation on a given year you can siphon that money off into the equity portion of your portfolio when they're doing not so well.  Buying low.  Vanguard's Bond Index VBMFX is up what?  3.3% this year?  That's not too bad. I'm Canadian so I use a different bond index, but it's at 4.6% already this year.    It's nice to have a suddenly bond-overweight portfolio to rebalance $10K from them into equities when the latter are feeling sick.

Winners rotate.

Precisely.  That Australian Bond index from my prior post is up over 10% year over year.

Chuck

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Re: What Percentage of Bonds to Have
« Reply #8 on: February 02, 2015, 01:12:15 PM »
I'm 0% bonds. But I'm also 26.


FFA

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Re: What Percentage of Bonds to Have
« Reply #9 on: February 02, 2015, 02:49:56 PM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.

DrF

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Re: What Percentage of Bonds to Have
« Reply #10 on: February 02, 2015, 03:09:06 PM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.

If you don't want treasuries, then look at an all corporate bond etf (like I said before ^^).

One from Fidelity is LQD.

Dodge

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Re: What Percentage of Bonds to Have
« Reply #11 on: February 02, 2015, 03:38:28 PM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.

If you're looking to keep your bond portion in your local currency (probably a good idea, but I haven't done any research on it). a long term CD (term deposit) is a viable option.  5 year CDs in Australia are currently giving 4.2%.  This website is like the depositaccounts.com of Australia:

http://www.canstar.com.au/term-deposits/


FFA

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Re: What Percentage of Bonds to Have
« Reply #12 on: February 02, 2015, 05:26:31 PM »
If you don't want treasuries, then look at an all corporate bond etf (like I said before ^^).

One from Fidelity is LQD.
Will check it out, thanks drfunk!

FFA

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Re: What Percentage of Bonds to Have
« Reply #13 on: February 02, 2015, 05:31:47 PM »
If you're looking to keep your bond portion in your local currency (probably a good idea, but I haven't done any research on it). a long term CD (term deposit) is a viable option.  5 year CDs in Australia are currently giving 4.2%.  This website is like the depositaccounts.com of Australia:

http://www.canstar.com.au/term-deposits/


Thanks again, yes term deposits are a good idea too, maybe over 3-5 years and I'll gradually average into VAF or other suitable bond fund.

There's a much awaited RBA announcement today where a rate cut is possible, so these 4% rates maybe gone soon too!

Dodge

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Re: What Percentage of Bonds to Have
« Reply #14 on: February 02, 2015, 05:49:03 PM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.

If you don't want treasuries, then look at an all corporate bond etf (like I said before ^^).

One from Fidelity is LQD.

Choosing funds based on yield is generally a bad idea, but if you're going to do it, I'd recommend Vanguards Long Term Bond Index.  It has about 50% more unique bonds (more diversified), it's distribution yield over the past year was 3.64% (vs. 3.29% with LQD), and it returned 22% over the last year (vs. 10% with LQD).  It's also has lower fees, which are easy to get with their ETF:

https://personal.vanguard.com/us/funds/snapshot?FundId=0927&FundIntExt=INT

Financial.Velociraptor

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Re: What Percentage of Bonds to Have
« Reply #15 on: February 02, 2015, 05:52:09 PM »
Hello! I am 54 and was wondering at today's low interest rates does it make  a huge difference to have a percentage in Bonds if so at 54 what should mine be?

Dale

Dale,

I'm 42 and FIRE.  My bond allocation is 4% (entirely in NIO).  NIO yields 5.9%, tax-free (munis).  Assuming a 25% tax bracket, that is equivalent to 7.375% taxable yield.  Not too shabby for a "low interest rate environment."  I write options for income and will steadily be adding that income to my muni holdings for quite some time.  I wrote more about NIO on my blog if you want to follow the link in the signature line and scroll down to Jan 26 post.

Short version, is I feel underallocated to bonds and like munis for the best risk/reward profile in the current environment.  Recommend shopping for muni funds with short or shortish durations though as interest rates can theoretically only go up from here.

DrF

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Re: What Percentage of Bonds to Have
« Reply #16 on: February 03, 2015, 07:27:43 AM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.


