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I am approaching retirement age, and I am trying to decide how to invest the "bond" portion of my retirement (non-taxed) account. I probably won't need to make withdrawals from the account for another five years, and even then I would withdraw no more than 4%/year. Currently, 40% of the account is in an intermediate bond index fund (the other 60% is in stock index funds).

In my situation, does it make sense to keep the 40% in an intermediate bond index fund, or would it be better to have some or all of the 40% in a short-term bond index fund or a money-market fund? If so, what proportion should be in (a) a money market fund, (b) a short-term bond index fund, and (c) an intermediate-term bond index fund?

Many thanks.
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<does it make sense to keep the 40% in an intermediate bond index fund, or would it be better to have some or all of the 40% in a short-term bond index fund or a money-market fund? If so, what proportion should be in (a) a money market fund, (b) a short-term bond index fund, and (c) an intermediate-term bond index fund?>

The Federal Reserve has just cut the fed funds and discount rates by 0.5%. It's possible (indeed, probable) that the deep-seated problems in the debt market will continue. There may be further cuts.

The last time the Fed did an extended rate-cutting campaign, in 2001-2004, the interest rates on short-term and money market funds dropped with them. Rates were cut until the real rate was negative (lower than inflation).

If your only choice is a fund, the intermediate fund would be better. Its net asset value (NAV) will rise, as the rates are cut.

A better alternative would be a ladder of medium-to-long term bonds and CDs. Since you will need the money starting in 5 years, you might want to start with 5 year bonds, and extend from there.

Wendy
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If your only choice is a fund, the intermediate fund would be better. Its net asset value (NAV) will rise, as the rates are cut.

Not necesarrily. This would assume intermediate term interest rates would follow Fed cuts, which may not happen (Greenspan's "conundrum," a.k.a., supply and demand is more complicated that rate ruts by the Fed). Also continued rate cuts by the Fed are not a certaintly, despite Wall Street's "what do we care about inflation, bail us out for our reckless investments" attitude.

At the moment how to work from an intermediate bond index fund allocation is unclear. A ladder with the equivalent yield would be safer over the long term (on the beleif that interest rates remain artificially low for the amount of debt). But there aren't any screaming alternatives, like Pen Fed CDs paying 100 basis points higher or TIPS over 2.5% with low inflation expectations. It might be best to sit tight, but make sure you have account transfers in operating condition (and a Pen Fed account, retirement if needed), so if opportunities arise, say in January, you can start moving money into safer places.
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Given you've divided your assets in a reasonable split among 60% stock index funds and 40% bond fund, I'd further split off from the bond allocation with an amount equal to 5 to 10 years of future income need put that into a money market fund, as security against unsettled market conditions. I prefer a short-term bond fund, or a mixture of short- and intermediate-term bond funds, for a more stable NAV, and look to the equity allocation for growth of assets. Both Wendy and Loki tend to ignore the convenience of bond funds in their zeal for CDs and individual bonds. Those require a lot more fiddling than you might want, and getting your money out can be costly if the instrument is not held to maturity.

db
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Both Wendy and Loki tend to ignore the convenience of bond funds in their zeal for CDs and individual bonds. Those require a lot more fiddling than you might want, and getting your money out can be costly if the instrument is not held to maturity.

I fail to see how a bond fund is any more convenient than a CD ladder. I'm not zealous about CDs, or anything else. I think people need to weigh liquidity, after-tax yield, risk, and potentially capital return in judging which bond/fixed-income asset to choose. Bond funds are subject to interest rate risk, which is not true if you ladder bonds or CDs and hold to maturity.
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which is not true if you ladder bonds or CDs and hold to maturity.

But it is true as soon as the first one matures, then you are stuck with the IR of the day when you re-purchase, whereas the fund can rearrange anytime. I think that is what was meant.

rk
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But it is true as soon as the first one matures, then you are stuck with the IR of the day when you re-purchase, whereas the fund can rearrange anytime. I think that is what was meant.

The way I look at it is that CDs and bills/notes may be problematic to repurchase at an attractive rate, but funds may be problematic to sell at an attractive price. You pays your money and you takes your choice, but you may be stuck in a fund with no attractive way out.

