Vanguard's recent suggestion to rebalance portfolios towards a 40/60 stock/bond allocation, driven by shrinking equity premiums and rising bond yields, prompts a guide for investors considering this shift. This guide navigates the complexities of bond investing, emphasizing the importance of choosing funds over individual bonds, and addresses key considerations such as duration, credit quality, and inflation exposure.
Stocks have gotten very expensive, bonds very cheap. If you want to move money from equities to fixed income, use this guide.ramatic move this month from Vanguard Group: It’s saying that the classic portfolio of 60% stocks and 40% bonds, with which it has been so enamored for so long, might not be quite right. Consider, it says, going over to 40% stocks and 60% bonds.
A common comparison is between the earnings yield on the S&P 500 and the interest yield on conventional 10-year Treasuries. This comparison is naïve. Stocks provide something close to a real yield, a return that keeps up with inflation. So the comparison should be to the yield on Treasury inflation-protected securities, also known as TIPS.
You get paid to take credit risk. Low-rated corporate bonds have better yields than high-rated corporate bonds, and high-rated corporate bonds have better yields than Treasuries. But losses to defaults take a bite out of the fat coupons on low-rated bonds. A nominal Treasury maturing in 2045 yields 4.9%. The TIPS for that year pays 2.4% plus inflation. If inflation averages more than 2.5%, you’ll do better with the TIPS. If it averages less than 2.5% you’ll do better with the nominal bond.
Here, timing refers to the timing of principal and interest payments. You might want to time the principal repayment, that is, the lump sum at redemption. There is something to be said for buying an individual Treasury bond to cover a specific obligation at a specific date in the future.
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