How to invest in bonds?

[novum123]

Hello everyone!

I'm at the point where I'd like to revisit my bond allocation. My portfolio is currently 50% VTI, 35% IXUS, and 15% cash, excluding Pillar 2. Pillar 2 accounts for ~15% of my net wealth.

It's my understanding that the purpose of bonds is to provide "ballast" during market downturns, when bonds oftentimes appreciate and benefit the portfolio through rebalancing (thus selling bonds high and buying stocks low). Unfortunately, although Pillar 2 behaves much like a bond (stable returns of ~1-2% / year), I cannot use it for rebalancing.

My questions are:

1. Should I count the Pillar 2 as bonds in my portfolio? Or would it be better to exclude it from the portfolio, estimate the annuity I'd start receiving after retiring, and subtract that from my expenses during retirement when thinking about how much I need to save for a SWR of ~3-3.5%?
2. How do I go about rebalancing? If I count Pillar 2 as bonds and keep just 5% cash / bonds in my brokerage, I don't think it would be enough to properly rebalance during a market downturn, I'd probably need to keep at least 10-15% in my brokerage, which is a bit more conservative than I'd prefer right now.
3. What bonds do I buy? I'd prefer government bond funds, because they're less correlated with stocks and provide better diversification than corporate bonds. Do I go only for Swiss bonds? Should I diversify into global bonds? For the purpose of rebalancing, I feel like going global is more important: e.g., consider a crash that affects mostly the US, leaving Switzerland mostly unaffected. Swiss bonds won't go up, but US treasuries will, so if I'm domestic-only, there's less opportunity for rebalancing.
4. What ratio of domestic vs global bonds should I use? Swiss bonds make up < 1% of global bond funds. Should I just consider Pillar 2 as the domestic bond allocation, and go global with the rest?
5. If I diversify into global bonds, should I hedge them to CHF, or should I keep them unhedged? I think leaving them unhedged might be fine for rebalancing, and hedging would be more important when I'd start withdrawing from my portfolio during retirement.

Lastly, what bond fund would you suggest? There are some pros and cons for each:

1. AGGG - global aggregate, unhedged, TER 0.1% - includes corporate bonds, which I'd rather avoid, but is diversified and highly liquid
2. AGGS - AGGG, but CHF-hedged, TER 0.1% - downside of being less liquid (at least several trades per day), but still liquid enough
3. BNDW - AGGG, but USD-hedged and US-domiciled, TER 0.05% - downside of being USD-hedged, but is US-domiciled (better TER, lower bid-ask spread and highly liquid, etc.)
4. IGLO - G7 government bonds, TER 0.2% - the kind of bonds I'm looking for, but is slightly less diversified (don't mind it much, I get the exposure I want)
5. IGLC - IGLO but CHF-hedged, TER 0.25% - downside of being highly quite illiquid (e.g., some days there are 0 trades on this fund!!!)
6. CSBGC3 / CSBGC7 / CSBGC0 - Swiss government bonds, 0-3 / 3-7 / 7-15 years, TER 0.15% - about as liquid as AGGS (at least several trades per day)

 

[mungomerbeliever]

@novum123 I would recommend checking portfolio visualizer and compare the different options that you have laid out

I would stay out of corporate bonds, they are too correlated with stocks, thus they don't serve as a good diversifier on a portfolio.

Your options are missing longterm government bonds and zero cupon long-term government bonds. A good place to read about those is the boogleheads wiki. These are the most negatively correlated with stocks, meaning when stocks zig, long term bonds zag. Unfortunately this is not what happened in the last few years with the inflation rise. Next best thing are gold and managed futures.

 

[novum123]

@mungomerbeliever

I would stay out of corporate bonds, they are too correlated with stocks

Thought so too

Your options are missing longterm government bonds and zero cupon long-term government bonds.

IGLO / IGLC are total government bond funds, so they include short-, intermediate-, and long-term bonds, but averages out to intermediate duration. I guess I could look for a long-term bond only fund, but I think I'd be taking on a bit too much interest rate risk in that case.

 

[mungomerbeliever]

@novum123 you stated --> It's my understanding that the purpose of bonds is to provide "ballast" during market downturns

that is not always true for ALL bonds, it's actually a spectrum. it's not the case for high yield coorporate bonds, down to coorporate bonds, goverment of low reputation, us treasuries and long term treasuries.

during pereods of market strees, there is a "flight to safety" and people long term US bonds will go up VERY fast.

rather than looking for bonds to your portfolio, you could look at it in a different way. what has low correlation with stocks, that's long term treasuries, gold and managed futures.

what i'm trying to say here is don't put bonds just because you are suposed to. look at what will work well with your stock allocation. IGLO/IGLC will not work in the same way than TLT or an equivalent. because not all bonds work on the same way.

 

[novum123]

@mungomerbeliever I agree, corporate bonds are more correlated with equities, and are undesirable to me.

IGLO / IGLC is a developed government-only bond fund, with an effective duration of 7.2 years, and it already holds 53.5% US treasuries.

