Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
jdamo
Posts: 209
Joined: Tue Apr 30, 2019 8:47 pm

Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by jdamo »

With all the talk about inflation coming and now the FED saying they will meet next week to discuss accelerating their response to recent inflation increases, I am considering changing some of my fixed income portion of our portfolio from VBTLX (Vanguard Total Bond Index Fund) vs VFICX (Vanguard Intermediate Term Investment Grade Bond Index. Shorter duration by about a year or so and better short term return recently, and long term return also. Would VFICX do better in a higher inflation environment?

The Vanguard data pages show about a 0.9% increase in CAGR and the portfolio analyzer shows about the same in about all time frames. Short term was about 0.6% better as I recall.

I know not to market time but it seems maybe a shift in this and my Investment Policy Statement may be a good idea. Maybe I am too conservative right now? Or am I listening to too much noise and stay with VBTLX since it is the largest and most diversified bond index on the planet?

We are retired for 2 yrs now with over 3-4 yrs cash reserve also. Total portfolio is ~ 26-29X annual withdrawal rate. Overall about 40% stocks/60% bond allocation.
Thoughts on changes from VBTLX to VFICX for say 20-30% of fixed income portion?
pasadena
Posts: 2337
Joined: Sat Jul 02, 2016 1:23 am
Location: PNW

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by pasadena »

I can't answer your question, as my technical understanding of bonds is not good enough (understatement), but there's still a significant difference between those two funds. Higher performance does come at the cost of a higher risk.

VFICX (and VFIDX) is mostly corporate bonds (with few of them highly rated, although I'm not sure how many corporate bonds can be rated AAA). VBTLX is mostly US government bonds. This means more credit risk for VFICX/VFIDX.

Code: Select all

Credit Quality   VFIDX    VBTLX
U.S. Government  8.10%   64.80%
AAA              4.10%    3.90%
AA               3.30%    3.30%
A               33.30%   11.90%
BBB             47.90%   16.20%
Less than BBB    2.90%    0.00%
NR               0.40%   -0.10%
Then there's the issuers. VFIDX is a little concentrated in Finance and Industry. Again, I'm just pointing that out, I don't have an informed opinion on it. But I think it's worth mentioning.

Code: Select all

Issuer                       VFIDX    VBTLX
Asset-Backed                 1.40%    0.40%
Commercial Mortgage-Backed   3.40%    2.30%
Finance                     30.40%    8.80%
Foreign                      4.80%    4.00%
Government Mortgage-Backed   0.10%   20.70%
Industrial                  46.20%   17.70%
Other                        0.60%    0.80%
Treasury/Agency              8.10%   43.00%
Utilities                    5.00%    2.30%
Munis have also performed better than VBTLX lately :)
Last edited by pasadena on Fri Jul 23, 2021 12:18 pm, edited 2 times in total.
Topic Author
jdamo
Posts: 209
Joined: Tue Apr 30, 2019 8:47 pm

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by jdamo »

Good points. I guess I need to decide if I am comfortable with more risk.
But the risk of inflation is there too.
User avatar
ApeAttack
Posts: 915
Joined: Wed Dec 23, 2020 7:28 pm
Location: Gorillatown, USA

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by ApeAttack »

jdamo wrote: Fri Jul 23, 2021 12:13 pm Good points. I guess I need to decide if I am comfortable with more risk.
But the risk of inflation is there too.
It would be worthwhile to compare how each fund performed during the March 2020 crash and other crashes if data are available. Corporate bonds funds tend to have significant losses during those times (less than stock funds, but still noticeable).

Many here view the purpose of bonds is to provide stability during market downturns and prefer to take risk on the equity side of their portfolio. If one's portfolio drops significantly, you introduce behavior risk... perhaps that doesn't apply to you though if you won't panic during an enormous downturn.
May all your index funds gain +0.5% today.
aristotelian
Posts: 12277
Joined: Wed Jan 11, 2017 7:05 pm

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by aristotelian »

OP, you might also consider VBILX (Intermediate Grade Bond Index). Similar to total bond in that it has a mix of corporate and government, but it contains only intermediate bonds. Has higher yield and higher 10 year returns than total bond, but that implies higher volatility.
Topic Author
jdamo
Posts: 209
Joined: Tue Apr 30, 2019 8:47 pm

