Asset Allocation · Investing

Bond-like Assets

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.

Why?

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.

Future Savings

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

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.

More assumptions:

  • 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.

Conclusion

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!

Hasta luego!

8 thoughts on “Bond-like Assets

  1. Keepig a constant ratio of stocks to bonds and rebalancing periodically (I think quarterly is good) it is a form of dollar-cost-avereraging between buying stocks and bonds. If your allocation is out-of-whack, then the theory is either stocks are over-valued or bonds are relatively cheap. So when you rebalance, you’re selling high and buying low. Nevertheless, given your situation, I think it’s rational for you to keep a practically 100% stock portfolio (I did at your age).

    I use the Charles Schwab annunity estimator calculator to estimate my SS benefits.
    https://www.schwab.com/annuities/fixed-income-annuity-calculator
    If I plug in $5800/mo. and assume you are 45 and want to collect at 70 as a single life only with no payout upon death, you get $462k. Assuming inflation is 2.5%, then the inflation factor over 25 years is 1.854 (1.025^25) so I value your SS at around $860k in today’s dollars. Bumping inflation to 3.5% and SS comes out at a little less than $1.1k.

    Food for thought.

    1. Thanks for the link to the calculator. That’s a much smarter way to estimate the value of my SS benefits. Using that calculator, but using Joint Life Only, I see it’s a $600k premium, or $1.17 million when factoring in 2.5% inflation, or $600k less than my estimate. I was kinda in the ballpark? SS alone would have put me in bond-like assets at 62%, and dropping the actual bonds puts me at 58%.

  2. 100% equities seems reasonable to me. That’s why I do it.

    How do you feel about repaying your mortgage early? Why not a 15Y mortgage? Will you have a mortgage going into retirement? If not, when do you pay it off?

      1. Sounds like you found the answer, but yeah, basically optionality. We continue to pay our mortgage off at the rate of the original 30-year terms, so effectively we’ll be done in 15. I don’t think I’d want a mortgage into retirement. I also suspect I’ll want a whole lot less house once the little people have moved out.

        I’m conflicted about paying it off. I think I’d make sure to have it paid off before I got back into bonds. However, I get the math behind not paying it off. But the psychological argument is hard to ignore.

  3. Until the rates rise it’s hard to justify bonds. I had considered TIPS to keep up same spare cash up with inflation but I’m still young enough (mid 30s) to YOLO into 100% stocks (or 99.5% stocks and 0.5% speculative crypto).

    1. Yeah, bond yields really suck so even thought the “textbooks” say I should be at around 60/40 stock/bond, I’m at 85/15 and leaning towards 90/10. I’m pretty close to pulling the FIRE trigger (targeting 2 years but it may be sooner) so need some reserves.

    2. As a software engineer in the security industry, I just can take the crypto seriously. To me, there are a whole lot of fools that don’t understand crypto that are just hoping for fools bigger than them. I like some of the ideals and properties of crypto currencies, IMHO there’s too many charlatans and hype.

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