Help me understand inflation/my portfolio of bonds

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Topic Author
the journey
Posts: 16
Joined: Fri Feb 02, 2018 8:03 pm

Help me understand inflation/my portfolio of bonds

Post by the journey »

Hello all,

I wanted to access the collective wisdom of the group.

My specific question is related to inflation and the bond allocation of my portfolio. What do I need to consider when higher inflation places pressure on my bond portfolio? I do understand how inflation affects bonds and also have read how to hedge against this with TIPS/REITS, etc.

I feel as though I have a gap in knowledge when I comes to managing my bond assets. My investor policy statement has me at 20% and I don't plan on changing that but am more concerned about the nuances or lack thereof. I feel unsure in regards to my specific plan and feel I am lacking direction.

I realize bonds are more about buoying a portfolio and less about returns but I want to be well educated and optimize this area of my portfolio as much as possible.

I'll just list out some details below to help with the overall picture.

Age: 43

Planned retirement age: ~60

Marginal rate: 37%

Asset allocation:

80% Equity (of this 30% international and 10% REITS, value and small tilt of 10%) and 20% Bonds

All bonds are in tax deferred vehicles except the muni fund with VG. Within my Fidelity 401k I have a fairly robust options with access to other bonds that vary from short term to long term options.

Bond Allocation at present:

22.3% (Baird Core Plus BCCIX) - best option in vehicle, 53.3% (Fidelity US Bond Index FXNAX) - 401k, 18.4% (VG High Yield VWAHX) - Taxable, 5.9% (PIMCO Real Return Instl PRRIX) - 401k



1. So, my specific question is focused on the bond portfolio and more specifically the strategy in regards to diversification and hedging against rising inflation. What bond fund classes should I seek out or adjust? I do want to stick with my IPS with equity composition/allocation and bond allocation. I just feel I need a more defined direction with what bond fund classes I have in my bond portfolio. I have never addressed my bond composition in my IPS aside from a percentage.
grok87
Posts: 10512
Joined: Tue Feb 27, 2007 8:00 pm

Re: Help me understand inflation/my portfolio of bonds

Post by grok87 »

the journey wrote: Sun May 09, 2021 9:31 am Hello all,

I wanted to access the collective wisdom of the group.

My specific question is related to inflation and the bond allocation of my portfolio. What do I need to consider when higher inflation places pressure on my bond portfolio? I do understand how inflation affects bonds and also have read how to hedge against this with TIPS/REITS, etc.

I feel as though I have a gap in knowledge when I comes to managing my bond assets. My investor policy statement has me at 20% and I don't plan on changing that but am more concerned about the nuances or lack thereof. I feel unsure in regards to my specific plan and feel I am lacking direction.

I realize bonds are more about buoying a portfolio and less about returns but I want to be well educated and optimize this area of my portfolio as much as possible.

I'll just list out some details below to help with the overall picture.

Age: 43

Planned retirement age: ~60

Marginal rate: 37%

Asset allocation:

80% Equity (of this 30% international and 10% REITS, value and small tilt of 10%) and 20% Bonds

All bonds are in tax deferred vehicles except the muni fund with VG. Within my Fidelity 401k I have a fairly robust options with access to other bonds that vary from short term to long term options.

Bond Allocation at present:

22.3% (Baird Core Plus BCCIX) - best option in vehicle, 53.3% (Fidelity US Bond Index FXNAX) - 401k, 18.4% (VG High Yield VWAHX) - Taxable, 5.9% (PIMCO Real Return Instl PRRIX) - 401k



1. So, my specific question is focused on the bond portfolio and more specifically the strategy in regards to diversification and hedging against rising inflation. What bond fund classes should I seek out or adjust? I do want to stick with my IPS with equity composition/allocation and bond allocation. I just feel I need a more defined direction with what bond fund classes I have in my bond portfolio. I have never addressed my bond composition in my IPS aside from a percentage.
David Swensen (RIP) recommends half treasuries and half tips. have you thought about ibonds?
RIP Mr. Bogle.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: Help me understand inflation/my portfolio of bonds

Post by dbr »

If you are worried about inflation and bonds then invest your bond allocation in TIPS. 20% of your portfolio in TIPS is a good choice. Note that this does not diversify bond choices but rather concentrates your holding for the specific purpose of addressing inflation risk to your fixed income. You do not incur extra default risk because Treasuries have very low (no) default risk. Duration risk can be adjusted between short, intermediate, and long funds. A theoretical argument would suggest that long Treasuries are a good diversifier for high stock portfolios but I doubt most people are comfortable with long bond risk on its own and would rather use shorter bonds to dilute portfolio risk. If your bond allocation were more substantial then a mix of nominal Treasuries and TIPS might be a possibility.

It is not necessary to be worried about inflation affecting bonds in a stock heavy portfolio. Note TIPS are adjusted for inflation but the existence of TIPS is not a hedge for effects of inflation on other assets.
Topic Author
the journey
Posts: 16
Joined: Fri Feb 02, 2018 8:03 pm

Re: Help me understand inflation/my portfolio of bonds

Post by the journey »

grok87 wrote: Sun May 09, 2021 11:40 am
the journey wrote: Sun May 09, 2021 9:31 am Hello all,

I wanted to access the collective wisdom of the group.

