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I’m gifting a Wall Street Journal article on the share of AI company debt in the bond market. Just as AI is becoming an ever-growing share of the S&P500, it is becoming a bigger share of the bond market. I have already shifted money from the S&P500 to the rest of the market, and to an international fund, now I’m wondering whether I should do the same for bonds.
Since my asset allocation is 50% stocks, I own a fair amount of bonds. Most of the money is in short and intermediate TIPs (VTAPX and VAIPX), and short and intermediate Treasuries (VFIRX and VSIGX), but some is in high-grade corporates (VFSUX and VFICX). Would you only hold Treasuries?
Kathy,
I really enjoyed this article and the discussion by everyone. Can you comment on your decision(s) for your mix of active and passive bond funds mentioned in the opening and in later comments? Thank you!
Buffett recommends 90% S&P and 10% in short term US Gov Bonds, when he dies for his wife. I modified slightly to 85% S&P and 15% cash at internet bank rates about 3.65% interest today, have had this goal for last 10 years or so. In my 60 years of investing I am 80 years old, the market was negative for me only 9 times. One time was close to a disaster as for three years in a row the market was down 45%, years 2000, 2001 and 2002. The savings grace, was I SOLD nothing. 3 to 4 years later I was back even and been increasing most years since. My 15% cash allows me to sell nothing until the market recovers. That is my comfort, and seems to work for me. $1 saved in 1966 has earned me $166! and that includes all the ups and downs over the years. Just do not like Bonds, as they never served me well.
Bill,
Can you describe your approach (time, source of funds strategy) to replenish /maintain your 15% cash allocation?
I agree, Kathy, the inflation info online does support 900% as you stated.
Is that adjusted for inflation? The internet tells me the cumulative inflation rate since 1966 is over 900%.
Thanks very much for sharing that WSJ article!
William Bernstein, Jonathan Clements, Rick Ferri and other leading investment experts recommend only holding Treasuries, while Professor Edward McQuarrie (“McQ” on the Bogleheads forums) did an exhaustive study recently comparing intermediate-term treasuries (VGIT) to Vanguard’s Total Bond Market fund (BND) that showed conclusively that ITT’s are superior to funds like BND that not only dilute Treasuries with lower-quality corporate issues but also have nudged their duration out to ~7 years, thereby exposing investors to considerably more interest rate risk than a true intermediate-term (5 year) fund. Bottom line from Dr. Bernstein: a TIPS ladder is the only place for long-duration bonds; otherwise use short-term Treasuries only and take your risk on the equity side.
Personally I keep of couple of years of residual living expenses in GOV and split the rest of my bond holdings equally between VTIP (short-term TIPS) and VGIT.
Like you I see the silly pop-ups from Vanguard urging me to consider dollar-hedged international bonds but their own track-record after using them in their target retirement date and LifeStrategy funds just shows that they add complexity for no additional return. Too bad they didn’t choose to include TIPS in any of those funds beside Target Retirement Income instead, as VTIP has out-performed all of their other bond funds since inception and short-term TIPS actually do offer meaningful diversification – especially for retirees.
Thanks for the analysis. I have a really hard time swallowing the idea of 50% in foreign bonds, government or corporate!
Same here because I don’t want the additional currency risk.
Vanguard does say hedged.
The cost of hedging currency risk is based on interest rate differentials which can offset the higher interest rate of the foreign currency.
Some would say that corporates are unnecessary, but I keep 10% to 15% in my portfolio, which is in line with the aggregate bond market, assuming a 50/50 portfolio. If 14.5% of those are exposed to AI and they take a 50% hit in a downturn, the total impact to my portfolio might be 1%. I figure the impact of AI on my bonds will likely be small. So, whatever you decide about your allocation, the effects of an AI meltdown on your bonds will probably be minimal.
I’m sure my current exposure is small, I’m more concerned about a potential increase.
I am a fan of Yogi Berra’s famous quote about predicting the future that applies in my mind to financial markets – “It’s tough to make predictions, especially about the future”.
Thanks for sharing-I normally skim through the WSJ so missed this one. We are 60/40 and of the 40% bonds, about half are in individual TIPs. Of the 20 in ETFs/funds, about 1/3 are in corporates. I’m not feeling overexposed, but I’ll run the question by our (conservative) advisor as he normally has an insightful view of articles in the financial media, amongst other things.
Thanks, would be interested to know the result.
My wife and I are fortunate that we’ve been able to live off dividends and interest and save whatever money I earn from self-employment for the last 5 years.
I’m 60/40 Equity/Fixed in my taxable account. My IRA is 90/10 equity. All the fixed income in the IRA are individual TIPS purchased through Fidelity.
The 40% in my taxable account was individual bonds…50% investment grade corporate, 50% muni (split 50% Michigan 50% national), all less than 7 year maturity. My short term was Treasuries < 6 months duration. I’ve been running this way for about 10 years.
Starting last year, I take the money as the bonds mature and put in bond mutual funds. This is a simplification move for me. I will be 69 in January and will take SS at 70.
My map for this conversion is pretty simple:
Michigan Muni -FMHTX
Other Muni- VTEI
Corp Bond- VCSH
Short term Cash SPRXX & FCNVX…these are Treasury based funds
More than you want to know, but risk tolerance and the desire to simplify will continue to evolve as age and personal circumstances intervene.
BTW, my mother in law is 96…her taxable and IRA are in FCNVX. I put it there 15 years ago.
We hold nearly all Treasurys in our bond allocation due to what Bill Bernstein has said. And I think it was someone else who said that return of your capital is more important than return on your capital.
