Bond index fund vs savings account

grumiofoundation

Eco_Miser said:

MDMD said:

Eco_Miser said:

MDMD said:

btcp said: 

Looks like premium bonds carry no risk of losing money, plus a potential to get extra. You can also instantly access it the same as cash. A better option than having cash with zero interest, if you are lucky enough.

The nominal capital put into premium bonds won’t decrease, however adjusting for inflation, the real-terms value of that original amount will not buy as much when you redeem them, so that inflation loss is your risk.

The inflation loss is offset by any prizes, so in the unlikely event you win £1m you will be comfortably ahead of inflation.

This is true. It is equally true for cash in a bank account, or under the mattress, or for money invested in bonds or stocks, or funds thereof.

Like winning the £1m, interest or dividends or capital growth may offset the loss to inflation, but only interest is guaranteed to happen.

Agreed, but I was commenting on the specific point that PBs carry no risk of losing money.

Ultimately nothing carries “no risk”, you need to choose the risk you are happy with, whether that is inflation, shortfall, liquidity, FX etc, or (better still) have a sufficiently diverse portfolio.

The only risk of PBs losing money is if the UK Treasury defaults - a truly miniscule risk since they can re-finance at negative interest rates.

There is of course a risk certainty of them losing value to inflation, but that is shared with all cash-like assets.

Well since with PB you could win more a larger prize you do actually therefore have a chance of beating inflation, even over the long term (likelihood is you won't though). 

Moe_The_Bartender

btcp said:

ChilliBob said:

Ive skimmed parts of this discussion, which were pretty interesting, but in the current climate I'm struggling see why somebody would choose to invest in bonds vs either (v low risk) savings sccounts/premium bonds, or (higher risk) equities in a lower risk fund likd World index tracker. 

I think I must be missing the *point* of this instrument in ones portfolio.. I get the low risk, but savings are even lower risk, and returns seem similar or even better. 

If either of you, or anyone else can point me to an article or give me some further info I'd find that both helpful and interesting

Cheers

My original question was about the location for my emergency money. The question is not about investment portfolio structure. After 5 pages of discussion I realized that bond fund is not a good instrument for this purpose.
Where can one put 20K in savings to have a better return? I have 123 Santander, and it's £120 a year on 20K, deduct £5 account fee and it leaves you with £60k. Not worth an effort. 

I park spare cash in CG Absolute Return. 

https://www.morningstarfunds.ie/ie/funds/snapshot/snapshot.aspx?id=F00000X791

You can’t guarantee that it will never make a loss if you’d wanted to get money out in March, you would have taken a small hit, but it resumed its upward path very quickly. It's incorporated in Ireland so if you wanted to sell units, it could take two or three days. Or you could invest in its sister IT, Capital Gearing Trust, so shares could be sold immediately but you would incur dealing costs.

joeNZ

masonic said:

The main point is to reduce volatility. If you can tolerate the risk of 100% equities in your investment accounts they may be of no benefit at all. Another reason is to generate some sort of return within an investment account wrapper where interest is not paid at all on cash. Historically, a third reason is to get a nice capital boost in a falling interest rate environment, but it is hard to see how that could continue.

The real issue seems to be the certainty of the continued inverse relationship between bonds and equities along with the fact that the reduction in bond yields any further seems unlikely. So, if bonds are not going to do the job of reducing volatility in the way traditional allocation strategies expect, the use of bonds versus cash seems a valid question to pose. So, for example, with an investment horizon of 10 years, the avoidance of having to cash up anything in the first 3 years (say) through a descending cash buffer seems something to consider?

Thrugelmir

btcp said:

ChilliBob said:

Ive skimmed parts of this discussion, which were pretty interesting, but in the current climate I'm struggling see why somebody would choose to invest in bonds vs either (v low risk) savings sccounts/premium bonds, or (higher risk) equities in a lower risk fund likd World index tracker. 