Hedge
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But it is true as soon as the first one matures, then you are stuck with the IR of the day when you re-purchase, whereas the fund can rearrange anytime. I think that is what was meant.

The arithmetic is simple. Yes, when you have to roll over a CD at a lower rate than before, you will have a lower yield than the bond fund may have at the later date. But the total return on the bond fund will be lower. Bond funds may work if you never need to sell the shares. If you do, you are subject to interest rate risk, which is a technical term relating to value of shares relative to changes in interest rates. Reinvestment risk is something else.
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Bond funds may work if you never need to sell the shares.

And, I would submit, if your initial rate of return is something you can be satisfied with - from now on.

Hedge
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Bond funds may work if you never need to sell the shares. If you do, you are subject to interest rate risk, which is a technical term relating to value of shares relative to changes in interest rates.

If a person wants to hold ay 25% of their portfolio in bonds, only tapping into the distributed interest, but never selling the actual bonds. In such a case, can a bond fund be as good as laddering CDs?
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"If a person wants to hold ay 25% of their portfolio in bonds, only tapping into the distributed interest, but never selling the actual bonds. In such a case, can a bond fund be as good as laddering CDs?"

In so many words, approximately yes, but not exactly so.

So yes, if you are willing to ignor the NAV of your bond shares and focus on the interest being paid, that is fine in most cases. Realize that interest rates will have to return to where they were when you bought them for the NAV to return. So eventually you may be forced to sell at a loss--especially if you bought the bond fund shares when intrest rates were at historic lows.

Now that interest rates have returned to more normal levels, that is less of a concern, but you would still rather buy a bond fund when interest rates are high. Then you have accumulated capital gains you can cash in whenever you want.

The laddered maturity bond portfolio avoids this risk because usually those bonds can be held to maturity. So you get full face value back regardless of what happens to interest rates.

And note that we are talking about investment quality bonds and bond funds. For junk bonds, all bets are off. They can collaspe in value very much like stocks crash, the bonds can default, the underlying companes can declare bankruptcy. All of which can mean your investment is not secure. Junk bonds should be acceptable only as part of a divsified portfolio and then not with the rent money.
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Realize that interest rates will have to return to where they were when you bought them for the NAV to return.

And this is true only if the only risk factor is interest rate risk. What we found with the Total Bond Index was that refinancing risk has drained about 1% of return per year, which would mean interest rates would have to be lower when you sold the fund than on the average when you bought it. For a Treasury fund, however, interest rate risk would be the only factor (assuming the US Treasury doesn't implode). I think for the Intermediate Index, with no mortgage bonds, interest rate risk would be the main factor, with some default risk considerations. (When we looked at the numbers, default risk on investment grade funds was fairly minimal compared to interest rate risk.)
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As it sounds, you are not too concerned with having an exact amount available at some future time; So you may be willing to continue and bear the "volatility" risk inherent in NAV. When and if you ever need to guarantee a set of future cash flows you may consider bonds or CDs and use/match the duration to the cash flow periods.

The question that I am hearing in this post sounds like:

Is a Short-Term Fund or an Intermediate-Term Fund the better play?

Well, the answer requires the famous crystal ball. Right now for you - five years to retirement - I can see no reason to change the mix you have unless you have some intuition as far as where interest rates are going! If you would "feel" better allocating into a shorter index, then allocate.

d(60/40)/dT
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I fail to see how a bond fund is any more convenient than a CD ladder. I think people need to weigh liquidity, after-tax yield, risk, and potentially capital return in judging which bond/fixed-income asset to choose. Bond funds are subject to interest rate risk, which is not true if you ladder bonds or CDs and hold to maturity.

Bond funds are more convenient because you do not have to plan ahead for when you need the money. If you fail to plan with a ladder, then you run the risk of having to sell before maturity.
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Bond funds are more convenient because you do not have to plan ahead for when you need the money. If you fail to plan with a ladder, then you run the risk of having to sell before maturity.

