Why Do I Own No Bonds In My Portfolio?

Someone recently asked me why I don't own any bonds in my portfolio.

It’s a great question, here is my current justification:

I am not convinced bond funds are a great investment. After all, the reason to invest in bonds is you are purchasing a series of future cash flows (even in the case of a zero-coupon bond, its just all paid at once) that are usually predefined; or bonds can act as a "stabilizer" for stock market volatility. Bond funds, may offer diversification, but I don't see the benefits I would be looking for.
My cash balance pension earns a return that is indexed to 1 yr treasury yields so in effect a sizable portion of my portfolio is already invested in government treasury bills.
Both I and my family still hold savings bonds in my name (my family holds a few savings bonds that will eventually be given to me as gifts).
I haven't figured out how to inexpensively purchase corporate bonds. Corporate bonds have some appeal to me, but I haven't found a vehicle to cost effectively purchase and hold bonds in. When I do, Im ready to take a closer look at some bond investing. Perhaps a bond ETF?

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Comments (19)

Have you ever looked at the 'Efficient Frontier' school of thought on portfolio allocation? I forget the exact name of the book, but it's something along those lines and the dude also has a mediocre website up.

Anyways, histocially, adding bonds to your portfolio appears to decrease risk while increasing return. I thought Vanguard or Fielity had some Bond ETF's or maybe they're index funds, but not sure on that.

Posted by Herb | December 1, 2006 1:56 PM

I agree with 2mil on this one. Bonds have virtually no appeal to me. For one, the prices right now are ridiculously high; the 10 yr Treasury is back down to about 4.5%, and there has been a compression of yields; junk debt isn't yielding nearly as much as it used to compared to risk-free assets. While diversifying into bonds would reduce the volatility of one's portfolio, I'm not sure how it would overall increase returns. If stocks historically produce a total return of ~ 11% and bonds return a total of 7%, I don't see how converting from an expected 11% return asset class into a 7% class increases returns.

Interestingly, I've noted recently that the popular financial press is recommending taking 120 minus your age to determine the stock/bond allocation. Not long ago the metric was 100 minus one's age. So for 2mil and many of the rest of us, bonds shouldn't make up much of our portfolio anyway.

Posted by CPA1298 | December 1, 2006 2:39 PM

Corporate bonds are the ones that interest me, they're more likely to give you a good return on your money. My fiance just covered these in her accounting class. The only problem with these is the fact that their expensive.

Posted by Matt | December 1, 2006 2:56 PM

Hello 2mil, I am also a young engineer in NC. I started reading your blog a few weeks ago and would like to comment.

I recently decided to allocate 10% of my portfolio to bonds in effort to improve diversification. After looking at a few backwards simulations on the diehards board, I saw that there were times in the past that bonds outperformed stocks for a very long period of time (20+ years). While I hope that doesn't happen (I have a 90% stock allocation) and it was rare (

Keep up the good work!

Anton

Posted by Anton | December 1, 2006 5:21 PM

I'm new to investments. I'm interested in doing a Roth. What company(finacial advisors) do you think would work well for investments?

Posted by Hustlermoneyblog.com | December 1, 2006 11:14 PM

Agree with Herb on this one. It's all about decreasing risk. Also, with the rising market we've had over the past 3+ years, it's hard to see the benefit, but when we turn the corner on the market and we start moving sideways to down, you'll be happy you have a bond component to your portfolio. I use the TIP ETF for my bond exposure.

RetiringEarly.com

Posted by fin_indie | December 2, 2006 12:43 PM

So how does everyone invest in bonds? Through a bond mutual fund? Conceptually I could see how a bond ETF could provide the benefits often discussed from of holding bonds, but I don't see how a bond mutual fund can provide those same benefits (I guess there would be a slight level of those benefits, but the churn of the fund I think destroys a chunk of the benefits). My 401(k) only overs a bond mutual fund.

Posted by 2 million | December 2, 2006 1:31 PM

Hustler, I feel confident recommending to anyone just starting to make investments in opening a Vanguard and investing in a broad market index fund or ETF. Low cost, broad exposure, in general, a good way to starting saving for retirement.

Posted by 2 million | December 2, 2006 1:34 PM

Ah, I should have mentioned that I also hold municipal bonds in the form of BSD, a closed-end fund. This fund has been incredibly good to me, both in dividends, as well as price appreciation -- somewhere north of 15% in the last year.

RetiringEarly.com

Posted by fin_indie | December 3, 2006 9:01 AM

2million asked: "So how does everyone invest in bonds?"

