Holding Corporate Bonds to Maturity to juice Cash Returns

[Greg]

What do people think for a younger 1NV35T0R with a long time horizon to make their cash-section a little more risky. I was thinking perhaps of purchasing short term (<5 year to maturity) for corporate bonds and holding them to maturity. You could then create a corporate bond ladder for maturities as well. Any thoughts on this?

[craigr]

IF you wanted to do this, I would definitely be using an index fund that held a very large selection of corporate bonds to diversify your risk. I would not want to select my own bonds to do this.

With that said, I'd still want to have a year of living expense set aside in very safe T-Bills as part of my cash just in case of job loss, emergencies, etc.

But this isn't an endorsement as I like my cash very safe in T-Bills. Yet I know the siren call of yield is powerful. But at the same time recognize that chasing yield has its own risks.

[Pointedstick]

The risk doesn't seem to justify the reward for me, personally. Most > 5 year AAA corporate bonds are still returning under 1%; less than CDs. AA and below will give you more than 1% for sure... but do you want to risk it?

[Ad Orientem]

This sounds like a VP thing. Same rule as always. If you can afford to take risks with it and are so inclined put it in a VP. If you don't want to take risks then put it in the PP. Tinkering with the PP just makes the whole thing one big VP.

[Greg]

Thanks for the replies everyone. This probably should be in the VP section and I already have over a year of expenses in cash (I try to take after many of the ERE principles). I was looking at some Goldman Sachs that were maturing in 2019 at around 2.9% I believe and how could Goldman ever go to poop? 

The question also comes to how likely is it that the individual bond will default. I know there are tables for this, but you could potentially cross your fingers and chase for that luscious yield...mmm...

[Ad Orientem]

The question also comes to how likely is it that the individual bond will default. I know there are tables for this, but you could potentially cross your fingers and chase for that luscious yield...mmm...

If I were inclined to risk money on a speculation, which is what owning individual securities of any kind other than treasuries is, I think I would look for something where I had a chance to hit a home run or maybe even a grand slam. But that's just me.

And no, I don't have a VP right now.

[AdamA]

What do people think for a younger 1NV35T0R with a long time horizon to make their cash-section a little more risky. I was thinking perhaps of purchasing short term (<5 year to maturity) for corporate bonds and holding them to maturity. You could then create a corporate bond ladder for maturities as well. Any thoughts on this?

You could also use 10 year treasury notes to get a little bit of yield.  In other words, you might keep 1/2 of your cash in T-bills and the other half in 10 year notes (as long as you have enough in T-bills to use in an emergency situation).

Of course, this would make your cash holdings a bit more volatile due to interest rate risk.

[KevinW]

I'll add that IMO adding a VP with a higher risk/reward profile than the PP is a better way of "juicing returns" than tampering with the PP components. The four PP assets are chosen deliberately based on the interplay between stocks, long term bonds, gold, and T-bills. Instead of

25% total stock market
25% long term Treasuries
25% gold
25% short term corporate bonds

I would advocate something like

90% - orthodox PP
10% -VP - total world stock index or small cap value index

[MachineGhost]

What do people think for a younger 1NV35T0R with a long time horizon to make their cash-section a little more risky. I was thinking perhaps of purchasing short term (<5 year to maturity) for corporate bonds and holding them to maturity. You could then create a corporate bond ladder for maturities as well. Any thoughts on this?

There's a couple of threads where this was brought up before, search for 'em.  But my two cents is what you think is the wrong way to look at corporate bonds, irregardless of the grade.  They are a Prosperity kicker not Tight Money and right now yields are so low for the risk, they are simply not worth doing unless you have the skill or advisor to pick out individual bonds as they become available and have enough capital to adequately diversify.  The default rate went up to about 15% with about a 50% loss after recovery during the 2008-2009 crisis so adequate diversification by sector is prudent.  The problem is you'll be lucky to find several bonds paying a yield commensurate with the risk right now, so you'll still be mostly in cash allocated to it.    Corporate bond funds are a waste of time because they are so diluted, the yield is not worth the perpetual duration with no guarantee of your principal getting back by a specific date.  However, I like the BulletShares ETF's even if the yields are a bit low.