If you don't want treasuries, then look at an all corporate bond etf (like I said before ^^).

One from Fidelity is LQD.

Choosing funds based on yield is generally a bad idea, but if you're going to do it, I'd recommend Vanguards Long Term Bond Index.  It has about 50% more unique bonds (more diversified), it's distribution yield over the past year was 3.64% (vs. 3.29% with LQD), and it returned 22% over the last year (vs. 10% with LQD).  It's also has lower fees, which are easy to get with their ETF:

https://personal.vanguard.com/us/funds/snapshot?FundId=0927&FundIntExt=INT

I'm usually lockstep in agreement with you Dodge, but here the OP is looking to not be invested in treasuries. The Vanguard ETF, BLV, is ~37% long term treasuries. If you check the returns, long term treasuries have been on a tear, probably contributing to the outperformance. Will they continue? Who is John Galt?

I was just offering an alternative that was strictly treasury free. Vanguard has an equivalent, VCLT, which is long-term, but they also have short and medium.

Dodge

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Re: What Percentage of Bonds to Have
« Reply #17 on: February 03, 2015, 07:55:46 AM »
Hi Dodge, thanks for the detailed reply. Re: market timing, yes I guess so but as mentioned in my early post the issue for me is Ive never owned any bonds. I would like to change my allocation now upon FIRE to include some bonds. But I really struggle to buy them in any big portion at the current time as I feel the QE policy is heavily distorting bond prices and the traditional correlation between bonds and stocks. I'm sure you would agree it has been highly abnormal monetary policy and we are still in the middle of it. One of the key point of having defensive assets as far as I'm concerned is to make you feel comfortable and enable you to take more risk in growth assets. I don't really feel comfortable about bonds at the current time, but wrestling with the usual wisdom that I should be holding bonds as a retiree. Hope this better explains my dilemma.


If you don't want treasuries, then look at an all corporate bond etf (like I said before ^^).

One from Fidelity is LQD.

Choosing funds based on yield is generally a bad idea, but if you're going to do it, I'd recommend Vanguards Long Term Bond Index.  It has about 50% more unique bonds (more diversified), it's distribution yield over the past year was 3.64% (vs. 3.29% with LQD), and it returned 22% over the last year (vs. 10% with LQD).  It's also has lower fees, which are easy to get with their ETF:

https://personal.vanguard.com/us/funds/snapshot?FundId=0927&FundIntExt=INT

I'm usually lockstep in agreement with you Dodge, but here the OP is looking to not be invested in treasuries. The Vanguard ETF, BLV, is ~37% long term treasuries. If you check the returns, long term treasuries have been on a tear, probably contributing to the outperformance. Will they continue? Who is John Galt?

I was just offering an alternative that was strictly treasury free. Vanguard has an equivalent, VCLT, which is long-term, but they also have short and medium.

I see.  What's the difference between Treasuries and Corporate bonds for the OPs purposes?  Are Treasuries expected to be more volatile than Corporate bonds when interest rates rise?

DrF

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Re: What Percentage of Bonds to Have
« Reply #18 on: February 03, 2015, 08:02:21 AM »
Or maybe a bit of transference of my opinion onto the OP. I think the belief out there is that long term treasuries are more likely to be influenced by rising interest rates. As your graphs show though, this is not really the case. In the crazy high inflation/interest rate era you graphed, long-term bonds did go down (slightly), but came back up after a few years.

I was just offering a non treasury alternative.

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Re: What Percentage of Bonds to Have
« Reply #19 on: February 03, 2015, 10:58:09 AM »
A CD ladder for the OP may be a good entry to lowering his beta.  Good comments, Dodge and DrFunk.

Kaspian

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Re: What Percentage of Bonds to Have
« Reply #20 on: February 03, 2015, 12:49:35 PM »
Ahh... All you bond bear whippersnappers full of youthful recency bias.   :)

One look at the attached should easily show how well us diversified folks and bond barons have done over the past decade and a half.  US Large caps don't even come close to being the winners in a diversified, rebalanced portfolio.