Bond strategy


D

Default User

I mentioned my problems with lack of tax-advantaged accounts in my
portfolio outside of the 401K (see "REIT strategy"). This problem goes
even more for bonds. I'm currently planning 70/30 stock/bond split. As
I can't hold very much in the way of bonds in the Roths, especially if
I go ahead and put REITs in there, what's a good strategy?

Possibilities:

1. Look at tax-exempt bond funds (ETFs?).

2. Go with regular bonds or funds and pay the tax (25% bracket).

3. "Trade" with the 401K by increasing its bond amount and decreasing
that in the brokerage account. The 401K only has one bond fund, that's
a Lehman Aggregate Index. Its average maturity is about 7.5 years as I
recall. Many of the sources I've read suggest shorter maturities.


Also, I've read differing opinions about whether foreign bond exposure
is a good idea or not. Obviously not an option in the 401K.




Brian
 
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R

Ron Peterson

I mentioned my problems with lack of tax-advantaged accounts in my
portfolio outside of the 401K (see "REIT strategy"). This problem goes
even more for bonds. I'm currently planning 70/30 stock/bond split. As
I can't hold very much in the way of bonds in the Roths, especially if
I go ahead and put REITs in there, what's a good strategy?
You might want to consider preferred stocks. PFF would be an ETF that
might work for you.

You might want to buy individual preferred stocks for a taxable
account because some some of the stocks in PFF aren't fully qualified
which is needed to get a tax break on dividends.
 
D

D T W .../\\...

Brian wrote:

The 401K only has one bond fund, that's a Lehman Aggregate Index. Its
average maturity is about 7.5 years as I recall.

What does the length of bond maturity mean to me when investing?
My 401K has short and intermediate term bond funds,,,,,,,,,

DTW .../\.../\.../\...



Default User said:
I mentioned my problems with lack of tax-advantaged accounts in my
portfolio outside of the 401K (see "REIT strategy"). This problem goes
even more for bonds. I'm currently planning 70/30 stock/bond split. As
I can't hold very much in the way of bonds in the Roths, especially if
I go ahead and put REITs in there, what's a good strategy?

Possibilities:

1. Look at tax-exempt bond funds (ETFs?).

2. Go with regular bonds or funds and pay the tax (25% bracket).

3. "Trade" with the 401K by increasing its bond amount and decreasing
that in the brokerage account. The 401K only has one bond fund, that's
a Lehman Aggregate Index. Its average maturity is about 7.5 years as I
recall. Many of the sources I've read suggest shorter maturities.


Also, I've read differing opinions about whether foreign bond exposure
is a good idea or not. Obviously not an option in the 401K.




Brian

======================================= MODERATOR'S COMMENT:
Please trim the post to which you are responding. "Trim" means that except for a FEW lines to add context, the previous post is deleted.
 
W

wyu

3. "Trade" with the 401K by increasing its bond amount and decreasing
that in the brokerage account. The 401K only has one bond fund, that's
a Lehman Aggregate Index. Its average maturity is about 7.5 years as I
recall. Many of the sources I've read suggest shorter maturities.
With longer maturities, you get more interest rate risk but also
higher returns. So you can model the formula something like so:

short bonds = risk 1.25
int bonds = risk 1.5
equities = risk 10

If you want a risk level of 8, you can choose either:

1.25x + 10(1-x) = 8
or
1.5x + 10(1-x) = 8

In the end, the overall risk level is still 8. But because you don't
have access to safer short-term bonds, you use int-term bonds instead
and then reduce the equity percentage to compensate for riskier bond
holdings.

If I was only considering tax reasons, my placement preference would
be:
1) 401K/IRA
2) Vanguard Variable Annuity
3) Tax-Exempt Bond Fund
4) Taxable Account
 
D

Default User

In the end, the overall risk level is still 8. But because you don't
have access to safer short-term bonds, you use int-term bonds instead
and then reduce the equity percentage to compensate for riskier bond
holdings.
Something to think about, thanks.
If I was only considering tax reasons, my placement preference would
be:
1) 401K/IRA
2) Vanguard Variable Annuity
Hmmm, I hadn't considered that for bonds. Looking at Vanguard, their
short-term investment grade corporate annuity isn't all that expensive.
The ER is .45%, while the similar mutual fund is .21%. The only ETF
they have for short-term bonds seems more weighted to Government than
corporate, but is lower fee of course.
3) Tax-Exempt Bond Fund
4) Taxable Account
I have the problem that I don't want to let the tax tail wag the
investment dog, as I've seen mentioned, if it's detrimental to the
overall portfolio.

My original strategy was to treat the two accounts totally separately,
as that's the easiest approach. I don't want to complicate things too
much, as I'm likely to get confused.





Brian
 
D

Default User

Ron said:
You might want to consider preferred stocks. PFF would be an ETF that
might work for you.
I'll take a look at it, thanks.
You might want to buy individual preferred stocks for a taxable
account because some some of the stocks in PFF aren't fully qualified
which is needed to get a tax break on dividends.
Ok.



