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Bond Index Funds or Something Else?

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AUTHOR: John on 1/28/2025

It seems all conventional wisdom says, as we get closer to retirement, gradually shift the allocation (mix) of your portfolio from equity funds to bond funds. I subscribe to the Boglehead investing methodology and agree with much of what Mr. Clements, and many others, have written on this site. My wife and I have been investing much of our savings in Index funds over the past 15 years. We are truly blessed and should be financially independent, able to retire, within the next 5 years (age 60). However, as I shift our portfolio from Equity index to Bonds index funds, I am struck by the low performance of bonds.  I know 2022 was a horrible year for bonds but even the 5 and 10-year returns don’t keep up with inflation.

I use Fidelity as my brokerage company.  Their Total US Bond Index fund, FXNAX returns are 1YR = +1.34%, 3YR = -2.4%, 10YR = +1.35%. Similar to Vanguard’s VBTLX.

Fidelity’s Inflation Protected Bond Index, FIPDX returns are better but not great.  1Yr =+2.0%, 3YR = -2.4%, 5YR = +1.8, 10YR =+2.5%

As a 55-year-old with retirement on the horizon, I know I need to reallocate to safer investments. My current allocation mix is 70% Stocks, 30% Bonds. I would like to be closer to a 55%, 45% mix but am struggling with the shift to poor bond returns.  I am not an aggressive investor but with 1-2% annual returns I feel I am losing money (e.g. Fidelity cash reserve SPAXX is currently paying 4%)

Does anyone have alternatives or some insight to ease this transition. Or maybe a lesson on bond return that will calm my concerns.  Thanks.

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Randy Dobkin
6 days ago

Rob Berger of YouTube fame has noted that you can expect the current yield from a bond fund to be its performance over the next X years, where X is twice the duration of the fund minus a year.

Here’s an announcement from Vanguard for two new shortest term Treasury index funds: https://corporate.vanguard.com/content/corporatesite/us/en/corp/who-we-are/pressroom/press-release-vanguard-to-offer-new-options-for-meeting-investors-short-term-liquidity-needs-112224.html

Scott Dichter
8 days ago

Doesn’t the research indicate that the best bang on bond funds is a managed fund with low expense that models a total bond market but doesn’t attempt to replicate it.

This makes a lot of sense because of the breadth of a true bond index, the inability to over buy inefficiencies (which happen more in bonds) and the generally higher expenses involved in bond trading.

Vanguard’s Core Bond Fund has beaten Vanguard Total Bond Fund over 10 years, that tends to mean it wasn’t a fluke.

Philip Stein
8 days ago

John, I think most commenters are recommending a move from bond funds to short-term treasury notes that you hold to maturity. That way, you get your principle back along with interest, and bear little, if any, credit risk.

If the amount of interest you receive exceeds the inflation rate, i.e., you receive a positive real return, then the spending power of your portfolio should increase—a favorable result as you approach retirement.

It’s important to acknowledge that we have had a buoyant economy for the last few years where bonds have done poorly compared to stocks. But we can expect bonds to outshine stocks when, not if, we experience the next recession. Then you will be glad you had some allocation to bonds in your portfolio.

Michael1
8 days ago
Reply to  Philip Stein

Re the first para on individual bonds over bond funds, here’s another perspective.

https://humbledollar.com/money-guide/great-debates-bonds-or-bond-funds/

B Carr
8 days ago

I subscribe to the advice of both Mr Grossman and Mr Clements (and the Bogleheads): for retirees, bonds ought to be of high quality and short(er) duration. IMO that = short-term treasury. Funds are easier to deal with than individual bonds. Index funds are the cheapest. QED…