[Ad Orientem]

I have to agree with MG. The US corporate bond market right now is about as unattractive in terms of risk reward as I can ever remember. If you want to speculate in bonds I would look outside the US. But that of course also involves currency risk (and if your lucky maybe reward). I don't have a VP, but if I were inclined to do one I would probably look outside the US. Maybe 10% in VEU or a cheap foreign bond fund. TGBAX has had a remarkably good track record for a long time and with a .60% ER it's not horribly expensive by active fund standards. The main drawback is that they have a really steep minimum investment.

But I just watched that Frontline show that I linked in the other forum about the retirement crisis. That was one of the most depressing and infuriating things I have seen on TV in a long time. And it has reinforced my already deeply conservative instincts.

[MachineGhost]

The five years that came to a close at the end of March will go down in financial history — and it was an extraordinary period for the group of bonds variously known as high yield, low grade, or junk.

http://rp-pix.com/oj

[notsheigetz]

I have to agree with MG. The US corporate bond market right now is about as unattractive in terms of risk reward as I can ever remember. If you want to speculate in bonds I would look outside the US.

Vanguard Wellesley invests 65% in investment grade corporate bonds and the other 35% in dividend paying stocks - and returned 10.5 percent over the past three years.

I just rolled a Roth IRA out of my PP and into this fund and will call it my Variable Portfolio. Based on the subject of this thread can someone tell me that this was a bad decision.

[Ad Orientem]

I have to agree with MG. The US corporate bond market right now is about as unattractive in terms of risk reward as I can ever remember. If you want to speculate in bonds I would look outside the US.

Vanguard Wellesley invests 65% in investment grade corporate bonds and the other 35% in dividend paying stocks - and returned 10.5 percent over the past three years.

I just rolled a Roth IRA out of my PP and into this fund and will call it my Variable Portfolio. Based on the subject of this thread can someone tell me that this was a bad decision.

I don't really consider VWINX to be speculative. It's very conservative and it holds stocks. That said if/when interest rates and or inflation start to rise it could take a nasty hit. But for a 401K if that's an available choice I would be fine with it.

[notsheigetz]

I don't really consider VWINX to be speculative. It's very conservative and it holds stocks. That said if/when interest rates and or inflation start to rise it could take a nasty hit. But for a 401K if that's an available choice I would be fine with it.

I don't consider it speculative either, actually. When I was doing the research that led me to the PP, it was actually my second choice.

I'm not investing in it because of a 401k restriction. It's a personal Roth IRA where I can do anything I want.

My point was if Corporate Bonds are as bad as most of this thread seems to think why do they do so well - and have for 40 years?

[MachineGhost]

My point was if Corporate Bonds are as bad as most of this thread seems to think why do they do so well - and have for 40 years?

You need to distinguish between investment grade which is a general waste of time on a net basis and high yield which goes in and out of extreme [over/under]valuations.  As well as holding individual bonds vs a bond fund.  A bond fund is riskier because it has a perpetual duration.  There's no way to guarantee your principal for reinvestment purposes.  Say you wanted to minimimze your exposure to raising interest rates, then you would want to have a 5-7 year corporate bond ladder not a bond fund.  The catch is you probably need more than 5-7 individual bonds for adequate diversification unless you were stick to triple AAA or other investment grade yields that don't really compensate you for the risk.  In other words, look at the BulletShares ETF's and imagine that the yields were higher such as back in 2008-2009 and you had a ladder of them out to 7 years.  Perfecto!  Even now its hard to see what is wrong with the BulletShares 2013 fund because the yield still seems high compared to everything else and the duration is mega-ultra-short.  The problem is these funds have to continually be generated each year so that implies they will buy above par to get the maturity needed, i.e. its not value weighted as opposed to doing it yourself.  So this will drag down the return.  I believe double digits is the minimum yield to maturity anyone should accept for the risk of high yield bonds.  But for getting such wide diversification, BulletShares might be acceptable at cost of lower yield.  In the corporate bond market, you cannot wait for bonds to come to your valuation target as with stocks because it is very dynamic and what is offered changes day to day.  You never know what will pop up and you have to act immediately because of the general lack of liquidity.  It may be hard to stay fully invested without using a fund.