Brian
 
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B

BreadWithSpam

D T W .../\\... said:
What does the length of bond maturity mean to me when investing?
My 401K has short and intermediate term bond funds,,,,,,,,,
In *very* brief: longer term indicates greater sensitivity
to interest rate fluctuations - rates go up, present values
go down. Longer term bonds will have higher price volatility.

In slightly less brief: maturity isn't really the relevant
question, but rather, "duration" - which is a measure of
the sensitivity of the bonds values versus interest rates.

Note that things like floating-rate bonds often have durations
which are very very small, yet maturities which may be long.
So if you're concerned with interest rate risk, note the
duration, not the maturity.

Duration, like maturity, is usually quoted in units of time -
years. I was just looking at the portfolio details of a
muni bond fund this morning which had an average maturity
of 23 years and an average duration of only about 5.5 yrs.

Re: the earlier poster who asked about a Lehman Agg Index fund:
While the average maturity of the Agg is now around 7.3,
the duration is around 4.6 and the average credit quality
is very high - only about 20% is corporate debt and even
that is all "investment grade" debt. The rest is treasuries
and government-related (ie. agencies) and high-quality
asset-backed (ie. FNMA conforming mortgages - none of
the subprime structured stuff). Assuming the expenses are
low, it's exactly what's typically meant by "the bond market"
for asset-allocation discussions. As far as fund
categories goes, it's "intermediate-term bonds," not
long-term.
 
T

Tad Borek

Default said:
I'm currently planning 70/30 stock/bond split. As
I can't hold very much in the way of bonds in the Roths, especially if
I go ahead and put REITs in there, what's a good strategy?

One comment - the old expression is, don't let the tax-tail wag the dog.
The point isn't to avoid taxes, it's to maximize after-tax returns. Your
choice of where to hold different types of investments may be driven
more by growth assumptions.

Example...pretend you don't want REITs at all and you want to figure out
how to use $10k of Roth "capacity". Would it make sense to hold your
bonds in the Roth? Probably not. Let's say these are your return
expectations for $40,000 that you're investing today, after some
undefined period of time, "gross" of tax drag:

$10,000 invested in bonds will grow to $13,000
$10,000 invested in (some aggressive asset class) will grow to $35,000
$10,000 invested in large-cap US stocks will grow to $22,000
$10,000 invested in international stocks will grow to $23,000

So you'll start with $40,000 today and end up with $93,000. Now..is it
better to use the Roth for your bonds, to avoid being taxed on the
interest? Or on "some aggressive asset class", to avoid tax on gains and
income? It'll depend on your assumptions about "tax drag" along the way
but that's a lot of ground to make up. If I was going to have $93k I'd
rather have $35k of it in a Roth than $13k in a Roth.

-Tad
 
D

Default User

Re: the earlier poster who asked about a Lehman Agg Index fund:
While the average maturity of the Agg is now around 7.3,
the duration is around 4.6 and the average credit quality
is very high - only about 20% is corporate debt and even
that is all "investment grade" debt. The rest is treasuries
and government-related (ie. agencies) and high-quality
asset-backed (ie. FNMA conforming mortgages - none of
the subprime structured stuff). Assuming the expenses are
low, it's exactly what's typically meant by "the bond market"
for asset-allocation discussions. As far as fund
categories goes, it's "intermediate-term bonds," not
long-term.
Sounds like you wouldn't feel too bad about that being the sole US bond
component, is that right?

The total projected expense ratio for the fund in the 401K is 0.0810%,
nice and low. I think I mentioned before, that includes management
expenses plus transaction/processing/etc. costs.




Brian
 
J

joetaxpayer

In slightly less brief: maturity isn't really the relevant
question, but rather, "duration" - which is a measure of
the sensitivity of the bonds values versus interest rates.
Duration starts with the maturity of a given bond, and mathematically
accounts for the reinvestment opportunity for the coupon. For what it's
worth, a zero coupon bond due in X years, has a duration of precisely X.
A tiny coupon will reduce the duration, a high coupon reduce it a lot.

A fund with a duration of, say, 5 years, will go up or down by about .5%
for each move in rates of .1% or very close to this number.

JOE
www.blog.joetaxpayer.com
 
B

BreadWithSpam

Default User said:
(e-mail address removed) wrote:

Sounds like you wouldn't feel too bad about that being the sole US
bond component, is that right?
If the asset class you're looking for is "the bond market" (or,
more accurately, "the *US* investment-grade bond market") that's
exactly it. Especially if you're looking for index-fund
representation of those asset classes. There are, of course,
actively managed bond funds, but it's awfully hard to generate
excess returns and overcome management fees in investment-grade
bonds.
The total projected expense ratio for the fund in the 401K is 0.0810%,
That seems a touch low, but not impossible - Vanguard's
institutional share class of their "total bond market fund" -
basically exactly this - is 7bps. (their investor shares
are 20bps and admiral shares are 11bps)

I've seen some discussion that there's no need to go outside
of treasuries for "bond market exposure" in some asset allocation
plans - but this would do just fine for the vast majority for
exposure to that.