Norman Retzke
9 days ago

My portfolio was gradually switched to “less aggressive” when I began taking RMDs. Approaching 79, I have a 51/49 portfolio allocation and have a 7 year “cash stash”. My overarching goals today are wealth preservation and beating inflation. Because of that I’m cautious with bond funds. For example, in 2020 I decided that the low returns I was getting via my bond ETFs and bond funds did not sufficiently compensate me for the perceived risk. I sold most of my bond funds and went into treasuries. Today bond funds are 5.01% of my overall portfolio. That was a good decision on my part. For example, Vanguard’s bond fund VCOBX is still down 6.96%. At present I continue to favor cash via longer term CDs and MM accounts, along with treasuries. Some think active bond funds may do better. I do own I-Bonds, an active “Income opportunity fund” up 38% since Dec 2020 and an actively managed “Income” Fund which is down 2.17% since then. Over the same period my VTIP Short term Inflation bond fund is up 10.3%. It has been a pleasant period for me. After 6 years of withdrawals for RMDs my overall portfolio is up 14.23%. I pay attention to allocation and individual holdings (currently 35). Morningstar’s X-Ray tool tells me my portfolio is “moderately risky” with a “core” investing style.

jimborooney
9 days ago

I like Roger Whitney’s thinking on this topic (Retirement Answer Man podcast). For your short horizon (~5 years) spending on basic living expenses, it is more important to have return OF your money vs. return ON your money. I use a 5 year Treasury bond ladder.

Chuck BV
9 days ago

My impression is that Jack Bogle made some very insightful and important observations about stocks and stock funds, and those got generalized to bonds as well. I think we saw the folly of that in 2022 as Bond indexes went into descent in tandem with stock indexes. These days I tend to favor short-term treasury funds as a kind of “easy” button, and for the moment there seems to be a lot of value in money market funds such as Fidelity’s SPAXX. In principle, given my views, a bond ladder and thoughtful incorporation of TIPS should be considered. I hope to consider those more thoughtfully when I do not have a pesky full-time job competing for my attention. I recall reading in Morningstar that, while managers of active stock funds rarely outperform their index (e.g., the S&P500), that is more common for managers of active bond funds.

William Dorner
9 days ago

John, I am going with the Buffet approach, 90% in the S&P and 10% in treasuries. Of course I modified a bit, and I am still working towards that goal, modified to be 85% S&P and 15% Cash. Currently I am down to 10 stocks and 5 indexes. For the Cash the interest rate averaged about 4% last year at internet banks, like Ally, Marcus and the like. Now that’s a lot better than Bonds and yes it is going downward, but no matter that 15% in Cash will tide me over when the market takes a downturn. In my experience over the last 55 years, the market was only down 9 times. So the average up is about 11% per year, including all those down years. So I and Buffett say you can take that risk, as it is pretty low overall. And that is right too, NO International stock funds needed.

Robert FREY
9 days ago

The only “safe” bond investment are individual TIPS. They are guaranteed by the US government (no default risk) and (if held to maturity) have a known real return (no interest rate risk). I would suggest a ten year ladder of individual TIPS to cover your retirement spending for ten years if the stock market suffers a prolonged decline. If stocks do not decline, sell stocks for income, and keep rolling that ten year ladder forward (by purchasing future TIPS as the current ones mature). They should be held in a tax deferred or tax free account.
TIPS mutual funds do have some risk, as they have no maturity date.

Rob Jennings
9 days ago

We buy stocks for long term performance and some inflation protection and bonds for (assured) spending and to diversify stocks (so performance is not the first reason). That said, we tend to focus on recent history for our decisions aka recency bias. If I am not mistaken in the period of 2000-2013 (not that long ago), bonds outperformed stocks most of those years..

jerry pinkard
10 days ago

I used to invest the fixed income part of our portfolio into intermediate bond funds or etfs. Due to attractive CD rates, I shifted mostly to CDs with 3 to 7 year terms a few years ago. In an effort to simplify our portfolio and reduce the number of accounts, I have been shifting CD funds when they mature to TIPS. I have been able to buy intermediate TIPS (4 to 6 years) at 2% yield over inflation which is attractive to me. I buy these on the secondary market using Fidelity. Fidelity has an excellent website for purchases and bond experts if you need help.