I think I must be missing the *point* of this instrument in ones portfolio.. I get the low risk, but savings are even lower risk, and returns seem similar or even better. 

If either of you, or anyone else can point me to an article or give me some further info I'd find that both helpful and interesting

Cheers

My original question was about the location for my emergency money. The question is not about investment portfolio structure. After 5 pages of discussion I realized that bond fund is not a good instrument for this purpose.
Where can one put 20K in savings to have a better return? I have 123 Santander, and it's £120 a year on 20K, deduct £5 account fee and it leaves you with £60k. Not worth an effort. 

£60 is better than nothing. If that's the most appropriate choice from those available. 

masonic

joeNZ said:

masonic said:

The main point is to reduce volatility. If you can tolerate the risk of 100% equities in your investment accounts they may be of no benefit at all. Another reason is to generate some sort of return within an investment account wrapper where interest is not paid at all on cash. Historically, a third reason is to get a nice capital boost in a falling interest rate environment, but it is hard to see how that could continue.

The real issue seems to be the certainty of the continued inverse relationship between bonds and equities along with the fact that the reduction in bond yields any further seems unlikely. So, if bonds are not going to do the job of reducing volatility in the way traditional allocation strategies expect, the use of bonds versus cash seems a valid question to pose. So, for example, with an investment horizon of 10 years, the avoidance of having to cash up anything in the first 3 years (say) through a descending cash buffer seems something to consider?

I'm not sure what you mean by a descending cash buffer. Traditional asset allocation strategies tend not to deal with decumulation scenarios very satisfactorily. One option is to hold separate pots for short, medium and long-term with anything needed in the short term covered by cash and cash-like assets. Medium-term investments could be held in defensive stocks, corporate bonds etc (corporate bonds may still have a place in a portfolio), and long-term investments would be 100% equities, or other high risk assets. One might not need anything in the medium term pot during the accumulation phase. The short-term pot would generally need to be maintained at a base level, with perhaps a temporary increase when circumstances require it. It could consist of a ladder of fixed term savings accounts, though at the moment there is little benefit to fixing. There may be no need to rebalance from other pots if you have an income and can replenish from that.

NottinghamKnight

Thrugelmir said:

btcp said:

ChilliBob said:

Ive skimmed parts of this discussion, which were pretty interesting, but in the current climate I'm struggling see why somebody would choose to invest in bonds vs either (v low risk) savings sccounts/premium bonds, or (higher risk) equities in a lower risk fund likd World index tracker. 

I think I must be missing the *point* of this instrument in ones portfolio.. I get the low risk, but savings are even lower risk, and returns seem similar or even better. 

If either of you, or anyone else can point me to an article or give me some further info I'd find that both helpful and interesting

Cheers

My original question was about the location for my emergency money. The question is not about investment portfolio structure. After 5 pages of discussion I realized that bond fund is not a good instrument for this purpose.
Where can one put 20K in savings to have a better return? I have 123 Santander, and it's £120 a year on 20K, deduct £5 account fee and it leaves you with £60k. Not worth an effort. 

£60 is better than nothing. If that's the most appropriate choice from those available. 

Nothing much available easy access above 0.5%, which is still £100 a year, less hassle but cashback on 123 account may make that more lucrative than the simple £60 net. 

joeNZ

masonic said:

joeNZ said:

masonic said:

The main point is to reduce volatility. If you can tolerate the risk of 100% equities in your investment accounts they may be of no benefit at all. Another reason is to generate some sort of return within an investment account wrapper where interest is not paid at all on cash. Historically, a third reason is to get a nice capital boost in a falling interest rate environment, but it is hard to see how that could continue.

The real issue seems to be the certainty of the continued inverse relationship between bonds and equities along with the fact that the reduction in bond yields any further seems unlikely. So, if bonds are not going to do the job of reducing volatility in the way traditional allocation strategies expect, the use of bonds versus cash seems a valid question to pose. So, for example, with an investment horizon of 10 years, the avoidance of having to cash up anything in the first 3 years (say) through a descending cash buffer seems something to consider?

