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Bond Market Risks: Keeping It Short, Simple, and Safe

A recurring theme in my asset allocation philosophy is to stick with simple and safe bonds in your portfolio. The problem is, there will be other bonds that outperform safe, shorter-term US Treasury bonds and you might start to question your decision. I try to remind myself to consider how they fit into your entire portfolio. I would rather take on risk with stocks due to their big upside potential and use bonds for stability in times of stress.

Here is an older WSJ article The Case for Minimizing Risk in Your Bond Holdings by William Bernstein on the subject. If you run into a paywall, I discuss the article here.

Recently, there have been more articles about the riskier bond options out there.

Corporate bonds – hidden risks? Credit ratings agencies continue to have the conflict of interest where they are paid by the bond issuers themselves – remember the financial crisis and those AAA-rated subprime bonds? These days, companies are loading up on debt, but they still really really really want their bonds to be rated as “investment-grade”. More than 50% of the corporate bond market is now rated BBB, just barely “investment grade” as opposed to “junk”, according to the Bloomberg article A $1 Trillion Powder Keg Threatens the Corporate Bond Market:

That’s a lot of borderline debt that will eventually have to be refinanced at higher rates.

Actively-managed bond funds – what’s really inside? In addition, I recommend reading this Forbes interview with bond manager Jeffrey Gundlach: The Bond King Speaks: Doubleline CEO Jeffrey Gundlach Offers His Best Investing Advice. There are many interesting insights, and here are some excerpts on bond index funds and the active bond fund competition:

On the fixed-income side, active bond managers have by and large outperformed the intermediate-term bond benchmark, the Barclays Bloomberg Aggregate Bond Index (the “Agg”).

What helps the active manager to outperform the index is that it’s quite possible in bonds to do things very differently from what’s in the traditional bond indexes. The Agg has no foreign bonds, certainly no emerging markets bonds, no below-investment-grade bonds, no bank loans, no structured finance to speak of like ABS or CMBS, all of which are viable asset classes. But the index doesn’t include them. Active bond managers can buy these things and increasingly over the last couple of decades have done so.

Active funds are being measured against an investment-grade U.S.-only index. The active funds can own tons of emerging markets, junk bonds, bank loans — some of them even own 10 or 15% equities. Obviously, if a manager is allowed to own equities against the bond index in a world where bond returns over the last two years are nearly zero on a total return basis, you can see there’s a lot of ways that bond managers can game an index more than a stock manager.

Is a stock manager really going to measure themselves against the S&P 500 and own 50% bonds? I doubt it. The industry’s evolved in a way that has given us an advantage.

That’s probably going to turn into the opposite soon, where these activities outside of the boundaries of U.S.-only, intermediate-grade only bonds will start hurting. Junk bonds are getting crushed. Investment-grade corporate bonds are doing horribly over the last year. Typically, these are systematically overweighted by the majority of active bond managers. Not us, not Doubleline.

You could categorize the industry fairly accurately with a broad stroke by saying most firms are perpetually overweight corporate credit, underweight treasuries and they even have some stocks with below-investment-grade ratings. When you get to a world where the lower quality material like junk bonds or emerging markets are starting to come under stress due to falling equity prices, and perhaps a slowing global economy, well, suddenly, these games that are often played don’t help.

As noted recently, Total Bond ETFs that track the AGG index have 60-80% of their holdings that are backed by the US government, and the rest are investment grade US corporate bonds. Overall it is mostly high-quality stuff. Meanwhile, an actively-managed bond fund can include riskier corporate bonds, complex asset-based securities, or bonds from Emerging Markets countries with much higher yields. Basically, bond managers can take on a lot of extra risk and get paid for it while the party lasts. This will make them look like they are beating the AGG benchmark, while their holdings are nothing like the benchmark.

With actively-managed bond funds, it’s always a question of the manager adding enough value to compensate for the higher expenses. Bill Gross used the be “Bond King”. Now it’s Gundlach. Maybe Gundlach will continue to successfully time his purchases in and out of various bonds. I choose not to depend on a specific manager’s skill. Instead, I stick with US Treasury bonds, investment-grade municipal bonds from a conservative bond manager, or FDIC-insured bank certificates of deposit for the bond portion of my portfolio.