Fixed income seems cyclical as to what is favored at any point in time. As that occurs and TIPS no longer offer a good yield, I may switch back to intermediate bond etfs.

FWIW, my portfolio is presently 57/45 and I need to rebalance back to our target AA of 50/50. I am 80 years old and wife is 82. We live off SS and my pension. We view our investments as more of an inheritance for our two children and grandchildren.

rgscl
12 days ago

Don’t move to bonds because you’re 5 years away from retirement. Move to bonds 5 years prior to withdrawals. Now in your case withdrawal and retirement dates might be the same. If you have a taxable portfolio, you should consider withdrawing from there first. And if you can hold off withdrawing from tax deferred accounts (IRA/401k), then you will have a 15 year window till RMD so a high equity allocation might make sense. I have been retired for 4 years now, I didn’t change my allocation, I constructed “2x bridges” till RMD – one via a SPIA (single premium immediate annuity) and a 2nd with a TSY bond ladder. Both have an IRR of around 3% (+/-) but the monthly “pay checks” show up regardless of the market conditions.

My $0.02, YMMV

Olin
11 days ago
Reply to  rgscl

What is a TSY in reference to a bond ladder?

Dan Malone
11 days ago
Reply to  Olin

I’m guessing U.S. Treasury, but also wish acronyms like this weren’t used to leave us guessing.

rgscl
11 days ago
Reply to  Dan Malone

Apologies, yes TSY is a short for US Treasuries. In this case, I was referring to US treasuries bond ladder.

Olin
11 days ago
Reply to  Dan Malone

I looked for acronym’s at treasury.gov and don’t see anything for TSY.
https://home.treasury.gov/system/files/261/2012-Abbreviations.pdf

Y S
12 days ago

While I use a short term Treasury ETF for my bond allocation, I recently came across ICSH ETF. If you favor a higher yield vs. state tax exemption.

Jonathan Clements
Admin
12 days ago
Reply to  Y S

ICSH is iShares Ultra Short-Term Bond Active ETF. A plea: Please don’t refer to funds or stocks solely by their ticker symbol. I don’t know these symbols off the top of my head, and I imagine most readers don’t, either.

Y S
12 days ago

will do, appreciate the feedback

Ben Rodriguez
12 days ago

Interestingly, now is a relatively good time to rotate out of stocks and into bonds. Stocks are at all-time highs and all-time PE values. Bonds are as cheap as they’ve been in 15 years or so

rgscl
12 days ago
Reply to  Ben Rodriguez

There is a view that they are likely to get cheaper (as in the 10Y will likely go up to 5%).

Ben Rodriguez
11 days ago
Reply to  rgscl

It could definitely happen. If I knew which direction yields or stocks were going, I’d be on a yacht in the Mediterranean.

Charles Moser
12 days ago

In my retirement accounts I am using TIPS with approximately 2% real return at present. Non retirement accounts I am using short term Treasuries bought at auction.

Dan Malone
12 days ago

I listened to Vanguard’s Economic and Market Outlook for 2025 yesterday. One of the main takeaways (the other is maintain at least 20% international diversification) is that bond yields are attractive right now, especially in comparison to expected returns in the U.S. stock market over the next decade. The risk premium for holding more volatile U.S. stocks over the next decade is, in Vanguard leadership’s opinion, not compelling in comparison to expected bond yields over that period. As someone within a few years of retirement and seeking to avoid the sequence of returns risk at the beginning of retirement, this was both important and convincing for me.

Take a look at this Vanguard news release quoting its Chief Economist, Joe Davis: “The long-term attractiveness of bonds continues to persist in the current interest rate environment,” concludes Mr. Davis. “We believe long-term investors will continue to benefit from a diversified portfolio consisting of fixed income and globally diversified equities.”

