Using LifeStrategy 20 as a Bond Fund

Wonky_Dan

Linton said:

Wonky_Dan said:

Linton said:

Wonky_Dan said:

I thought I'd drag this back up in the hope of some advice. I'm mid 30's and I've been looking to start adding some bonds into my SW workplace pension to diversify, eventually getting to an 80/20 split. I've currently got the equity portion allocated as per global market cap which I'm happy with.

The core funds that I have access to are either a passive corporate bond fund, UK index linked gilt fund or standard gilt fund. I've started building a position slowly in the passive UK Gilt fund now that prices are starting to drop a bit and yields rising. I understand the potential intrest rate risk with these.

Ideally I feel that I'd like a global government bond fund for further diversification, however there are none available to me, other than expensive and/or actively managed strategic funds. I have the access to the Threadneedle Global Bond fund which would work out in the region of 0.7% which feels a bit too expensive for me. Alternatively I have Lifestrategy 20 which would cost me 0.58% a year.

My question really is would the LS20 at that cost be worth adding for some extra diversification or should I just stick with gilts, or perhaps a 50:50 inflation linked gilt : standard gilt split for some sort of inflation protection? I know I'm very late the index linked bond party...

I feel you are concentrating on the wrong things.  You seem to be very concerned aboutr the fees but you are happily moving from 100% equity to 80% equity.

Over the past 10 years VLS100 has averaged 12% return per year, VLS80 10.4% return per year.  So the difference in  return between a 100% equity and the corresponding 80/20 one was more than 10 times the difference in charges between the 2 funds you mention.

I am unclear as to why you want 20% bonds.  What do you think it will give you?  Once you have determined that perhaps it will be more obvious as to which bond fund (if any) you should choose.  It is more importrant that the funds you choose match your objectives than what the charges are.

I just feel like it would be a sensible thing to do to start building a position slowly in something other than pure equities. I'll not be swapping to 80:20 straight away, just a slow build up over a few years as I get older. My workplace pension is my largest saving vehicle for retirement so I look at it as building a less volatile holding as I work my way towards 40. I realistically want to retire earlier than state pension age if possible.

If we hit a big crash and I'm 100% equities in my 40's that could potentially take a decade to recover, I don't think I'd be too pleased with myself. Also wih the current uncertainty in everything, doing this slowly makes more sense to me
rather than selling 20% of my equities and dumping it all in Gilts in 1 go.

So you want protection against a crash.  You say you want to retire earlier than SP age.  How much earlier?  5 years ealier would make you 63, still another 25 years or so to go.  There probably will be at least two major crashes in 25 years, but you will for most of that period have room for your 10 years recovery aided by your ongoing purchase of cheap fund units.

A big equity crash could be 50%, and we can assume that your bonds remain constant,  So an 80/20 portfolio would fall by 40% whereas a 100% equity portfolio would fall 50%.  Is the difference significant?  Is it worth sacrificing say 1.6%/year return to achieve?  You run the risk of losing more on your precautions than you would in a crash.

Perhaps it would be more sensible to review the situation in 10-15 years time and perhaps start to move significant money into cash or and/or go for a 60/40 split.

I'd like to retire mid 50's,and given my current savings rate that should certainly be doable for me. I've used compound growth calculators with a 3% growth rate and I should still be pretty comfortable. Still I have 20 years or more as you say. I do have an isa which I'll be using to bridge a few years if necessary, depending on how life turns out. 

It isn't so much that I'm looking for crash protection in the form of lowering volatility. I read a post on the US bogleheads forum from a poster who basically said that he has several years expenses in his portfolio in bonds so that if there's a crash, you can live off selling the bonds whilst the equities recover. 

This made sense to me so that is the main reason I thought about building a position in bonds slowly. More as extra financial backup in a way. Whether or not this thinking is in fact correct I couldn't honestly say. I'll admit to only starting to pay attention to my pension and investments with the last few years so I'm new. I've been working on educating myself but I still have a long way to go. 

Perhaps it would give me a better outcome to remain fully in equities for longer as you suggest.

masonic

Bonds could be useful to live off when a crash comes along, but it is an irrelevant point for you as you cannot access your pension yet. Why buy bonds now for a risk 20 years in the future? I suspect you'll be able to buy bonds at a fairer valuation say 5-10 years ahead of when you intend to retire. In the mean time you'll likely benefit from greater growth in equities.

JohnWinder

My question really is would the LS20 at that cost be worth adding for some extra diversification or should I just stick with gilts, or perhaps a 50:50 inflation linked gilt : standard gilt split for some sort of inflation protection?

I don't feel the LS20 rather than bonds is worth it for the extra diversification, if you're comparing that with your global equity fund plus some government bonds. You'd be getting some corporate bonds which I can't see the point of when you have equities in any % your want, and global equities plus govt bonds (even if it's only your own govt) is pretty darn diversified. As well, not much inflation liked bonds in VLS20, and for the life of me I can't see why linkers are not a good choice if you're going to own government bonds. They have the same anticipated real return as nominal bonds, plus you get unexpected inflation protection. What's not to like about that for half your bond holding?

I'm not suggesting you should have bonds now; plenty of sensible comments have already been offered to you. But I would add that if you slowly buy bonds now, you won't be at 20% for a while, and 80/20 is not crazy territory for someone closing in on retirement.

All of that aside, you read as though you're pretty clued up on the issues here, so you should feel confident in following your own best judgment on these matters because no one else has a crystal ball that can see ahead to what would be your most rewarding strategy.

Just to add, as with the passive market cap weight of my equities, I thought doing the same with my FI would be a good idea too.

I don't think that's a truism. You market cap weight as many equities as is reasonable so as to reduce the risk associated with any one stock/sector/country/whatever failing. That same risk does not exist with government bonds; they're not supposed to default. I don't think it's necessarily wise to rely on that, especially if you held mostly bonds, but cap weighting doesn't protect you from a govt default. Depends how risk averse you are, and what alternatives are available; I'd hesitate at a fee of 0.7%/yr for global govt bonds. Hang around, fees like that are likely to come down in coming years if there's a god.

Last thought: write it all down in your investment policy statement.