1. PTTDX
2. PRPFX
3. PPIAX
4. GLRBX
5. FAX

Posted by Larry Nusbaum | December 3, 2006 7:02 PM

BSD is a great way to get bond exposure, and they seem to pay modest dividend which keeps the portfolio stable.

I'm not big in to bonds, and really don't own any more than about 5% in my portfolio, but I also think they're a safe way to start out in the investment world.

Good discussion!

-Grant

Posted by Grant | December 3, 2006 10:29 PM

All these holding vehicles provided above are bond funds (thank you Larry and Grant for you comments). Thats my problem I guess - most people invest in bonds through funds and I am not convinced thats a good investment. Call me grazy

I am assuming these are all open-ended funds?

Posted by 2 million | December 4, 2006 8:55 AM

I clicked on one of the "featured links" on the left hand side of your webpage. It brought me to a payday loan website that offered loans with this in small print "* Finance charges are calculated on the basis of $15 per $100 borrowed for each 14 day period, which is equivalent to an APR of 391.07%."

Great service you provide for your readers.

Posted by Mike | December 4, 2006 10:02 AM

Thats a good point - I should point out that I haven't reviewed the Featured Links/Sites - that is mostly paid advertising.
I should probably but some sort of disclaimer there. All other links are stuff I personally use/recommend.

Posted by 2 million | December 4, 2006 10:46 AM

You might want to try investing in US Government Treasury bonds via www.treasurydirect.gov. I think this is the most user-friendly way to invest directly in fixed income instruments, and as a bonus your interest earnings may be free from state and local taxes. Of course the yields are going to be less than you would get from corporates, but the government has rock-solid credit so you don't have to worry about default.

Posted by MoneyMan | December 4, 2006 9:43 PM

The reason to own bonds is for low volatility and low correlation to the stock market. Corporate bonds have higher yields, but are very well correlated to the stock market. If you want to take on company risk, stocks provide a better return for the risk.

It's actually been shown that a 90/10 stock/bond mix has outperformed a 100/0 mix.

My bonds are held in the form of the Pimco Total Return fund in my 401k. When I get older, I will add TIPS, most likely to my IRA. 2mil, you may find Tips to be to your liking.

Posted by Zack | December 7, 2006 5:25 PM

I once was a 100% equities person. My perspective has changed greatly - not because I'm older, but because of research and my changed understanding of diversification.
I think Zack has the issue right on the head.
In order to ensure you buy low and sell high, you want to have target % allocated to various minimally correlated asset classes. Then rebalance periodicly - usually quarterly or annually. When you rebalance you sell high and buy low (the underperforming asset classes).
Bonds, Reits, domestic large cap, small caps have fairly low correlation. I've been reading that large cap foreign investments are increasingly correlated with US large cap, but I still think there's some non-correlation. Finally there's foreign emerging. Bonds play a very important role in the diversification process. It's not so much that bonds will out perform equities but the fact that they act (often) as a battery for potential; stocks perform well, you sell off at the high and rebalance into bonds. several quarters later the cycle reverses itself. stocks perform poorly, bonds are stable. when you rebalance you'll now be buying stocks at the cheap. This is the rebalancing benefit that disciplined investors achieve. It actually gives them a turbo-boost above their chosen index's performance.
So the issue isn't so much that equities have a higher average performance - everything moves up and down - it's that you can mitigate the downs your equities suffer and buy back in on the cheap by using your bonds as a reserve. As a matter of fact, the greater the volatility - the more likely bonds are to help.
Regards,
makingourway

Posted by makingourway | December 9, 2006 11:58 PM

For corporate bonds, the easiest way to invest is through the Corporate Notes/Smartnotes program which certain companies and quasi government agencies such as Fannie Mae or Freddie Mac use to issue new corporate offerings. There are no transaction fees for purchasing, so if you buy a note and hold it until maturity, then there are no transaction fees whatsoever. I checked the list of available offerings through Scottrade, and almost all of them had yields of 5-6% (these are all investment grade securities). Occaisionally, there are some formerly investment grade bonds which get reclassified as junk bonds, such as GMAC Credit or Ford Motor Credit, and the yields are much higher, 8% or more. I haven't seen these offerings for awhile, though.

Posted by paul | December 10, 2006 12:18 PM

GLRBX, James Golden Rainbow.
A smooth ride, good returns. Just do it.
Gotta love the name, too.

Posted by SteveO | January 12, 2008 12:19 PM