My specific question is related to inflation and the bond allocation of my portfolio. What do I need to consider when higher inflation places pressure on my bond portfolio? I do understand how inflation affects bonds and also have read how to hedge against this with TIPS/REITS, etc.

I feel as though I have a gap in knowledge when I comes to managing my bond assets. My investor policy statement has me at 20% and I don't plan on changing that but am more concerned about the nuances or lack thereof. I feel unsure in regards to my specific plan and feel I am lacking direction.

I realize bonds are more about buoying a portfolio and less about returns but I want to be well educated and optimize this area of my portfolio as much as possible.

I'll just list out some details below to help with the overall picture.

Age: 43

Planned retirement age: ~60

Marginal rate: 37%

Asset allocation:

80% Equity (of this 30% international and 10% REITS, value and small tilt of 10%) and 20% Bonds

All bonds are in tax deferred vehicles except the muni fund with VG. Within my Fidelity 401k I have a fairly robust options with access to other bonds that vary from short term to long term options.

Bond Allocation at present:

22.3% (Baird Core Plus BCCIX) - best option in vehicle, 53.3% (Fidelity US Bond Index FXNAX) - 401k, 18.4% (VG High Yield VWAHX) - Taxable, 5.9% (PIMCO Real Return Instl PRRIX) - 401k



1. So, my specific question is focused on the bond portfolio and more specifically the strategy in regards to diversification and hedging against rising inflation. What bond fund classes should I seek out or adjust? I do want to stick with my IPS with equity composition/allocation and bond allocation. I just feel I need a more defined direction with what bond fund classes I have in my bond portfolio. I have never addressed my bond composition in my IPS aside from a percentage.
David Swensen (RIP) recommends half treasuries and half tips. have you thought about ibonds?

Thank you for the responses. I took time to review David Swensen's recommendations in regards to TIPS and treasuries. This was actually very helpful to get some direction on percentages to consider with the TIPS allocation. I guess I could just execute a trade within my 401k and devote some treasuries toward TIPS to approximate the percentage I determine is best for my situation.

In regards to the I bonds, that is something I have not considered but seems to be a good option. Only downside seems to be the ceiling of 10k per SSN (not considering 5k possible from tax return). Otherwise it offers tax deferral in a taxable account and a variable inflation rate adjustment.
grok87
Posts: 10512
Joined: Tue Feb 27, 2007 8:00 pm

Re: Help me understand inflation/my portfolio of bonds

Post by grok87 »

the journey wrote: Sun May 09, 2021 3:58 pm
grok87 wrote: Sun May 09, 2021 11:40 am
the journey wrote: Sun May 09, 2021 9:31 am Hello all,

I wanted to access the collective wisdom of the group.

My specific question is related to inflation and the bond allocation of my portfolio. What do I need to consider when higher inflation places pressure on my bond portfolio? I do understand how inflation affects bonds and also have read how to hedge against this with TIPS/REITS, etc.

I feel as though I have a gap in knowledge when I comes to managing my bond assets. My investor policy statement has me at 20% and I don't plan on changing that but am more concerned about the nuances or lack thereof. I feel unsure in regards to my specific plan and feel I am lacking direction.

I realize bonds are more about buoying a portfolio and less about returns but I want to be well educated and optimize this area of my portfolio as much as possible.

I'll just list out some details below to help with the overall picture.

Age: 43

Planned retirement age: ~60

Marginal rate: 37%

Asset allocation:

80% Equity (of this 30% international and 10% REITS, value and small tilt of 10%) and 20% Bonds

All bonds are in tax deferred vehicles except the muni fund with VG. Within my Fidelity 401k I have a fairly robust options with access to other bonds that vary from short term to long term options.

Bond Allocation at present:

22.3% (Baird Core Plus BCCIX) - best option in vehicle, 53.3% (Fidelity US Bond Index FXNAX) - 401k, 18.4% (VG High Yield VWAHX) - Taxable, 5.9% (PIMCO Real Return Instl PRRIX) - 401k



1. So, my specific question is focused on the bond portfolio and more specifically the strategy in regards to diversification and hedging against rising inflation. What bond fund classes should I seek out or adjust? I do want to stick with my IPS with equity composition/allocation and bond allocation. I just feel I need a more defined direction with what bond fund classes I have in my bond portfolio. I have never addressed my bond composition in my IPS aside from a percentage.
David Swensen (RIP) recommends half treasuries and half tips. have you thought about ibonds?

Thank you for the responses. I took time to review David Swensen's recommendations in regards to TIPS and treasuries. This was actually very helpful to get some direction on percentages to consider with the TIPS allocation. I guess I could just execute a trade within my 401k and devote some treasuries toward TIPS to approximate the percentage I determine is best for my situation.