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by jdamo »

Thanks for the replies.
I will look into VBILX also.
I just debate this change vs Taylor Larimore's 3 fund portfolio (basically what we have now)
But I worry about inflation's affect on the 3-fund too.
User avatar
Taylor Larimore
Posts: 32842
Joined: Tue Feb 27, 2007 7:09 pm
Location: Miami FL

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by Taylor Larimore »

jdamo wrote: Fri Jul 23, 2021 11:32 am With all the talk about inflation coming and now the FED saying they will meet next week to discuss accelerating their response to recent inflation increases, I am considering changing some of my fixed income portion of our portfolio from VBTLX (Vanguard Total Bond Index Fund) vs VFICX (Vanguard Intermediate Term Investment Grade Bond Index. Shorter duration by about a year or so and better short term return recently, and long term return also. Would VFICX do better in a higher inflation environment?

The Vanguard data pages show about a 0.9% increase in CAGR and the portfolio analyzer shows about the same in about all time frames. Short term was about 0.6% better as I recall.

I know not to market time but it seems maybe a shift in this and my Investment Policy Statement may be a good idea. Maybe I am too conservative right now? Or am I listening to too much noise and stay with VBTLX since it is the largest and most diversified bond index on the planet?

We are retired for 2 yrs now with over 3-4 yrs cash reserve also. Total portfolio is ~ 26-29X annual withdrawal rate. Overall about 40% stocks/60% bond allocation.
Thoughts on changes from VBTLX to VFICX for say 20-30% of fixed income portion?
jdamo:

There is no "free-lunch" in taxable bonds. Higher return nearly always reflects higher risk.

You can see below how VBTLX (Total Bond Market) would have performed in The Three-Fund Portfolio during the terrible inflation of the late 70s:

YEAR--INFLATION--BOND INDEX--S&P 500 T.R. INDEX--MSCI EAFE T.R.INDEX
1976-------4.9%--------15.6%------------23.8%--------------------3.6%
1977-------6.7-----------3.0-------------(-7.2)-------------------17.5
1978-------9.0-----------1.4---------------6.6--------------------33.1
1979------13.3-----------1.9--------------18.4-------------------10.9 (Highest Annual Inflation Rate)
1980------12.5-----------2.7--------------32.4-------------------25.4
1981-------8.9-----------6.3-------------(-4.9)------------------(-2.5)
1982-------3.8----------32.6--------------21.6------------------(-0.3) (Highest Bond Index Return)
1983-------3.8-----------8.4--------------22.6-------------------24.8
1984-------3.9----------15.2---------------6.3--------------------3.5
1985-------3.8----------22.1--------------31.7-------------------51.4
1986-------1.1----------15.2--------------18.7-------------------65.8 (Vanguard Total Bond Market Inception )
1987-------4.4-----------2.8----------------5.2-------------------24.6
1988-------4.4-----------7.9---------------16.6-------------------27.8
1989-------4.6----------14.5---------------31.7------------------11.4
1990-------6.1-----------8.9---------------(-3.1)---------------(-22.8)
1991-------3.1----------16.0---------------30.5------------------12.4
1992-------2.9-----------7.4-----------------7.6----------------(-11.9) (Vanguard Total Stock Market Inception)
1993-------2.7-----------9.7----------------10.1------------------32.6
1994-------2.7---------(-2.9)----------------1.3--------------------7.6 (Lowest Bond Index Return)
1995-------2.5----------18.5---------------37.6-------------------11.8 (Highest S&P Index Return)
1996-------3.3-----------3.6----------------23.0--------------------7.2 (Vanguard Total International Stock Market Inception
1997-------1.7-----------9.7----------------33.4--------------------2.6
1998-------1.6-----------8.7----------------28.6-------------------19.1
1999-------2.7---------(-0.8)---------------21.0-------------------28.3
2000-------3.4----------11.6---------------(-9.1)----------------(-15.8)
2001-------1.6-----------8.4--------------(-11.9)----------------(-19.8)
2002-------2.4----------10.3-------------(-22.1)----------------(-15.3)
2003-------1.9-----------4.1----------------28.7-------------------40.4
2004-------3.3-----------4.3----------------10.9-------------------20.9
2005-------3.4-----------2.4-----------------4.9-------------------15.8
2006-------2.5-----------4.3----------------15.8------------------26.8
2007-------4.1-----------7.0-----------------5.5------------------11.6
2008-------0.1-----------5.2--------------(-37.0)---------------(-43.1) (Lowest U.S. and International Stock Returns)
2009-------2.7-----------5.9----------------26.5------------------32.5
2010-------1.5-----------6.5----------------15.1-------------------8.2
2011-------3.0-----------7.7-----------------2.1----------------(-11.7)
2012-------1.7-----------4.3----------------16.0------------------17.9
2013-------1.5---------(-2.0)---------------32.4------------------23.3
2014-------1.6-----------6.0----------------13.7-----------------(-4.5)
2015-------0.7-----------0.5-----------------1.4-----------------(-0.4)
2016-------2.1-----------2.6----------------12.0-------------------1.5
2017-------2.1-----------3.5----------------21.8------------------25.6
2018-------2.5---------(-0.1)--------------(-4.4)---------------(-13.4)
2019-------2.3-----------8.7----------------31.5------------------22.7
2020-------1.4-----------7.7----------------18.4------------------11.3