True, true, but if you fail to plan properly with a bond fund, and rates go up, then you will get less than your initial investment from your fund when you sell.

Hedge
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Bond funds are more convenient because you do not have to plan ahead for when you need the money. If you fail to plan with a ladder, then you run the risk of having to sell before maturity.

Every time you allocate money, whether in a bond fund or laddering or anything else, you are planning ahead.

A bond fund does provide greater liquidity than a CD or a bond. But laddering provides essentially the same liquidity as a bond fund (depending on intervals between rungs in the ladder).

Every time I have money to allocate to fixed income, I need to decide what to do with the money. Being close enough to retirement to care about liquidity after retirement, that is part of the consideration. But let's not confuse liquidity with convenience.
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I don't mean to sound like a dolt, but I've been trying to get a better understanding of why so many folks think bond funds are not as good as laddering CDs. It would seem that the major reason is the risk of having to sell shares of a bond fund at a time when the NAV is lower than when you purchased the shares, due to the fact that interest rates had risen since the time of purchase. Is this the main reason why folks prefer laddering CDs to purchasing a bond fund? For myself, I soon will cease to have any earned income. I've been partly to mostly retired for 8 years now, doing a little part-time consulting. Up until now, I've been around 92% in equities, but I've started to shift money in the IRA portion of my portfolio into fixed assets (Treasuries). My goal is to get around 30% or so in fixed assets, on the short end. If interest rates ever get really high again, then I would move it into the long end. My portfolio is large enough so that I can live off the distributions from the taxable side of my portfolio. The most I would ever take from the IRA would be the interest, and probably not for many years. Even if the market were to drop considerably, I wouldn't be in trouble from a cash flow standpoint. Bottom line: In such circumstances, isn't a bond fund in my IRA about the same as laddering CDs in term or income and risk?
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I don't mean to sound like a dolt, but I've been trying to get a better understanding of why so many folks think bond funds are not as good as laddering CDs. It would seem that the major reason is the risk of having to sell shares of a bond fund at a time when the NAV is lower than when you purchased the shares, due to the fact that interest rates had risen since the time of purchase. Is this the main reason why folks prefer laddering CDs to purchasing a bond fund? For myself, I soon will cease to have any earned income. I've been partly to mostly retired for 8 years now, doing a little part-time consulting. Up until now, I've been around 92% in equities, but I've started to shift money in the IRA portion of my portfolio into fixed assets (Treasuries). My goal is to get around 30% or so in fixed assets, on the short end. If interest rates ever get really high again, then I would move it into the long end. My portfolio is large enough so that I can live off the distributions from the taxable side of my portfolio. The most I would ever take from the IRA would be the interest, and probably not for many years. Even if the market were to drop considerably, I wouldn't be in trouble from a cash flow standpoint. Bottom line: In such circumstances, isn't a bond fund in my IRA about the same as laddering CDs in term or income and risk?

Yes, the argument against a bond fund whose main risk is interest rate risk is that you may have to sell shares at less than what your paid for them. (With a fund with refinancing, call, or default risk, there are other issues.)

From an income generating perspective, something like an Intermediate Bond Index Fund (not mortgage bonds) will probably come out around the same over the long run as a ladder of CDs and/or a mix of Treasury/Investment Grade Corporates. (Although, it has consistently been possible for the last several years to find CDs that are better, because they have their own supply and demand to worry about.) So, if you never need the principal, you are probably fine with a fund, and you can let your heirs worry about selling shares for a loss. (This is how Bruce feels.)
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<<<<<<<<<<<<<<So, if you never need the principal, you are probably fine with a fund, and you can let your heirs worry about selling shares for a loss.>>>>>>>>>> Yes, but............but the cost basis of the shares will be changed to their value on the date of death
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Yes, but............but the cost basis of the shares will be changed to their value on the date of death

So, the shares will be worth less and if they happen to go back up, then you pay taxes on the gain.
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Yes, the argument against a bond fund whose main risk is interest rate risk is that you may have to sell shares at less than what your paid for them. (With a fund with refinancing, call, or default risk, there are other issues.)