I'm not sure what you mean by a descending cash buffer. Traditional asset allocation strategies tend not to deal with decumulation scenarios very satisfactorily. One option is to hold separate pots for short, medium and long-term with anything needed in the short term covered by cash and cash-like assets. Medium-term investments could be held in defensive stocks, corporate bonds etc (corporate bonds may still have a place in a portfolio), and long-term investments would be 100% equities, or other high risk assets. One might not need anything in the medium term pot during the accumulation phase. The short-term pot would generally need to be maintained at a base level, with perhaps a temporary increase when circumstances require it. It could consist of a ladder of fixed term savings accounts, though at the moment there is little benefit to fixing. There may be no need to rebalance from other pots if you have an income and can replenish from that.

I guess I am talking about potential decumulation but not in the simplest sense. I actually "want" to generate excess absolute growth by the end of the period despite having cash needs over the investment period. The possible response to use a constant low SWR of say 2% is not possible due to the profile of cash needs.
I was suggesting that the most important priority might be to protect against forced withdrawal in the early years of the period (the specific horizon being say 10 years). And as a response to hold an initial 5 years of cash expenses (say) that drops to 2 years (say) and then held at 2 years for the rest of the term (all in the best available cash accounts). Everything else is held in equities. Any serious drop in equities in the first 3 years can easily be ignored hence avoiding longer term damage to the portfolio through drawdown. Its a modified bucket strategy whereby there are only two buckets where the first x years of expenses are held for consumption in the early years. As the years progress, if interest rates rise, the portfolio can be rebalanced into a more traditional bond/equity split. I realise that the downside is that 3 years of descending cash is not working for growth but I'm looking for something that can respond to the unusual status of bonds right now.
I cannot see how buying traditional bond funds right now can make any sense. There seems to be plenty of recommendations around corporate bonds but these just seem to be correlated to equity risk and hence won't offer the balance to equities that a balanced portfoilio is supposed to offer.

masonic

joeNZ said:

masonic said:

joeNZ said:

masonic said:

The main point is to reduce volatility. If you can tolerate the risk of 100% equities in your investment accounts they may be of no benefit at all. Another reason is to generate some sort of return within an investment account wrapper where interest is not paid at all on cash. Historically, a third reason is to get a nice capital boost in a falling interest rate environment, but it is hard to see how that could continue.

The real issue seems to be the certainty of the continued inverse relationship between bonds and equities along with the fact that the reduction in bond yields any further seems unlikely. So, if bonds are not going to do the job of reducing volatility in the way traditional allocation strategies expect, the use of bonds versus cash seems a valid question to pose. So, for example, with an investment horizon of 10 years, the avoidance of having to cash up anything in the first 3 years (say) through a descending cash buffer seems something to consider?

I'm not sure what you mean by a descending cash buffer. Traditional asset allocation strategies tend not to deal with decumulation scenarios very satisfactorily. One option is to hold separate pots for short, medium and long-term with anything needed in the short term covered by cash and cash-like assets. Medium-term investments could be held in defensive stocks, corporate bonds etc (corporate bonds may still have a place in a portfolio), and long-term investments would be 100% equities, or other high risk assets. One might not need anything in the medium term pot during the accumulation phase. The short-term pot would generally need to be maintained at a base level, with perhaps a temporary increase when circumstances require it. It could consist of a ladder of fixed term savings accounts, though at the moment there is little benefit to fixing. There may be no need to rebalance from other pots if you have an income and can replenish from that.

