Bond Warnings? Have a Diversification Plan and Ignore the Pundits! ALL OF THEM! I mean it.

Bond Warnings? Have a Diversification Plan and Ignore the Pundits! ALL OF THEM! I mean it.

As you know the stock and bond markets declined over the last two days, September 8 and 9th, 2016. My portfolio was hit hard losing about 1.3% by both stocks and bonds. I am back to a YTD return of 5% to 6%. This is an opportunity to illustrate how bonds work and the rationale for my decision to invest half of my portfolio in Vanguard’s Total Bond Market Index.

This short term loss these last two days (or during these high priced times) shouldn’t surprise us. The facts are that both stocks and bonds are pricey, and when they go down, THEY GO DOWN!  And interests rates have been low for several years. Sooner or later, they will start to increase. Another fact, stocks and bonds can both go down on the same trading day.

Vanguard Wellesley Income -1.2%
Vanguard Extended Market Index -2.91%
Vanguard Total International Bond Index -0.54%
Vanguard Total Stock Market ETF -2.49%
Vanguard Total International Stock Index  -2.05%
Vanguard Total Bond Market Index -0.45%

This past summer, the major stock market indexes reached record levels. Take a look at the price (value) of your bonds in your portfolio. The bond market prices have been high for a number of years now.

For example, I have the most money in this bond index, so I want to illustrate it:

 

  • Total Bond Market Index
    Fund Inception Date 11/12/2001
  • High: $11.25 07/25/2012
  • Low: $9.58 10/31/2008
  • Right now the fund price is $11.08, after yesterday’s close.
  • $11.08 price tag is not in record territory, but it is pricey.

 

My portfolio will go down when bonds go down because I have 70% of all my money in bonds. 50% of my total portfolio, roughly $800,000, is invested in the Total Bond Market Index. That’s why it moves the value of my portfolio up and down, depending on the bond markets mood regarding interests rates, and numerous other factors (North Korea’s nuclear missile test, employment predictions not as rosy as previously expected, BLAH, BLAH). Who cares? These factors are out of my control, that’s why I IGNORE THEM.

I especially find egregious that the brokers are now trying to get investors to purchase gold. Don’t fall for that either. This post will briefly explain why a balanced, fully diversified portfolio with the appropriate risk factors attributed for bonds will suffice over a stock and bond market crash. One thing that any diversified plan cannot address is your emotions. All good plans require your toughness to stick with it, no matter what.

Roughly calculating, my portfolio could lose up to 10% in a major bond crash, when interest rates finally go up significantly. But I am not worried. What is not reported anywhere is that my bond holdings are in intermediate maturities, which means that most of the bonds in the Total Bond Market Index will be traded out and new bonds reflecting the higher interest rates will replace them. Nothing wrong with the bond fund manager to purchase bonds that pay higher interest rates. Heck, don’t we all want the bond market to pay more? Of course, specially us retirees who want more bond return.

How a bond fund, such as the Total Bond Market Index, works

However, the process of selling mature bonds and replacing them with higher yield bonds will be 100% complete in about 6-7 years. In the meantime, my portfolio will decline from its current value. That’s why it is important to really think about this and hang on to your bonds when they decline in value. It takes a lot of nerve to stick with your plan through a full-blown crash (2008), bear market, or a simple correction like we experienced at the beginning of 2016. Because we get ZERO support to stay with our plan from the financial press, we have to be psychological tough. All successful investing requires that you have a plan that you understand, especially the risks, and live with your plan through thick or thin.

Bond risks increase as the maturities extend out for many years. Long-term bonds, maturities over 20 years, are the most sensitive to increases in interest rates. Short-term bonds (2-3 years) are the lease sensitive (and the least risky) to interest rate hikes. That’s why long-term bonds pay higher yields than short-term. But there is a middle ground. The Total Bond Market Index has intermediate maturities, about seven years, and the fund has three different types of bonds: GNMAs, Treasuries, and Corporate bonds. So, what is not to like. The risk is diversified out with three different types of bonds and the maturity is something I am comfortable with. Finally, the investment cost is a mere .06%.

Check out the Total Bond Market Index on Vanguard right here.

Like stocks, bonds will recover over time, and like stocks, when bond prices go down, it’s a buying opportunity.

I control everything I can with my decisions to:

  1. Have a simple diversification plan
  2. Stocks and bonds indices
  3. Low Costs
  4. 80% of my money in Vanguard and 20% in TIAA’s traditional annuity paying 3.0% currently (for a graph of my portfolio asset allocation at the end of 2016, click here)
  5. Learn to manage my money without an adviser
  6. Use past investing mistakes to fine tune all of the above
  7. Never blame others, never blame the market, always learn from experience whether positive or negative.

Steve’s bio:

Stephen A. Schullo, Ph.D. (UCLA ’96) taught in the Los Angeles Unified School District (LAUSD) for 24 years and UCLA Extension, retired in 2008. The first generation Italian-American, ex-Marine, Vietnam veteran wrote investment articles for United Teachers-Los Angeles’ union newspaper (circ. 40,000) for 11 years. A thrice-featured volunteer retirement plan advocate, twice in the Los Angeles Times and once in U.S. News and World Report. He has recently been on the national broadcast PBS Frontline: The Retirement Gamble. He started an investor self-help group with Sandy Keaton for LAUSD colleagues and wrote 6,500 posts in three investment forums since 1997. Frequently quoted and interviewed by the media, testified at state legislative hearings, and honored with the “Unsung Hero” by the 40,000 member Los Angeles teachers’ union for his retirement investing advocacy.

After eleven years, Steve still serves on LAUSD’s Investment Advisory Committee as Member-at-Large and former co-chair. The committee oversees 457(b)/403(b) plans for 55,000 former and current LAUSD employees, assets of $2.4 billion.

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