Bond funds – government bond funds (munis or fed) can be a good source of tax-free income in a taxable account. This can be particularly useful when you are still earning income, you’re looking for the asset allocation stability that bonds are generally used to deliver, and you’re trying to keep taxable income low.
Individual bonds – again, government bonds like TIPS, T bonds and T bills are useful when capital preservation becomes important, usually after you retire, and you’re looking for tax effective source of passive income. In a ladder, these become a great way of annuitizing a part of your portfolio to protect against sequence of return risk. Each year a rung on the ladder matures, providing you with the option to either use it to spend when the market is down, or reinvest it when you’re decumulating from your portfolio. The big brokerage firms all sell bonds on the secondary market and they only charge a couple basis points above market asking price. Very reasonable, liquid, and easy to do.
We hold about 50% bonds in retirement divided almost equally between an individual TIPs ladder and a few bond funds, both of which serve different purposes. The 10 year TIPs ladder is the foundation of our strategy as each TIPs is liability matched against a future annual gap between income and expenses. Both bond and stock ETFs/funds get rebalanced into the TIPs ladder. TIPs are not that difficult to buy occasionally and while they do have tax challenges, they are the only tool which provides guaranteed future purchasing power which outweighs the downsides in our case.
Anybody who was paying attention in 2022 should realize that there is a downside to bond funds over individual bonds. As a US Federal employee I have access to the G fund in the TSP (Federal 401k equivalent). That has no duration and cannot lose value, and provides yields similar to Treasury Bills. Outside of that, I had a bond fund (Vanguard BND) that took a 15-20% dive at the same time that large cap and total market indexes (Vanguard VTI) took a similar dive. So much for non-correlated investments and spreading risks. That got me to finally pay attention to the mechanics of investing in treasury notes. It seems a lot safer than a bond fund, and it appears that doing so is more tedious than complex. My wife and I are pre-retirees and still pressed for time and attention, so she uses a SPDR short term treasury ETF in the hope that it’s the next best thing to actually taking the time to build a T-Bill bond ladder.
Owning individual bonds does not really reduce your risk. The value of a bond that you buy direct from the will decline in value and you would take a loss if you had to sell it before maturity. If you hold it to maturity you get all your money back, but if you own an index fund they will hold the bond to maturity too and you will still collect the interest every month.
I lost about 15% on my Vanguard bond fund last year but the individual bonds in the fund still pay the interest and as the low rate ones expire they are replaced by higher rate ones.
I sometimes buy US treasuries direct, but otherwise bond funds. I do not have the expertise nor want to spend the time determining the best bonds. As I understand it, the spread between buy and sell can be pretty wide, and is another disincentive to buy bonds (except treasuries issues).
I believe in simplicity. I use bond funds. Convince me that individual bonds are likely to give me a substantial benefit in terms of return or reduced risk, and I might consider changing my approach… other wise I’ll just keep it simple.
Bond funds – government bond funds (munis or fed) can be a good source of tax-free income in a taxable account. This can be particularly useful when you are still earning income, you’re looking for the asset allocation stability that bonds are generally used to deliver, and you’re trying to keep taxable income low.
Individual bonds – again, government bonds like TIPS, T bonds and T bills are useful when capital preservation becomes important, usually after you retire, and you’re looking for tax effective source of passive income. In a ladder, these become a great way of annuitizing a part of your portfolio to protect against sequence of return risk. Each year a rung on the ladder matures, providing you with the option to either use it to spend when the market is down, or reinvest it when you’re decumulating from your portfolio. The big brokerage firms all sell bonds on the secondary market and they only charge a couple basis points above market asking price. Very reasonable, liquid, and easy to do.
We hold about 50% bonds in retirement divided almost equally between an individual TIPs ladder and a few bond funds, both of which serve different purposes. The 10 year TIPs ladder is the foundation of our strategy as each TIPs is liability matched against a future annual gap between income and expenses. Both bond and stock ETFs/funds get rebalanced into the TIPs ladder. TIPs are not that difficult to buy occasionally and while they do have tax challenges, they are the only tool which provides guaranteed future purchasing power which outweighs the downsides in our case.
When rates are up, bond funds are attractive. When rates drop, collect capital gains and get out.
Otherwise, avoid them.
Anybody who was paying attention in 2022 should realize that there is a downside to bond funds over individual bonds. As a US Federal employee I have access to the G fund in the TSP (Federal 401k equivalent). That has no duration and cannot lose value, and provides yields similar to Treasury Bills. Outside of that, I had a bond fund (Vanguard BND) that took a 15-20% dive at the same time that large cap and total market indexes (Vanguard VTI) took a similar dive. So much for non-correlated investments and spreading risks. That got me to finally pay attention to the mechanics of investing in treasury notes. It seems a lot safer than a bond fund, and it appears that doing so is more tedious than complex. My wife and I are pre-retirees and still pressed for time and attention, so she uses a SPDR short term treasury ETF in the hope that it’s the next best thing to actually taking the time to build a T-Bill bond ladder.
Owning individual bonds does not really reduce your risk. The value of a bond that you buy direct from the will decline in value and you would take a loss if you had to sell it before maturity. If you hold it to maturity you get all your money back, but if you own an index fund they will hold the bond to maturity too and you will still collect the interest every month.
I lost about 15% on my Vanguard bond fund last year but the individual bonds in the fund still pay the interest and as the low rate ones expire they are replaced by higher rate ones.
Agree, Charles. Lucky you, having access to that government employee fund. That sounds excellent.
Booch221 – see my full comment above.
I sometimes buy US treasuries direct, but otherwise bond funds. I do not have the expertise nor want to spend the time determining the best bonds. As I understand it, the spread between buy and sell can be pretty wide, and is another disincentive to buy bonds (except treasuries issues).
I believe in simplicity. I use bond funds. Convince me that individual bonds are likely to give me a substantial benefit in terms of return or reduced risk, and I might consider changing my approach… other wise I’ll just keep it simple.