If the duration seems a bit long, just moderate it with some
cash or GICs or whatever short/ultra-short option you have
in the 401k. (Assuming it's a similarly decent fund and
not invested in structured deals backed by subprimes...).

If, for example, you wanted 40% bonds in your portfolio but
wanted the bonds to have half the duration of the Agg, you
could go 20% Agg and 20% cash.

Can you tell us exactly which funds you do have available
in that 401k? (If you posted them already, I must have
missed them)
 
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D

Default User

If the asset class you're looking for is "the bond market" (or,
more accurately, "the US investment-grade bond market") that's
exactly it.
I suppose so. I'm just a guy trying to get his head around a reasonable
asset allocation and get the investment house in order. That way things
can be a bit more automagic. The advice I'd read said to stick with
shorter term bond exposure.
That seems a touch low, but not impossible
It's right out of the "fee matrix" sheet for all the funds. They tend
to be pretty low, one of the good things about the plan.

Annual
Fund Other Per
Management Fees Expenses Total $1,000
Bond Market Index Fund 0.0120% 0.0690% 0.0810% $0.81
If the duration seems a bit long, just moderate it with some
cash or GICs or whatever short/ultra-short option you have
in the 401k.
What we have is a "Stable Value Fund":

"The Fund is invested in interest-bearing contracts or other
arrangements issued by insurance companies or other financial
institutions."

It has a fixed return rate adjusted each quarter, currently 5.12%.
Can you tell us exactly which funds you do have available
in that 401k?
I'll start a separate reply for that, to keep this message shorter. I
replied earlier but it bounced for length, mostly due to inadequate
snippage.




Brian
 
D

Default User

Can you tell us exactly which funds you do have available
in that 401k?
Here's the available funds with their projected expenses out of the fee
matrix:


Fund Annual
Management Other Per
Fees Expenses Total $1,000
Lifecycle Funds:
Lifecycle Retirement Fund 0.4900% 0.0671% 0.5571% $5.57
Lifecycle 2010 Fund 0.4900% 0.0543% 0.5443% $5.44
Lifecycle 2020 Fund 0.4900% 0.0489% 0.5389% $5.39
Lifecycle 2030 Fund 0.4900% 0.0602% 0.5502% $5.50
Lifecycle 2040 Fund 0.4900% 0.0646% 0.5546% $5.55

Index Funds:
Bond Market Index Fund 0.0120% 0.0690% 0.0810% $0.81
Balanced Index Fund 0.0110% 0.0516% 0.0626% $0.63
(S&P 500 Index Fund [60%]
Bond Market Index Fund [40%])
S&P 500 Index Fund 0.0100% 0.0402% 0.0502% $0.50
International Index Fund 0.0350% 0.0817% 0.1167% $1.17
Russell 2000 Index Fund 0.0220% 0.0378% 0.0598% $0.60

Actively Managed Funds:
Stable Value Fund 0.1731% 0.0394% 0.2125% $2.12
Large Companies Value Fund 0.2400% 0.0400% 0.2800% $2.80
Large Companies Core Fund 0.3000% 0.1893% 0.4893% $4.89
Large Companies Growth Fund 0.3600% 0.0458% 0.4058% $4.06
Large Companies International Fund 0.4500% 0.1808% 0.6308% $6.31
Small/Mid Companies Value Fund 0.5800% 0.0499% 0.6299% $6.30
Small/Mid Companies Growth Fund 0.7300% 0.0454% 0.7754% $7.75
Science & Technology Fund 0.5625% 0.0395% 0.6020% $6.02

Other:
Company Stock Fund 0.0112% 0.0373% 0.0485% $0.48




Brian
 
D

Default User

Tad said:
One comment - the old expression is, don't let the tax-tail wag the
dog. The point isn't to avoid taxes, it's to maximize after-tax
returns.
Right, and that's the situation I'm in, trying to figure out which
assets fit best in the various accounts.
Now..is it
better to use the Roth for your bonds, to avoid being taxed on the
interest? Or on "some aggressive asset class", to avoid tax on gains
and income?
Which investments did you have in mind that would be preferable over
bonds in this case?



Brian
 
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B

BreadWithSpam

[this fell off my rader a few days ago:]
Default User said:
(e-mail address removed) wrote:
[sounds about right, and fees seemed like you'd said]
What we have is a "Stable Value Fund":
That'd be it. Stable Value is, for asset-allocation purposes,
the same as "cash" or a money market fund. It'll throw off
interest comparable (perhaps a touch higher) than money
market funds, and, as the name implies, the value is stable -
it has a duration of zero - rates go up, rates go down, the
value of your investment in it won't change - just the
interest rate.

Anyway, your whole "bond market" allocation could easily
be just the combination of that Leh Agg Index + the
stable value fund -- in whatever proportion you want
in order to adjust the duration down anywhere between
zero and the full dur of the agg.
 

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