Cash & Bonds BONDS VS CASH IN SAVINGS

Just because I like graphics



If interest rates increase then investors can earn more interest on other bonds. To attract buyers to a bond if people want to sell it, the bond price must decrease.

On the other hand, if interest rates decrease then the bond’s price will increase. This is because the fixed-rate bond is now paying a higher rate compared to what investors are getting in the market.

One popular bond investing strategy is called “laddering” and provides a trade-off between lower rates on short-term bonds and higher interest rate risk of long-term bonds. In this strategy, you invest in a group of bonds at different maturities.

 

Brain Food

The Debate Over Active Versus Passive Investing In Bonds

and

Bonds are different: Active vs. Passive management

Learning outcomes:

1. Why active managers in the fixed income and equity space have different performance relative to benchmarks and passive funds
2. The impact of transaction costs on bond portfolio returns
3. Why passive bond investing involves a series of active decisions

 

Hi @The Falcon,

Sorry to bring up a 6 month old comment. Was not sure a question warranted a new thread or not.
I've been reading a book that mentions couch potato investing (not an oz book), and the author mentioned an interesting idea.

Firstly is the idea of having some portion of your investment as government bonds. I know almost nothing about government bonds but I had a quick read up and it seems they are a bit like term deposits but they can be bought and sold on the market which means the value can go up and down (unlike term deposits), and when stocks tend to go down, bonds tend to go up, and vice versa, so diversifying into both is an idea especially as you get older and volatility becomes more of an issue. From what I understand, the downside is that in the long term bonds are lower risk and as a result have a lower return.

So the idea that I found interesting was this -
Lets say you decided you wanted a split portfolio of 70% index funds and 30% bonds.
Any time you are ready to invest more money, invest in the one that is lower than its target percentage in value proportions so that you are investing in the one that has lagged instead of the one that has performed best and is overvalued. On top of this, once a year re-allocate it, so if after a year the stock market has done well and 80% of the value is index funds and 20% bonds then sell down enough of the index fund which is overvalued and put it into bonds which are undervalued, to re-balance. And similarly if the stock market crashes and you find your portfolio value being 50% shares and 50% bonds, you sell bonds to buy more shares to re-balance. The idea is that this would take advantage of drops in the market buy buying more when it is cheaper so that when it recovers you are further ahead than if you just held on to all your stocks, and the result should be reducing volatility while at the same time increasing returns.

If I understand correctly, a big part of this idea is that the value of bonds change with the market as they can be traded so you would be hedging the value and I assume term deposits would not work for this situation since they are not traded, so the actual capital value doesn't change.

I'm still in the first steps of learning about shares and was wondering if you (and/or others) wouldn't mind giving your thoughts on this idea.

 

@Anthony Brew you are touching on the basics of multi asset portfolio and modern portfolio theory. It is true that AAA Government bonds can appreciate in value in an equities sell off (negative correlation) though this is not guaranteed, so cash or TD can also be used for similar results.. With regards to rebalancing either with inflows or by selling, there may be a premium for doing so or there may not. This is a topic just by itself. Note though that selling appreciating assets has tax consequences and this needs to be carefully considered. If you are interested in all this kind of stuff I suggest Bogleheads as an excellent resource.

 

I don’t hold Bond Funds but for those that like to hold a Bond Fund for rebalancing purposes but who also want Term Deposits for the guaranteed return of principal at given times (more so for retirees) then the following reference table might be useful.

The other benefit with this combination is that should the market continue to severely correct into a long drawn out bear market resulting in the bond fund becoming depleted there’s at least the safety of the term deposit allocation to fall back on. That is, you don’t want to end up rebalancing into poverty. Sometimes illiquidity can be your friend. GICs are the Canadian equivelent of Term Deposits:



The Most Boring Battle Ever: Bond ETFs or GICs? – Canadian Portfolio Manager Blog

 

Hi @Nodrog, I have a question about tern deposits in a portfolio.

It seems that the return of term deposits is pretty close to inflation. Please correct me if this is wrong because then everything else I am about to say is wrong.

So if term deposits return roughly the same as inflation, and since money devalues for the same amount, after your TD matures, you have a higher 'number' of dollars, but the real value had not changed.

Which then would mean if you actually use the returns from the TD to live off, then the real value is dropping by as much as you use and you are eating into your capital.

So it seems like you would need to split your portfolio between TDs and everything else (which have varying degrees of speculativeness), and if you used a withdrawal rate, you would need to calculate it on the "everything else" part excluding the TD part because if you withdraw from your TD's then you are eating into your capital.

And in the same vein, I don't understand floor with upside. If the guaranteed income "floor" is income from TD's, then if you use that to live off you are eating into your capital. Which would be ok if your life expectancy was lower, but for anyone retiring early with 40+ years of life expectancy, this cost would form a serious risk of the money not lasting.