In regards to the I bonds, that is something I have not considered but seems to be a good option. Only downside seems to be the ceiling of 10k per SSN (not considering 5k possible from tax return). Otherwise it offers tax deferral in a taxable account and a variable inflation rate adjustment.
the other downside about ibonds is that you have to maintain a separate account or accounts at treasury direct. so there is the question as to whether it is worth the effort for the $10k per person per year that you can save. for me the answer is yes, especially in this low interest rate environment.
cheers,
grok
RIP Mr. Bogle.
Topic Author
the journey
Posts: 16
Joined: Fri Feb 02, 2018 8:03 pm

Re: Help me understand inflation/my portfolio of bonds

Post by the journey »

dbr wrote: Sun May 09, 2021 1:44 pm If you are worried about inflation and bonds then invest your bond allocation in TIPS. 20% of your portfolio in TIPS is a good choice. Note that this does not diversify bond choices but rather concentrates your holding for the specific purpose of addressing inflation risk to your fixed income. You do not incur extra default risk because Treasuries have very low (no) default risk. Duration risk can be adjusted between short, intermediate, and long funds. A theoretical argument would suggest that long Treasuries are a good diversifier for high stock portfolios but I doubt most people are comfortable with long bond risk on its own and would rather use shorter bonds to dilute portfolio risk. If your bond allocation were more substantial then a mix of nominal Treasuries and TIPS might be a possibility.

It is not necessary to be worried about inflation affecting bonds in a stock heavy portfolio. Note TIPS are adjusted for inflation but the existence of TIPS is not a hedge for effects of inflation on other assets.


I guess the driving factor for my discussion is a concern that inflation and/or elevated rates in the near future may drive muted bond returns for a period. I do understand that it is impossible to predict the future, but given my present lack of complexity/strategy in my bond allocation, this gives me an opportunity to learn more and make an educated allocation.

Also, I is quite possible that I am overthinking this as I do have a equity heavy portfolio. I feel firm in my percentage of portfolio allocation to bonds and maybe a bit more involvement of inflation protected funds may provide me better comfort. Also, I could mix in some shorter duration bonds as well.

Or, maybe it's best for me to do nothing.


I have also read that true high yield bonds do provide some protection specifically against inflation within bonds. I realize that would insert a equity like risk into my bond allocation as well. Thoughts on that? Not really inclined to go this route but just wondering others thoughts. I do have the VG high yield muni fund but I understands this to not truly be a high yield bond product.
dbr
Posts: 46181
Joined: Sun Mar 04, 2007 8:50 am

Re: Help me understand inflation/my portfolio of bonds

Post by dbr »

the journey wrote: Sun May 09, 2021 4:17 pm
dbr wrote: Sun May 09, 2021 1:44 pm If you are worried about inflation and bonds then invest your bond allocation in TIPS. 20% of your portfolio in TIPS is a good choice. Note that this does not diversify bond choices but rather concentrates your holding for the specific purpose of addressing inflation risk to your fixed income. You do not incur extra default risk because Treasuries have very low (no) default risk. Duration risk can be adjusted between short, intermediate, and long funds. A theoretical argument would suggest that long Treasuries are a good diversifier for high stock portfolios but I doubt most people are comfortable with long bond risk on its own and would rather use shorter bonds to dilute portfolio risk. If your bond allocation were more substantial then a mix of nominal Treasuries and TIPS might be a possibility.

It is not necessary to be worried about inflation affecting bonds in a stock heavy portfolio. Note TIPS are adjusted for inflation but the existence of TIPS is not a hedge for effects of inflation on other assets.


I guess the driving factor for my discussion is a concern that inflation and/or elevated rates in the near future may drive muted bond returns for a period. I do understand that it is impossible to predict the future, but given my present lack of complexity/strategy in my bond allocation, this gives me an opportunity to learn more and make an educated allocation.

Also, I is quite possible that I am overthinking this as I do have a equity heavy portfolio. I feel firm in my percentage of portfolio allocation to bonds and maybe a bit more involvement of inflation protected funds may provide me better comfort. Also, I could mix in some shorter duration bonds as well.

Or, maybe it's best for me to do nothing.


I have also read that true high yield bonds do provide some protection specifically against inflation within bonds. I realize that would insert a equity like risk into my bond allocation as well. Thoughts on that? Not really inclined to go this route but just wondering others thoughts. I do have the VG high yield muni fund but I understands this to not truly be a high yield bond product.
I think you are worrying about a non-problem. If you are really concerned about bonds the concern should be that rates do not go up and we are condemned to low bond returns forever. Long term investors don't need to be concerned about the transitional loss of bond value as rates go up. After time we will be better off. If one just wants to avoid this, then one can invest in cash, or for an inflation indexed short bond, in short TIPS. I bonds are also an option. Think about how unreasonable it is to hold all that risk in stocks but worry that bonds may drop a little in value. If a current investor wants to worry about something the choice would probably be about when the current stock bull market is going to stop and we get a significant market decline. I am very happy hitting rebalance bands and selling stocks and buying bonds.
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