While TLT has an effective duration of 16.4 years and would probably have a better regression coefficient with stocks, but it's a bit too much interest rate risk for me, and it exposes me to single (foreign) country risk.

 

[nicolek]

@novum123 In current market conditions, I'd just buy US treasury bonds. It's hard to beat the 5+% yield with very safe profile. You could just go buying T-Bills (zero coupon) and keep rolling them as they expire.

Or you could buy BOXX ETF (which simulates roughly the same yield). Then you don't even need to roll. In theory it should have a similar risk profile.

BOXX Stock Fund Price and Chart — AMEX:BOXX — TradingView

 

[tobiahjude99]

@novum123 Bonds should be in your local currency.

You can see pillar 2 as bond-like in my opinion, but it‘s essentially not usable for your normal portfolio. But you can still count it as part of your total portfolio. If you want the annuity or lump sum cash depends on you. Also what will the conversion rate be? When will your retire etc.

2.: Nobody forces you to have bonds and you are not required to rebalance anything during market crashes. You can simply ride it out. That‘s hard of course and it’s mainly a psychological thing anyway. 100% stocks will more than likely perform better over the long run anyway, than any % in bonds and you rebalancing with those.

3.-5.: I‘d probably go total woeld bond market hedged to CHF, GLAC for example. It‘s essentially BNDW hedged to CHF.

 

[novum123]

@tobiahjude99

If you want the annuity or lump sum cash depends on you.

Indeed, I haven't decided, I have plenty of time to think. It depends a lot on whether I'll retire in Switzerland, or in another EU country.

When will your retire

I'm aiming for an early retirement at ~50 years, so I wouldn't be able to draw out anything from Pillar 2 for about ~8 years. I still have about ~20 years of work until then.

You can simply ride it out. [...] 100% stocks will more than likely perform better over the long run anyway

I think that's an oversimplification, and quite optimistic. Yes, statistically, 100% stocks wins most of the times over very long periods of time (30+ years). However, I think most people have a very significant recency bias and don't know what it's like to go through a prolonged crash. There have been times when a 100% stocks portfolio took 20 years to recover, and rather recently we had the Lost Decade.

Yes, I do have a separate emergency fund that could cover my expenses for ~1 year, and I don't count that towards my portfolio. But if there will be anything similar to the longer downturns from the past, with possibly a decade+ of difficult working conditions / high unemployment and poor market performance, then having some bonds would be very helpful.

I‘d probably go total woeld bond market hedged to CHF, GLAC for example

I looked at GLAC as well, it's the same thing as AGGS (same bond index, CHF hedged). What I didn't like about it is that it has a lot of corporate bonds, but it has a lot more AUM than IGLC (which is very small). Appreciate the suggestion!

 

[tobiahjude99]

@novum123 And you are now mixing up psychological reasons with what‘s objectively better, from a return perspective.
It‘s totally fine of course having bonds, if otherwise you can’t stay the course during a bear market. Not arguing against that.

The 20 years recovery period (you probably mean the great depression, which is unrealistic to repeat to say the least) ignores, that in accumulation you invest every month and then are in the situation to buy very low. This means breaking even wayyy earlier then the 20 years.

Even a lump sum investment during the dotcom 2000, "only" took 10 years to break even again, and only 4-5 during the gfc 2008. And again if you keep investing, that changes all the numbers.

In retirement different of course, you dont invest anymore. But before that bonds are pretty objectively a drag on return.

There is even a new study arguing for 100% stocks (with a home bias) for any phase:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4590406

50% home bias seems very high, but the optimal range in their data set already starts at 35%.

A video that references this paper:

Now I‘m not saying to forgoe bonds in retirement. It‘s still the state of the art by most finance professionals on how to approach retirement. And for such a strategy you basically need to be a robot to not go insane during a big crash, and you are retired, wandering if it will recover etc.

Just wanting to challenge this statement here

 

[zimirah]

@novum123 I do consider pillar 2 as bonds in my portfolio but excluding it from the rebalancing portion. However, if you want you could rebalance somehow through it: you can personally contribute to the pillar 2 up to a certain amount or you can use it for mortgage for a property (would the house be considered in the bond portion of the portfolio in this case?)

 

[greenhill]

@novum123 I recommend you the below articles about bonds and an article about Vanguard LifeStrategy. In Vanguard LifeStrategy ETF USD hedged bonds were replaced aby EUR hedged bonds. In Vanguard LifeStrategy for clients from UK USD hedged bonds were replaced by GBP hedged bonds.

What Role Do Bonds Play in a Portfolio?

https://www.morningstar.com/bonds/what-role-do-bonds-play-portfolio

How to Invest Better With Bonds

https://www.morningstar.com/bonds/how-invest-better-with-bonds

Self-Healing Wounds: Bonds Still Have a Place in Portfolios

https://www.morningstar.co.uk/uk/ne...s-bonds-still-have-a-place-in-portfolios.aspx

VANGUARD LIFESTRATEGY REVIEW – A RETRIEVER IN A BABUSHKA DOLL

https://www.bankeronwheels.com/vanguard-lifestrategy-ucits-etfs-europe/