Amazon Audible: Free 3-Month Trial w/ 3 Free AudioBooks (New Prime Members)

Amazon Audible has new promotion of a free 3-month trial including 3 audiobook credits. This offer is only available to Prime members who are “new” Audible customers (not an existing subscribers or have utilized a free trial in the last 12 months). You will receive 1 audiobook credit each month for 3 months (3 free book credits in total). Audible usually only offers a 1-month free trial, and otherwise costs $14.95/per month for 1 audiobook per month.

My favorite feature of these Audible trials is that once you get a book, it is yours “forever”. You can go back an listen whenever you want, even if you membership is not active. Additional features include the ability to swap out audiobooks if you don’t like it after listening for a bit, and 30% off the list price of additional audiobooks. You can even have Alexa read your audiobook to you.

Upon completion of your 3-month trial, your subscription will autorenew at the standard rate of $14.95/month (unless cancelled). However, you can cancel online and hassle-free at any time before your trial ends and still receive the full benefits through the end of the trial period. I would do this first thing, and then you can always change your mind and opt back in if you want to keep your subscription.

I’m currently listening to 12 Rules for Life: An Antidote to Chaos by Jordan Peterson. I’ve redeemed previous credits for Shoe Dog (Nike origin story, my review), When Breathe Becomes Air, and I Can’t Make This Up: Life Lessons from Kevin Hart. Next up, probably The Subtle Art of Not Giving a F*ck: A Counterintuitive Approach to Living a Good Life.

My Money Blog Portfolio Income – October 2018

For a young person making a plan to reach financial independence at a very early age (under 50), I think using a 3% withdrawal rate is a reasonable rule of thumb. For someone retiring at a more traditional age (closer to 65), I think 4% is a … [Read the rest]

Top 10 Best Small Business Credit Card Bonus Offers – October 2018

Do you have small business income or work as an independent contractor? Do you have side hustle either by yourself or via a company like Uber/Lyft, Amazon, eBay, Etsy, Airbnb, and so on? You are eligible to open a small business credit card, … [Read the rest]

TopCashBack Existing User Promo: Free Fall-Themed Dish Towel ($2.99 Value)

If you shop at Target stores and are an existing TopCashBack portal member, grab a free $2.99 Thanksgiving Dish Towel at this link. Offer expires Sunday, October 21st at 11:59pm PST. Instructions: 1) Simply click the "Get Offer" button to go to … [Read the rest]

My Money Blog Portfolio Asset Allocation, October 2018

Here's my quarterly portfolio update for Q3 2018. These are my real-world holdings and includes 401k/403b/IRAs and taxable brokerage accounts but excludes our house, cash reserves, and a few side investments. The goal of this portfolio is to … [Read the rest]

Infographic: Where Did Housing Prices Crash the Most and the Least?

The Washington Post had an article looking back 10 years later: How the housing market has changed since the crash. Inside was an interesting map of where the home prices crashed the most and the least (click to enlarge): I wish they had a … [Read the rest]

Starbucks Masterpass Promo: Buy $10, Get Free $5 Gift Card

Here's another Starbucks promotion that can land you a free caffeine boost. Buy a $10+ Starbucks eGift Card with Masterpass, get a free $5 Starbuck eGift card. Masterpass is the online checkout system for Mastercard (like Visa and Visa Checkout). … [Read the rest]

Ally Bank Payback Time Promotion: 1% Additional Cash Bonus (~6% APY 3-month CD)

Ally Bank has a new promotion called Ally Payback Time that is offering a 1% cash bonus (up to $1,000) on new deposits on top of their existing interest rates. Valid for both new and existing customers. Given the holding period, this roughly … [Read the rest]

Savings I Bonds November 2018 Interest Rate: 2.32% Inflation Rate

Savings I Bonds are a unique, low-risk investment backed by the US Treasury that pay out a variable interest rate linked to inflation. You could own them as an alternative to bank certificates of deposit (they are liquid after 12 months) or bonds … [Read the rest]

Citi Simplicity Card Review: 0% for 21 Months (1.75 Years), No Late Fees, No Penalty Rates

Interest rates are rising, and that applies to credit cards as well. Our partner Citi has updated the Citi Simplicity® Card with an extended 0% intro period for balance transfers while also offering some "accident forgiveness insurance". Do you … [Read the rest]

EBSB Direct High Yield Savings Account 2.50% APY ($5,000 minimum)

EBSB Direct has a new High Yield Statement Savings Account that pays 2.50% APY on balances between $5,000 and $1 million. No interest is paid if your balance is below $5,000. $50 minimum to open. If you are an existing EBSB Direct customer, … [Read the rest]