Taking a Punch

BOXER MIKE TYSON observed, shortly before he bit Evander Holyfield’s ear, that, “Everyone has a plan until they get punched in the mouth.”

Well, the bond market has me black and blue and gnashing my teeth. Have Treasury bonds lost their diversifying power in these inflationary times? For decades, they’d mostly held their ground or gained during stock market routs. Not this year.

My longstanding plan has been to invest in conventional short- and intermediate-term Treasury funds to cushion volatility and as a source of money to add to my stock funds when the market tanks. But this year through May 6, with the S&P 500 index down 14% from its record high, the Fidelity Intermediate Treasury Bond Index Fund that I had in my IRA is off 10%.

That’s a worse return than some high-yield junk bond funds. What to do? I’m still working, so I don’t need income from my bond holdings. Some might say to hunker down in conventional high-quality, short-term bond funds and call it a day. Instead, I’ve researched some alternatives with even less interest-rate risk and decided to diversify widely, so I have a little bet on almost everything.

Maybe I’m nuts, but I now own a ton of fixed-income positions spread over various retirement accounts, a taxable investment account and a separate account for my emergency savings. The complexity doesn’t bother me too much. But the idea of having at least some investments that are bucking the bond bloodbath really appeals to me.

I recently started using a spreadsheet to look at all the fixed-income exposure in my portfolio and emergency savings. In the spreadsheet, I include both the bond funds I’ve purchased and the fixed-income portion of my large balanced fund holdings. For purposes of this analysis, I considered my balanced funds’ bond holdings to be similar to a total bond market index fund.

The exercise clearly showed that, despite my focus on shorter-maturity Treasurys when buying bond funds, I still had a lot of exposure to intermediate and longer-term bonds, including corporates. These higher-volatility bond holdings came compliments of the balanced funds I own. I also realized that I lacked certain niche bond funds and securities that can fare well in an inflationary environment, including some specifically designed to limit the risk of rising rates.

Result? I’ve embarked on a somewhat unconventional strategy. In my portfolio and my emergency fund I have—or will soon have—a finger in these different bond-market pots:

• Series I savings bonds issued by the U.S. Treasury. I bonds have a periodic inflation adjustment built into their yields. I learned a lot about them from HumbleDollar contributor John Lim. For those who buy during the six months starting May, the yield for the first six months will be an annualized 9.6%, plus the principal value is guaranteed by Uncle Sam.
• A floating-rate Treasury fund from WisdomTree, whose yield will rise and fall with prevailing interest rates. It’ll be a good bet only if rates keep rising.
• A bond ladder built with iShares defined-maturity ETFs. The iShares website has a handy “estimated net acquisition yield” calculator to give you an idea, depending on your purchase price, of a fund’s return if it’s held to maturity. There’s little principal risk with the Treasury versions of these funds if they’re held to maturity—for instance, through December 2022, 2023 and so on. The corporate funds, however, carry some credit risk.

• A conventional, actively managed Fidelity short-term bond fund in my 401(k), one of the few fixed-income fund choices that my 401(k) offers. This is a little redundant and probably the first fund I’d sell to take advantage of further weakness in stocks. But for now, I want a bond fund in my 401(k). Its share price fluctuates modestly with interest rate changes and the fund comes with some credit risk.
• A conventional short-term Treasury ETF, perhaps from Vanguard, in my IRA. It’ll fluctuate a little with interest rates but there’s no credit risk.
• My balanced funds’ fixed-income holdings, which are akin to a total bond market index fund. They’re quite exposed to interest rate and credit risk.
• Fidelity Inflation-Protected Bond Index Fund in my IRA, where such funds belong for tax reasons. The fund should outperform a conventional intermediate-term Treasury fund if inflation continues to come in higher than expected. Its value will rise and fall significantly with interest rates.

Except for the inflation-indexed bond fund and the bond holdings in my balanced funds, I have scant principal risk. I’m diversified pretty much across the board, so different funds should perform well in different market environments. Finally, my new holdings, such as the Series I savings bonds, are much safer and should deliver higher returns than the funds I owned before.

William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart and check out his earlier articles.

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