How to best buy bonds for a retirement portfolio?

October 6, 2011 8:29 PM

How do I pick bonds for the bonds portion of a retirement portfolio?

I really like the idea of low cost index funds and right now my TIAA-CREF is going 100 percent into their S&P 500 offering. I realize this is somewhat risky, so I'm considering targeting a portfolio of 70 percent equity and 30 percent bonds.

Ideally, there would be some kind of index similar to my equity fund. But the closest I've located is the Barclays Capital Aggregate Bond Index, and I have no idea how it changes, what its competitors are, and whether it serves well as an index itself.

I'm also not clear on what the best method of investing in that index is. For example, I could invest in the AGG ETF via my Roth IRA (a 0.22 expense ratio), or I could go with the mutual fund TBIIX offered in the 403b (0.13 expense ratio). The mutual fund seems like a better deal, but I figure I'm missing something.

Is there a better index? Should I just be using Treasuries?

posted by pwnguin to Work & Money (10 answers total)

I like Vanguard'sTotal Bond Market Index.
It is weighted towards treasury bonds, but with a mix of corporate bonds as well.
posted by archaic at 8:39 PM on October 6, 2011

My understanding of bonds is that they reflect the current value of a future fixed payout. The problem is that interest rates are almost zero, which means they can only go up.

When the market interest rates on bonds go up, it takes less present value to get the same fixed payout... thus the price of existing bonds drops.

It is therefor (if I understand things correctly), very likely that bonds will drop in value eventually... this probably does not bode well for bond funds in general.


I'm not an investment adviser, and I'm probably wrong about aspects of this... but I hope it helps.
posted by MikeWarot at 8:59 PM on October 6, 2011

TBIIX is an excellent total bond market index fund and has a very low expense ratio. It is very similar to the Vanguard Total Bond Fund that archaic mentioned.

For a very simple two-fund portfolio, splitting your investment between the S&P fund and the bond index fund would be a good way to go.
posted by JackFlash at 9:08 PM on October 6, 2011

According to your link, TBIIX is intended to mimic the Barclays Aggregate index (which actually is the generic "bond" benchmark the industry uses), so it seems to make sense to go with the cheaper option. Also, the AGG ETF is traded like a stock, so you'll probably have to pay a commission for each trade you make. That could be a problem if you intend to make regular contributions. I imagine the TIAA-CREF fund is available without a transaction fee.
posted by mullacc at 9:12 PM on October 6, 2011

If you compare the TBIIX vs VBMFX in Google Finance TBIIX has a better return over time.
posted by archaic at 3:41 AM on October 7, 2011

Consider long treasuries and TIPs. When the shit hits the fan, the market runs for treasuries, not corporate/agency/municipal/etc bonds. Unfortunately, treasury yields are at a record low right now. TIPs give you protection against rising interest rates.

Vanguard and Fidelity both have low cost treasury funds.
posted by monstrouspudding at 5:16 AM on October 7, 2011

If you decide on treasuries and TIPs (which is what I do for the bond portion of my portfolio), there are Exchange Traded Funds (ETFs), which allow you to avoid the fees associated with funds.

iShares Barclays 7-10 Year Treasury (IEF)
iShares Barclays TIPS Bond (TIP)

Some people worry about how indexed ETFs will perform during a market dislocation, but I held these through the '08 craziness and nothing strange happened. I figure if things get any worse than the end of '08, then all bets are off anyway.

It got the idea for using indexed bond ETFs from this book:

Unconventional Success: A Fundamental Approach to Personal Investment
posted by diogenes at 6:05 AM on October 7, 2011

I just read your initial post more closely, and I see that you're perfectly aware of ETFs. Anyway, at least now you know the ticker symbols for treasury and TIP ETFs ;)
posted by diogenes at 6:11 AM on October 7, 2011

... there are Exchange Traded Funds (ETFs), which allow you to avoid the fees associated with funds.

ETFs are just another form of mutual fund and also have fees just like mutual funds. In fact, the Barclays ETFs have slightly larger fees than the Vanguard Total Bond Fund with a $10,000 investment (VBTLX). Purchasing ETFs incurs the loss of a bid/ask spread and particularly bond ETFs often trade at a premium or discount to the net asset value. For a long term investor, ETFs may be not better and may be worse than buying a regular low cost open-ended mutual fund.
posted by JackFlash at 8:22 AM on October 7, 2011

Yea, stocks are down and bonds keep hitting record highs. It doesn't seem like a great idea to hold them at this very moment.

On the other hand, smarter people than I have tried to time the Bond market and failed:

Gross, co-chief investment officer at Pacific Investment Management Co., had been reducing the vulnerability of his Total Return Fund to interest-rate swings and increasing its reliance on credit quality since July 2010 by shifting from Treasuries to corporate and non-U.S. sovereign debt.

The strategy backfired in August as the U.S. economy slowed and Europe’s debt crisis worsened. The $242 billion Pimco Total Return Fund trailed 80 percent of rivals so far in 2011, according to Bloomberg data.
...
In August, Gross told the Financial Times that it was a “mistake to bet so heavily against the price of U.S. government debt.”

I wish I could find as much about the Agg Index in in personal finance literature as I've seen about the S&P, but oh well. Anyways, it looks like TBIIX is the winner.
posted by pwnguin at 9:15 PM on October 7, 2011