Archives for October 26, 2015

William Bernstein: Picking The Right Bonds For Your Portfolio

pie_flat_blank_200Author and investment advisor William Bernstein wrote a thoughtful WSJ piece on bonds, which I think is useful for the DIY investor. The overall theme is that you should take minimal risks with the bonds in your portfolio. Taken in isolation, some types of bonds are likely to provide higher long-term returns than others. However, you should consider how they fit into your entire portfolio. Historically, it has been more efficient to take your risk with stocks and use your bonds for their stability. Bonds become the “dry powder” you can use to buy more stocks after a crash (rebalance!).

I found myself breaking down the article into three main categories. The types of bonds he recommends most, the ones he considers acceptable, and the rest which should be avoided. These are my short notes; read the article for the supporting arguments.

PREFER

  • Individual US Treasury bonds, manually laddered.
  • US Treasury bond mutual funds, for smaller balances.
  • Top-yielding FDIC-Insured Certificates of Deposit, manually laddered.
  • Short-term or intermediate-term, higher-quality municipal-bond funds, for large taxable balances.

OKAY

  • “Total bond index” mutual funds, as they consist mainly of high-grade, government-backed bonds.
  • US Treasury bond mutual funds for larger balances.

AVOID

  • All corporate bonds, but especially avoid lower-grade and/or longer-term corporate bonds.
  • Lower-grade and/or longer-term municipal bonds.

I would point out that inflation-protected bonds (TIPs) are not mentioned directly, I guess because they aren’t directly comparable to these nominal bonds. Either that, or he just considered them to be the same as traditional Treasuries. He talks about TIPs a lot elsewhere (including his books), so a little specific advice would have been helpful.

My other opinion is that running your own bond ladder is quite doable but only the most DIY of DIY investors would do it better than a low-cost bond fund. I own individual TIPS and it’s not hard but not a ton of fun either to keep track of auction dates and avoid cash drag. Vanguard charges only 0.12% annually for their short-term government bond ETF (VGSH) and Admiral fund equivalent. $12 a year per $10,000. $120 a year for $100,000. I’d rather just pay that unless I had millions or I had a lot more free time. However, if you’re already paying a financial advisor, I would let them manage an individual bond ladder as part of their fee.

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