As with anything investment-related, see my disclaimers. Investing involves risk. My analysis is provided solely for entertainment purposes and in no way do I recommend any course of action. Don't trust random idiots like me on the internet for investing advice. Or for anything else, for that matter.
This past week, I sold my bond holdings and spread the proceeds between our US equities and international equities allocation. It was a combination of selling our positions in VTIP, BND and VBIPX, and then gifting appreciated shares of VTEB.
Previously, my fixed income target was 15%. Recently, I realized that I wasn’t considering some bond-like assets that we have: our future savings, and our expected Social Security benefits. Additionally, since we have a mortgage, we were lending money from one hand and borrowing from the other, which doesn’t make a whole lot of sense.
I’ve been happily employed for nearly two decades. I expect to be employed for the next twenty to twenty-five years. Given our past financial history, I have no doubt I’ll be able to continue to max out my annual 401(k) contribution, as well as both of our IRA contributions all the way to retirement. My assumptions:
- Current in mid-forties
- 2021 contribution limits:
- 401(k): $19,500 + $6,500 catchup if over 50
- IRA: $6,000 + $1,000 catchup if over 50
- A 2% annual increase in contribution limits, roughly pacing inflation
- Retiring in our mid-sixties
With those assumptions, I have somewhere between $700,000 and $1,000,000 of future savings before I retire. My human capital behaves like a bond in many ways. Pretending my future savings are a bond means I’m somewhere between 50% and 60% in bond-like assets. Reducing our actual bond allocation to zero still means we’re 45% to 55% in bond-like assets. This is far more conservative than I want to be for my age.
My future savings estimate is actually conservative. We haven’t been limiting our savings to only retirement accounts, but we’ve also been saving a sizable amount in our taxable accounts.
To be clear, future savings aren’t bonds. They’re a guess and all sorts of things can happen between now and retirement. But to ignore it completely in deciding on the appropriate stock/bond ratio would be a mistake. As I get closer to retirement and my expected future savings declines, my bond-like ratio will change and I’ll need to get more into bonds
Social Security is very much not a bond. But there are more similarities between SS and bonds than there are with equities, making them a bond-like asset.
- My expected monthly primary insurance amount (PIA), in 2021 dollars: ~$5,800
- Delaying retirement until age 70 for maximum PIA of $4,170
- .50% spousal benefit of $1,656
- Using the 4% rule, I’m valuing total expected benefits at $1,741,000 (2021 dollars)
- I’m still thinking about how to value this. I suspect I’ve gone high and should probably look at fixed annuities to get a better valuation. Totally open to feedback here. Bumping the percentage to 5% drops the total benefits value to $1.4 million, but leaves us with a 65% bond-like exposure.
- Benefits remain the same as they are today. Not likely, but hard to know what they’ll be when I retire. I should add a heavy discount percentage if I wanted to be more conservative.
Including the raw, expected total social security benefits into my assets and I find myself 70% in bonds-and-bond-like assets. Even with its political risk, including social security assets puts me even deeper into bond territory than I want to be.
If I combine my expected future savings and the value of my expected social security benefits, I see that I’m 78.78% in bonds. Dropping my 15% allocation this week only shifts that to 76.59%. My actual bond holdings were only a drop in the bucket.
Mortgages: The Negative Bond
One final reason why I decided to sell our bond holdings was because of our mortgage.
We currently hold a 30-year mortgage on our home. We refinanced last March, right before the pandemic got going in earnest. At the time, going from 4% to 3.25% was great, but we would have come out even better by waiting six months. Hindsight is 20/20.
A mortgage is a negative bond of sorts. Instead of lending money to a corporation or a government, with a mortgage, I’m the borrower. (duh!). For those playing at home:
True Bond Allocation = (Actual Bond Allocation – Mortgage Balance) / (Total Assets)
Instead of being 15% in bonds, our mortgage caused us to be actually -25% in bonds and 125% in equities.
That was surprising.
I could interpret holding a mortgage as being an argument in keeping an allocation in bonds. But it makes little sense to lend from one hand and borrow using the other. Before I get back into bonds, I should consider having my mortgage paid off first.
You’ll notice, I’m ignoring the value of my home. In many ways, it’s a counterbalance to the loan. Yep, my mortgage is again, not quite like a bond.
Why were we 15% in bonds in the first place? Because I was mimicking the target allocation from my Wealthfront account from years ago. I’d set my Wealthfront account to be as aggressive as possible, but now I realize that it probably wasn’t aggressive enough.
After evaluating these other three bond-like asset classes, I decided it was time to get out of my actual bonds, splitting my mix between domestic and international stocks. I’m still working on calculating for when I’ll return to buying bonds, but I suspect it’s at least another decade or two away. More blog posts to follow, I suspect.
So, where are the flaws in my arguments? Other perspectives on bond allocations that I should consider? I’d love to hear about them in the comments!