I guess I am talking about potential decumulation but not in the simplest sense. I actually "want" to generate excess absolute growth by the end of the period despite having cash needs over the investment period. The possible response to use a constant low SWR of say 2% is not possible due to the profile of cash needs.
I was suggesting that the most important priority might be to protect against forced withdrawal in the early years of the period (the specific horizon being say 10 years). And as a response to hold an initial 5 years of cash expenses (say) that drops to 2 years (say) and then held at 2 years for the rest of the term (all in the best available cash accounts). Everything else is held in equities. Any serious drop in equities in the first 3 years can easily be ignored hence avoiding longer term damage to the portfolio through drawdown. Its a modified bucket strategy whereby there are only two buckets where the first x years of expenses are held for consumption in the early years. As the years progress, if interest rates rise, the portfolio can be rebalanced into a more traditional bond/equity split. I realise that the downside is that 3 years of descending cash is not working for growth but I'm looking for something that can respond to the unusual status of bonds right now.
I cannot see how buying traditional bond funds right now can make any sense. There seems to be plenty of recommendations around corporate bonds but these just seem to be correlated to equity risk and hence won't offer the balance to equities that a balanced portfoilio is supposed to offer.

Ok, I understand what you are getting at now, but I would challenge the 3 years. If you are saying you will probably need to spend some of your assets over the first 3 years, but not after the third year, then that makes sense, but if you are drawing down steadily over time then a 3 year cash buffer is going to be insufficient because the risk of a loss from 100% equities (assuming vanilla global passive), even over 5 years will be significant. Whereas there isn't a great deal of difference in the risk of a >10% or a >20% loss over 1, 2, or 3 years. If you have, say a 10-20% risk of a >10% loss over 1 year, and it's still a >10% risk over 5 years, you'd need to factor in what percentage of your assets were being held in cash, and the opportunity cost of doing so vs the actual impact being a forced seller would have on you. You may not be deriving sufficient benefit to justify holding cash beyond the fixed 2 year buffer. I am highly doubtful there will be a meaningful improvement in bond yields within the next 3 years that would allow you to reinvest your descending cash into government bonds.

joeNZ

masonic said:

joeNZ said:

masonic said:

joeNZ said:

masonic said:

The main point is to reduce volatility. If you can tolerate the risk of 100% equities in your investment accounts they may be of no benefit at all. Another reason is to generate some sort of return within an investment account wrapper where interest is not paid at all on cash. Historically, a third reason is to get a nice capital boost in a falling interest rate environment, but it is hard to see how that could continue.

The real issue seems to be the certainty of the continued inverse relationship between bonds and equities along with the fact that the reduction in bond yields any further seems unlikely. So, if bonds are not going to do the job of reducing volatility in the way traditional allocation strategies expect, the use of bonds versus cash seems a valid question to pose. So, for example, with an investment horizon of 10 years, the avoidance of having to cash up anything in the first 3 years (say) through a descending cash buffer seems something to consider?

I'm not sure what you mean by a descending cash buffer. Traditional asset allocation strategies tend not to deal with decumulation scenarios very satisfactorily. One option is to hold separate pots for short, medium and long-term with anything needed in the short term covered by cash and cash-like assets. Medium-term investments could be held in defensive stocks, corporate bonds etc (corporate bonds may still have a place in a portfolio), and long-term investments would be 100% equities, or other high risk assets. One might not need anything in the medium term pot during the accumulation phase. The short-term pot would generally need to be maintained at a base level, with perhaps a temporary increase when circumstances require it. It could consist of a ladder of fixed term savings accounts, though at the moment there is little benefit to fixing. There may be no need to rebalance from other pots if you have an income and can replenish from that.