From an income generating perspective, something like an Intermediate Bond Index Fund (not mortgage bonds) will probably come out around the same over the long run as a ladder of CDs and/or a mix of Treasury/Investment Grade Corporates. (Although, it has consistently been possible for the last several years to find CDs that are better, because they have their own supply and demand to worry about.) So, if you never need the principal, you are probably fine with a fund, and you can let your heirs worry about selling shares for a loss. (This is how Bruce feels.)


Thanks, thanks a lot for the help.
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"I've been trying to get a better understanding of why so many folks think bond funds are not as good as laddering CDs."

I don't think we intend to run down bond funds too much. They are fine, but we are trying to make readers aware that bond ladders (and CD ladders) have advantages that fit especially well with most retirees need for steady, predictable income.

Once people are aware of the choices, they should be able to decide for themselves what works best for them.

This the ". . . to educate . . . " aspect of Fooldom. We are not twisting any arms.
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I confess I have only read a few posts on this topic, but I didn't see anyone mention an inflation protected bond fund. Vanguard has a nice one that we hold, and it has done quite well, in my opinion. Of course, there is also the option of buying individual TIPS, which have received a lot of press on this board, such as what interest rate is a good buy. We do have one block of 1.6% 10-yr TIPS, which, while certainly not a barn burner, is well into the black. A block of 2% 10-yr TIPS has done much better. Seems to me the long term threat is inflation, even official inflation.

I make no claims to being any kind of expert on bonds so I would like to hear opinions of those more experienced.

I have posted before that I felt need to get at least 5% on bonds so I did buy some long-term corporate bonds going out to 2029 (Note: as we are in our mid 70s, these will probably involve decisions of our heirs.) back when interest rates went into the toilet. Of these, our only one in the black, and that slightly, is a UPS AAA grade bond maturing in 2017 (5.25% bought in 2002 and now 10 yrs to maturity), and it has spent a lot of time in the red. A Bank of America (I believe rated A+) 5.45% 2028 bond (bought in 2003 and now 25 yrs to maturity) has always been in the red, even though it is paying a half percent more than a 30-yr Treasury.

I do like CDs and we have lots of those, also, in ladders with PenFed (out to 7 yrs) and E-Trade, mainly. Earlier this year bought a brokered CD at 6% with Schwab with a maturity of 2027 (if not called). We also have one sizable Treasury CD with BB&T where the interest can fluctuate, but we can make one withdrawal a month should we need some money.

brucedoe
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I agree with brucedoe that TIPs could be a useful component.  It amazes me that with the dollar dropping so far agains other currencies that we have not seen higher inflation on imported goods.  I speculate that globalization of more and more products has helped keep product cost falling but how long can this continue?   Low rent increases have also contributed to keeping official inflation figures low but this may not continue either.  Therefore, I expect inflation to become a significant problem within the next several years - which could lead to rising interest rates and losses on current bonds.

I am no fan of bonds while interest rates remain low.  Consider that the $ has lost at least 30% in value vs. other major currencies in past few years (thanks George) while international stocks have soared.  Trends may reverse but many US banks and insurance companies have current P/E's less than 10.  When it becomes clear whether they have significant loan exposures or not, they should be a better bet than low interest bonds. 
 
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It amazes me that with the dollar dropping so far agains other currencies that we have not seen higher inflation on imported goods.

Past dollar devaluation is already factored in to current prices.  The current accelerating drop is a recent phenomenon (couple of weeks).   It will take a while to see that change. 

wrt bond rate hikes:  That's why many on this board are limiting their purchases to short term CD ladders (1 yr.and 2 yr.). 

Trends may reverse but many US banks and insurance companies have current P/E's less than 10.  When it becomes clear whether they have significant loan exposures or not, they should be a better bet than low interest bonds. 

Many on this board are looking for income, as opposed to capital appreciation.  Others just want to avoid the risk of a loss.  These are uncharted waters thanks to globalization, derivatives and the unique circumstances due to debt load, non-existent average personal savings rate and government deficits.

I'm not sure how long one has to wait to clarify loan exposure.  I would say that it does matter and discretion is advised.

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