But also we've been in a disinflationary bond bull for 30 of those years.  Look at the performance of bonds between 1940 and 1980 before you make up your mind.  It won't look so hot nor be so "conservative" because to get higher returns with investment grade, bond funds have to go to longer and longer durations which then becomes a triple or quadruple whammy under rising inflation.  Mom and Pop apparantely don't understand this risk and will get massacred.

[MachineGhost]

Wow, the situation is worse than I thought.  Last night I calculated the yield to maturity for the high yield BulletShares ETFs and they come out as thus:

BulletShares 2013 High Yield 1.90%
BulletShares 2014 High Yield 2.75%
BulletShares 2015 High Yield 4.00%
BulletShares 2016 High Yield 4.63%
BulletShares 2017 High Yield 4.79%
BulletShares 2018 High Yield 5.68%

There are some individual bonds I'm interested in.  Provided they are still available at the right prices, I'll report back.

[MachineGhost]

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[notsheigetz]

I already rolled over my Roth Ira to VWINX and will also do my wife's if I'm satisfied with the new Vanguard account. Should amount to about 7% of our current portfolio with the rest 100% PP.

Bottom line is I am looking for a little juice in the PP or a hedge against prosperity if you will - as I think MT and Craig admitted in the book that the PP doesn't do as well in times of prosperity.

I figure 2008 set my retirement date back about two years (I'm 64) and now this is about as conservative a play as I'm ready for at this time so I will call it my VP.

My point was if Corporate Bonds are as bad as most of this thread seems to think why do they do so well - and have for 40 years?

You need to distinguish between investment grade which is a general waste of time on a net basis and high yield which goes in and out of extreme [over/under]valuations.  As well as holding individual bonds vs a bond fund.  A bond fund is riskier because it has a perpetual duration.  There's no way to guarantee your principal for reinvestment purposes.  Say you wanted to minimimze your exposure to raising interest rates, then you would want to have a 5-7 year corporate bond ladder not a bond fund.  The catch is you probably need more than 5-7 individual bonds for adequate diversification unless you were stick to triple AAA or other investment grade yields that don't really compensate you for the risk.  In other words, look at the BulletShares ETF's and imagine that the yields were higher such as back in 2008-2009 and you had a ladder of them out to 7 years.  Perfecto!  Even now its hard to see what is wrong with the BulletShares 2013 fund because the yield still seems high compared to everything else and the duration is mega-ultra-short.  The problem is these funds have to continually be generated each year so that implies they will buy above par to get the maturity needed, i.e. its not value weighted as opposed to doing it yourself.  So this will drag down the return.  I believe double digits is the minimum yield to maturity anyone should accept for the risk of high yield bonds.  But for getting such wide diversification, BulletShares might be acceptable at cost of lower yield.  In the corporate bond market, you cannot wait for bonds to come to your valuation target as with stocks because it is very dynamic and what is offered changes day to day.  You never know what will pop up and you have to act immediately because of the general lack of liquidity.  It may be hard to stay fully invested without using a fund.

But also we've been in a disinflationary bond bull for 30 of those years.  Look at the performance of bonds between 1940 and 1980 before you make up your mind.  It won't look so hot nor be so "conservative" because to get higher returns with investment grade, bond funds have to go to longer and longer durations which then becomes a triple or quadruple whammy under rising inflation.  Mom and Pop apparantely don't understand this risk and will get massacred.