Being retired, having always been 100% in stock indexes, and having 110% of our our retirement income replaced I can’t justify bond funds. But I appreciate articles such as this one because it always challenges me to rethink our portfolio
Does your 110% funded rate have a COLA?
About 60% does. We continue to invest our access into retirement accounts and savings buckets for vacations, cars, and our”Rainey day” accounts
We are currently 10% cash, 10% Vanguard Growth, 30% Vanguard Total Market U.S.,50 Vanguard All World.
If I were to add bonds we would be something like 10%Cash, 55% Vanguard All World, 10% Vanguard Growth, 25% Vanguard Total Bond
My thought exactly. Also, if you’ve won the game, why take a lot of risk?
After 30+ years of investing I know that downturns always come back. I always sleep well no matter what the stock markets do. I’m a big picture guy not a micro manager
Noting that downturns always come back is fine if you are many years from retirement or you have sufficient wealth to weather a downturn that could last for many years. Adjusting for inflation, the Dow didn’t regain its value in Nov 1965 until July 1995. More recently, the Dow was at the same level in May 2013 that it was at in Jan 2000.
Owning a bond fund hardly turns someone into a micromanager.
Any idea thought of giving some space in the bond allocation to foreign government bonds?
Vanguard keeps nagging me to put 20 to 50% of my bond allocation in “low- cost, currency-hedged international bonds”. It also tells me I actually have 6% in international bonds, only 1.4% is (semi) intentional. If Vanguard is going to put foreign bonds in my regular bond funds I should just get rid of the 1.4%. No idea how much is government debt.
Interesting. That’s a higher allocation than I would have expected them to recommend.
Vanguard Total International Bond ETF (BNDX), is about half government issues. It tracks an index but caps its exposure to Chinese bonds.
I think as a general rule, it’s better to hold your own nation’s government securities over a foreign country’s. You don’t have any currency risk, although you could hedge that at a cost. Most nations give some form of tax break for citizens holding their own government bonds.
That is the conventional wisdom. Of course lately that currency “risk” has actually been a benefit to a U.S. investor holding unhedged assets in foreign currencies. And there’s the recent questions about the future safety of Treasuries and the dollar. Not that I’m really concerned about that, just recognizing the other side.
I believe the general recommendation to hold bonds in one’s own currency is because most of one’s expenses will be in their local currency. In our case, we spend as much or more in foreign currencies as in dollars.
I’m obviously not sure about your IRS’s position on this, but I think the main issue would be the complexity it adds to your tax reporting when holding foreign government bonds. This is well beyond my knowledge, but I imagine you’d deal with things like reclaiming double taxation and currency conversion hassles—I’m assuming you’d need to report your gains in dollars rather than pounds or euros. It might be more trouble than it’s worth.
That’s a good point and always something to be careful of. I’d have this in an IRA so no tax reporting. Even if I held them in a taxable U.S. brokerage account, if in a fund that’s traded in the U.S., it’s not an issue. I’d get the same Form 1099 reporting as for a fund holding only U.S. bonds.
The bigger challenge is finding a good international bond fund that isn’t hedged to the dollar. As you mentioned, what most U.S. investors want is a hedged fund, so that’s what’s offered. iShares did recently release an unhedged one, but there’s no track record. And I have no interest in individual bonds.
Most of my bond funds are in my IRA, so no tax issues. I have intermediate munis in taxable, so only state tax on those. My new car fund is in Wellesley, which holds bonds as well as stock, but I haven’t noticed any tax issues.
My bonds are split in thirds in short term, short term TIPS, and an intermediate total bond.
The article states 14.5% of investment-grade corporate bonds are tied to AI. It also states that 40% of the S&P500 is tied to AI.
I think the premise of the article is not to move away from corporates altogether, but to think about diversifying your corporate exposure, much like you did when you diversified away from the S&P500 in your stock exposure.
I would not let talk of AI sway your decision. If you have been contemplating moving away from corporates for reasons others have stated in the comments (i.e. “playing it safe with my bonds) then that is another matter.
I have read various authors in the financial media comparing the yields of cash, bonds and stocks, and then constructing allocation ratios based on that. I respectfully disagree. I have specific purposes for my cash, bonds and stocks. The primary driver, for us in our eighth year of retirement, is mitigation of sequence of returns risk. So, the purpose of my cash, and also bonds is to ensure that the needed cash for future withdrawals will be there, while the interest they earn is of secondary importance.
My bond allocation is limited to treasurys (regular and TIPS) with maturities of 5 years or less, with a smidgeon of I-bonds. I think other bond allocations would probably provide a better return. But I remember Jonathan preferring to do his risk taking in the stock market while preferring safety over yield with his bonds. And I agree with him.
I too am at 50/50 during these days of unusually high stock valuations, and I think your bond allocation is very sensible.
Thanks. Like Mark, I agree. The bonds are for diversification and protection during down turns. I wouldn’t say I’ve won the game, but I’ve done well enough I want to mitigate risk. That’s why I don’t want much AI showing up in my bond funds.
Totally agree with your thoughts on bonds, echoes my reason to hold them.
After getting burned in the recent bond crash, I’ve shifted to holding primarily individual government bonds in a ladder structure. The only bond fund I hold is a Vanguard short-dated managed fund. I don’t view bonds as a yield product but rather as a risk management and stability tool.
Mark,
Is the Vanguard short-dated managed bond fund VBIRX (BSV ETF) or some other managed fund?
I’d hold more than Treasuries personally. My largest holding is a core plus fund.
Btw, here’s a recent article from Morningstar suggesting benefit to actively managed bond funds over indexes.
https://www.morningstar.com/funds/eric-jacobson-entire-face-bond-market-has-changed