If there are flaws in my understanding, can you point them out please?

 

Floor with upside is really best suited to older retirees. It’s a very conservative strategy requiring quite a lot of capital.

If it weren’t for you wanting to live overseas (think it was you?) then living off dividends like a few other young retirees here could be an option.

Other than that there’s numerous approaches for younger retirees including the Bucket approach and others based on Safe Withdrawal Rates etc.

One that seems to be gaining popularity is the Dynamic Spending Strategy. Refer to following:

Sustaining retirement income in a lower-return world
How to put a dynamic retirement spending strategy in place
https://personal.vanguard.com/pdf/ISGELR.pdf

@Snowball has a blog detailing his very early retirement path resulting in him living off dividends:

Strong Money Australia - BUILDING FINANCIAL STRENGTH AND A LIFE OF FREEDOM

 

Are US bonds safe and easy to buy? Nathan Birch believes Aus is at risk of hyperinflation.

 

Thanks for the links @Nodrog

Ok yea that confirms that the risk free 'floor' comes with the bigger risk of reducing capital faster and not lasting as long. I would have thought that anyone with so much capital to be able to use this approach would have so much that they could just keep 25% of assets in cash and it would smooth the short term bumps so long that they could still just put the rest in equities with little problem, so thereby seeming to make the floor with upside idea redundant anyway.

The dynamic spending strategy is interesting and I haven't heard of that before. It provides a very nice compromise between the other 2 styles which I have heard of, but noticed comes with serious problems.

I agree that if I retired in Australia, living off dividends would be ideal and the whole thing would be much simpler.

 

Might be worth doing a little research into Market history to truely understand how long Markets can experience terrible times.

That said in our case having enough in fixed interest / other safe assets to generously cover essential expenses for a lifetime is still less than 25%. About a third of that is inflation protected.

 

Sounds strange to me. The best protection against country specific inflation is a globally diversified share portfolio easily done with a few index funds. Unless he meant Inflation protected bonds but the income would probably make you vomit.

A useful table for protecting against different types of risk (TIPs = US Inflation Protected Bonds):


Deep Risk Under President Trump

 

Wonderful to see how keen you are in thoroughly researching these areas to give yourself the best chance of success at early retirement.

This might interest you also:
Variable percentage withdrawal - Bogleheads

Most of my research has been directed toward a later retirement age than yours specific to our needs. So I’m no expert on any of this.

Here’s a few of the more popular Global Sites specific to early retirement:

https://forum.mrmoneymustache.com/
https://forum.mrmoneymustache.com/investor-alley/
Early Retirement & Financial Independence Community
Start here (Early Retirement Now)

Getting off topic here though.

 

I use FIIIG and they have intro seminars. You should go to them.

A direct bond will guarantee a regular payment and guarantee your money back at the end. An etf will do neither.

If you stay with investment grade bonds you should be fine - Bendigo bank, Sydney airports, Suncorp and the like.

Don’t get greedy with bonds. That is when they turn into equity - but you risk the total loss in capital.

Not a financial product advisor. Seek a product advisor for product advice.

 

Depends what you want from your bonds safety vs higher returns. When the **** hits the fan the products you mentioned will behave more like equities rather than Government guaranteed bonds. Other than Govt bonds (excluding a catastrophic event) there is no guarantee you’ll get your money back when you might need it the most.

Then again I’m older and a conservative type suffering from paranoia. So might be best to ignore what I’ve just said.

 

If Bendigo bank fail to make the interest and capital repayments to its bond holders we might as well give up and leave the country.

 

Yes fair enough, as I said I’m likely too conservative and have perhaps been reading too much market history. But I think many would be surprised how close that and worse came during the GFC for some of the smaller banks. Really Australia came out of the GFC relatively unscathed compared to most thanks to the mining boom.

And fortunately one doesn’t need to leave the country nowadays to protect against Home country risk.

All I’m suggesting is that the type of bonds you mentioned really need to be considered part of the risk portfolio as opposed to risk free (or as close as you can get).

Where’s @The Falcon when I need him to expand on this better than me. I’ve heard he’s replaced Pat Rafter to promote Bonds. And in that area safety first is paramount.

 

Yes what I am talking about is ultra low risk v risk free.

You can get another 1% on cash. Short date the bonds and diversify the holdings and you can comfortably get 4%.

 

I’m running a worse rig than these blokes!

This matter almost comes down to ones philosophy as to what bonds are for. Decide that and you’ll find something on the bond continuum to suit your purpose.

Personally I’ve no interest in valuing individual bonds ; face, coupon vs default risk....bond fund for my purpose is just fine. Criticism of bond funds for mine is overblown.

 

I don't understand what you mean by inflation protected? Is there a type of fixed interest where they pay interest and then at the end the capital is returned to you inflation adjusted?

 

You can get bonds that pay an interest rate plus the current CPI.