Vanguard’s updated 10-year annualized return projections:

  • Global bonds, ex-U.S.: 4.3% – 5.3%
  • U.S. bonds: 4.3% – 5.3%
  • Global equities (ex-U.S., developed): 7.3% – 9.3%
  • Global equities (emerging): 5.2% – 7.2%
  • U.S. equities: 2.8% – 4.8%

Yes, Vanguard’s return analysis for the next decade is based on the current historically high U.S. stock market valuation (multiples of earnings), which Jonathan and others are skeptical of as a predictive tool. But all things considered, I am now more comfortable with a good portion of bonds in my portfolio for the next 10 years.  Vanguard’s Head of Fixed Income – with a disclaimer that “all investing is personal” — likes expected returns in the 3 – 6 year bond maturities in particular. 

BMORE
6 days ago
Reply to  Dan Malone

Nice summary. Here’s the link to the entire report: https://corporate.vanguard.com/content/dam/corp/research/pdf/isg_vemo_2025.pdf

David Lancaster
12 days ago

No matter the yield make sure you allocate to bonds. Our allocation at 67 years old is 45/45/10. Two days ago when the market dropped significantly our portfolio actual gained >1K due to our bond allocation. Also a recent Morningstar article

https://www.morningstar.com/portfolios/experts-forecast-stock-bond-returns-2025-edition

reported that many financial analysts are predicting that in the years ahead bond returns will/may outperform stock due to current bond yields vs the current high equity prices.

Last edited 12 days ago by David Lancaster
August West
12 days ago

I’m using VUSXX (plus I get the benefit of no state tax on the dividends)

Jonathan Clements
Admin
12 days ago
Reply to  August West

VUSXX is Vanguard Treasury Money Market Investor Shares. A plea: Please don’t refer to funds or stocks solely by their ticker symbol. I don’t know these symbols off the top of my head — despite, in this case, actually owning the fund. Indeed, I imagine most readers don’t know them, either.

Jonathan Clements
Admin
12 days ago

We shouldn’t drive looking in the rearview mirror. It’s hardly surprising that recent bond market returns have been so low given the starting yield:

https://fred.stlouisfed.org/series/DFII10

And, yes, the starting yield is the best guide to your likely return with high-quality bonds. Today, with the starting yield on 10-year Treasurys at 4.5%, returns should be respectable, though not great.

Two additional thoughts. First, I’d favor shorter-term bonds and cash investments, knowing you’re giving up yield but compensating by allocating somewhat more to stocks. Second, I’d allocate to these conservative investments based not on some arbitrary “gut feel” portfolio percentage, but based on how many years of portfolio withdrawals you want to set aside. Once retired, will you need $30,000 a year from your portfolio to cover spending? You might allocate five or seven years of portfolio withdrawals to cash and short-term bonds, meaning $150,000 to $210,000.

S
S
8 days ago

Jonathan, Do you hold TIPS?

Jonathan Clements
Admin
8 days ago
Reply to  S

I split my bond-market money evenly between a short-term TIPS fund and a short-term conventional government bond fund.

Bill C
12 days ago

I’ve used ST T Bills purchased on the secondary market with durations of 1-3 years. If held to maturity you will receive the YTM as stated at purchase (however they will fluctuate in vale before maturing). I also hold positions of IBonds and TIPs (also purchased on secondary market), as well as a high yield bond fund. I allocate this mix based on my Investment policy statement.

Michael1
12 days ago

Great question and I also look forward to other comments.

From my perspective, true the last few years have not been great for bonds, but historically they have done better than cash. How do we know when things are really changing? I hear you on the low returns but consider this part of the price of diversification. We use Fidelity Total Bond FTBFX and Fidelity Inflation-Protected Bond FIPDX.

Also, consider Fidelity Premium Money Market Fund FZDXX to replace SPAXX for your cash. 

S Phillips
13 days ago

Thanks for posting this.I’ve wondered the exact same thing. Looking forward to hearing what people have to say.

I wonder sometimes why take a risk at all for 2% return?

stelea99
12 days ago
Reply to  S Phillips

The point of having bonds or bonds/cash is so that the next time there is a 5 quarter decline in the stock market when your stocks have declined by over 50%, you will still have the other non-stock portion of your total portfolio, which did not decline, to sell if needed to support your life style.

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