I guess I am talking about potential decumulation but not in the simplest sense. I actually "want" to generate excess absolute growth by the end of the period despite having cash needs over the investment period. The possible response to use a constant low SWR of say 2% is not possible due to the profile of cash needs.
I was suggesting that the most important priority might be to protect against forced withdrawal in the early years of the period (the specific horizon being say 10 years). And as a response to hold an initial 5 years of cash expenses (say) that drops to 2 years (say) and then held at 2 years for the rest of the term (all in the best available cash accounts). Everything else is held in equities. Any serious drop in equities in the first 3 years can easily be ignored hence avoiding longer term damage to the portfolio through drawdown. Its a modified bucket strategy whereby there are only two buckets where the first x years of expenses are held for consumption in the early years. As the years progress, if interest rates rise, the portfolio can be rebalanced into a more traditional bond/equity split. I realise that the downside is that 3 years of descending cash is not working for growth but I'm looking for something that can respond to the unusual status of bonds right now.
I cannot see how buying traditional bond funds right now can make any sense. There seems to be plenty of recommendations around corporate bonds but these just seem to be correlated to equity risk and hence won't offer the balance to equities that a balanced portfoilio is supposed to offer.

Ok, I understand what you are getting at now, but I would challenge the 3 years. If you are saying you will probably need to spend some of your assets over the first 3 years, but not after the third year, then that makes sense, but if you are drawing down steadily over time then a 3 year cash buffer is going to be insufficient because the risk of a loss from 100% equities (assuming vanilla global passive), even over 5 years will be significant. Whereas there isn't a great deal of difference in the risk of a >10% or a >20% loss over 1, 2, or 3 years. If you have, say a 10-20% risk of a >10% loss over 1 year, and it's still a >10% risk over 5 years, you'd need to factor in what percentage of your assets were being held in cash, and the opportunity cost of doing so vs the actual impact being a forced seller would have on you. You may not be deriving sufficient benefit to justify holding cash beyond the fixed 2 year buffer. I am highly doubtful there will be a meaningful improvement in bond yields within the next 3 years that would allow you to reinvest your descending cash into government bonds.

Yeh, the problem is lack of crystal ball.
We obviously have no way of knowing the yearly return rates from equities or knowing when and how long the next bear will last. The limited modelling I've done generates a large range of outcomes .... but the worst results appear to come from an extended early bear period that demands a substantial equity sell off to fund ongoing expenses.
The expenses need is front loaded steadily reducing after 5 years and the idea is that there will be no need to draw from the equity at all in first 3 years with the reducing cash pool to hand. Beyond year 5, with expense needs reducing, the response to a bear market would be much less problematic - cutting expenses would be viable. I guess I'm just trying to mitigate against a severe market drop in early part of the investment period (which happens to match the most demanding part of the expenses profile). 
I definitely feel uncomfortable all-in with equities so I'm looking for a balancing asset and all I can come up with is cash. The rebalancing to bonds that I plan to do if rates increase would come from the cash pool in the first 3 years (unlikely I know), after that equities would be converted. 
The real trouble is finding a reasonable asset not correlated with equities - I can obviously diversify the equity pool as far as possible but there's still plenty correlation in there. Also I have a firmish end date of 10 years where I'm likely to need to cash up much of the portfolio so I can't just wait it out. In fact, if bonds don't normalise, I might have to start a slow process of cashing up from year 7.
I guess you're saying that holding a couple of years of expenses should get me through most serious market drops in which case the opportunity cost of the initial 5 year descending cash profile is unjustified. The alternative position is that whatever happens in the first 5 years in the market, I have no risk of having to sell out at market bottom.

masonic

joeNZ said:

I definitely feel uncomfortable all-in with equities so I'm looking for a balancing asset and all I can come up with is cash. The rebalancing to bonds that I plan to do if rates increase would come from the cash pool in the first 3 years (unlikely I know), after that equities would be converted. 
The real trouble is finding a reasonable asset not correlated with equities - I can obviously diversify the equity pool as far as possible but there's still plenty correlation in there. Also I have a firmish end date of 10 years where I'm likely to need to cash up much of the portfolio so I can't just wait it out. In fact, if bonds don't normalise, I might have to start a slow process of cashing up from year 7.

Have you considered capital preservation investment trusts such as CGT, PNL and RICA (a couple of those have OEIC equivalents if that is your preference)? These don't eschew bonds entirely, but hold a mix of assets that has tended to hold up quite well during market turbulence and may serve as a second line of defence after cash.