Sources: U.S. Labor Department (CPI-U); Bloomberg Barclays Aggregate Bond Index; Standard & Poors; and DFTurner

Lessons learned:

* Past performance does not forecast future performance.

* The Aggregate Bond Index (benchmark for Vanguard Total U.S.Bond Market Index Fund) had only four negative years (all small) reflecting very low risk.

* In 2008 the S&P 500 Stock Index plunged (-38.5%). During the next 2 years it gained +41.52% (stay-the-course).

* Foreign Stocks enjoyed the highest annual return (1986).

* Table demonstrates the futility of using past performance to forecast future performance.

* Diversification is important.

* Inflation climbed from 4.9% in 1976 to 13.3% in 1976. During that period a combination of Total Bond Market and stocks beat inflation.

Taylor
Jack Bogle's Words of Wisdom: "The Lehman Bond Index (total bond market), in substance, is an appropriate choice for investors with an intermediate-term time horizon and seeking top quality."
"Simplicity is the master key to financial success." -- Jack Bogle
TurtleBeatsHare
Posts: 121
Joined: Fri Jun 25, 2021 2:01 pm

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by TurtleBeatsHare »

The primary difference between those two funds is the % they hold of US government securities (it's about 65% vs. 8%); the average duration's and expense ratios are more or less the same. With the intermediate, investment grade index, you are taking additional credit-default risk, but likely obtaining a higher return on investment. That means that those bonds will tend to correlate a bit more with the 60% of your portfolio in equities (i.e., when the economy is bad, more companies will default on average, and so your positive bond performance from declining interest rates will be slightly less positive because the portfolio will likely have additional defaults relative to the 65% treasury portfolio) and will provide less of a counterbalance to your equities during a recession. However, you'll likely be compensated with a higher return on your investment overall and have better distribution cash flow and will take a smaller hit over time due to inflation. However, the 65% treasury portfolio is more subject to the risk that the Federal Reserve decides to keep treasury rates artificially low due as a way to monetize/inflate the US's way out of debt.

Neither are particularly good inflation protection assets. In fact, they might be two of the worst ways to hedge against inflation. If you are looking for purely an inflation hedge, TIPS (particularly short term TIPS) and commodity indices are the way to go because their performance correlates with inflation and commodities have high magnitude, meaning they can cover other parts of your portfolio, even if they have slightly less correlation than short TIPS.

Try searching the forum for TIPS ladder, if you want to read some forum posts about building an inflation hedge.
Topic Author
jdamo
Posts: 209
Joined: Tue Apr 30, 2019 8:47 pm

Re: Total Bond Index vs Interm-grade bond index? Which is Better for Inflation?

Post by jdamo »

Thanks Taylor and Turtlebeatshare! This forum is great for real feedback!

I appreciate the historical returns.... despite not an indicator of future performance..nevertheless we gotta look at something.
The diversification Taylor mentions is important.
And the increased credit risk you both mention.
These are good things to think about.

I will also research the TIPS ladder as suggested.
Post Reply