Future distribution yield of bond funds

aroominyork

Thanks All – useful discussion. As ever, bonds make equities seen so simple…  For clarification, this is purely retirement planning (we are early 60s). I knew this inheritance would come one day and since, with it, we will not add significantly more to our retirement fund (nor draw on it yet since we are still working) it raises a question of whether our 70/30 equity/FI strategy needs re-thinking, but that is one for another day.

JohnWinder said:

cash pays c.3% for a one year fix, what is the attraction of such a (bond) fund (yielding 1.7%) if you are not predicting that a capital gain will be made?...........Are many people taking their route of replacing bonds with cash?

But if you’re a long term investor, then you might choose the bond fund because its duration (many years) more closely matches your drawdown horizon than a term deposit with a duration of less than 1 year. It’s horses for courses, and generally the best returns come from duration matching the investment with the needs; and the longer the term of investing the higher the returns are expected to be.

If we are talking about funds rather than individual bonds – and if we rebalance equities/bonds/cash annually – does that mean holding both a medium/long duration fund and also, for when it has been volatile and I do not want to sell it, a short duration fund?

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences.

...New money is different, and what you are really asking is 'should I wait before investing it because I don't like the outlook for my investment of choice vs cash'. I'm sure you are not considering staying in cash for the long term, nor considering investing money you intend to spend in the short term.

Earning 3.5% net of basic rate tax is still a little better than using a cash ISA where you'd get no more than 2.6% at current rates. Presumably not all of it would be taxed. But what happens after that first year?

I wouldn’t take money out of a tax wrapper. The option is to change the tax wraps from 70/30 to being mostly equities, and hold cash with some of the new money.

“What happens after the first year” is key. Take the Vanguard aggregate fund: as time passes and new issues replace maturity holdings, the yield will gradually rise if the fund price remains steady. I guess, like many people (especially relatively new investors) I am adjusting to the bond bull run being over and that we may be reverting to bonds playing their historic role of diversifying from equities. If so, and if equities fall, presumably there will be some capital growth in bonds. Which leads onto…

masonic said:

I've been using a ladder of fixed term savings accounts plus a little gold as a bond proxy for a couple of years now (alongside WP funds). I'm poised to start replacing that with bonds as it has largely served its purpose in preventing me from suffering a ~20% loss of capital from my bonds component.

I prefer bonds (when they are not ridiculously priced) for their usual negative correlation with equities.

So your view is that you have shielded yourself from falls (well done) and you think bonds are now appropriately priced for the task at despite cash's better superficial yield? If so, is that because of the potential capital gain if equities fall? By the way, by ‘bonds’ do you mean govt only or aggregate (my guess is not high yield)?

Frequentlyhere said:

Occam investing has a few great articles.

Thanks – I like Occam and will read this soon.

JohnWinder

If we are talking about funds rather than individual bonds – and if we rebalance equities/bonds/cash annually – does that mean holding both a medium/long duration fund and also, for when it has been volatile and I do not want to sell it, a short duration fund?

If by that you mean ‘assuming rebalancing a stock/bond/cash portfolio without withdrawing, should one hold a short duration bond fund in addition to the desired medium term one?’, then I can’t see any reason to. Having a mix of different duration bond funds can optimize duration for withdrawals, but I haven’t heard it suggested that it helps for rebalancing purposes. Whatever, rebalancing is a two edged sword with regard to returns, and two bond funds rather than one (duration differing, only) is unlikely to swing the returns/costs needle much, so it could an issue akin to how many angels can dance on the head of a pin.

aroominyork

JohnWinder said:

If we are talking about funds rather than individual bonds – and if we rebalance equities/bonds/cash annually – does that mean holding both a medium/long duration fund and also, for when it has been volatile and I do not want to sell it, a short duration fund?

If by that you mean ‘assuming rebalancing a stock/bond/cash portfolio without withdrawing, should one hold a short duration bond fund in addition to the desired medium term one?’, then I can’t see any reason to. Having a mix of different duration bond funds can optimize duration for withdrawals, but I haven’t heard it suggested that it helps for rebalancing purposes. Whatever, rebalancing is a two edged sword with regard to returns, and two bond funds rather than one (duration differing, only) is unlikely to swing the returns/costs needle much, so it could an issue akin to how many angels can dance on the head of a pin.

I was unclear - I meant during withdrawals. I like the 'bucket' concept: equities, bonds and cash, rebalancing annually. In that context, might a short duration fund change the allocation from, say: 65% equities, 20% bonds, 15% cash, to 65% equities, 15% long duration bonds, 10% short duration bonds, 10% cash.

masonic

aroominyork said:

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences.

...New money is different, and what you are really asking is 'should I wait before investing it because I don't like the outlook for my investment of choice vs cash'. I'm sure you are not considering staying in cash for the long term, nor considering investing money you intend to spend in the short term.

Earning 3.5% net of basic rate tax is still a little better than using a cash ISA where you'd get no more than 2.6% at current rates. Presumably not all of it would be taxed. But what happens after that first year?

I wouldn’t take money out of a tax wrapper. The option is to change the tax wraps from 70/30 to being mostly equities, and hold cash with some of the new money.

“What happens after the first year” is key. Take the Vanguard aggregate fund: as time passes and new issues replace maturity holdings, the yield will gradually rise if the fund price remains steady. I guess, like many people (especially relatively new investors) I am adjusting to the bond bull run being over and that we may be reverting to bonds playing their historic role of diversifying from equities. If so, and if equities fall, presumably there will be some capital growth in bonds. Which leads onto…

masonic said:

I've been using a ladder of fixed term savings accounts plus a little gold as a bond proxy for a couple of years now (alongside WP funds). I'm poised to start replacing that with bonds as it has largely served its purpose in preventing me from suffering a ~20% loss of capital from my bonds component.

I prefer bonds (when they are not ridiculously priced) for their usual negative correlation with equities.

So your view is that you have shielded yourself from falls (well done) and you think bonds are now appropriately priced for the task at despite cash's better superficial yield? If so, is that because of the potential capital gain if equities fall? By the way, by ‘bonds’ do you mean govt only or aggregate (my guess is not high yield)?

Looking at the actual results, the equities part of my portfolio delivered an annualised return of +3.42% over the last 2 years and my bond proxies delivered only a little less than this, taking my average down slightly to +3.35% per year (cash was about 2.2% using a ladder of fixed term accounts, the rest of the lifting was done by the small gold allocation). If I had stuck with a hedged global aggregate bond index fund, that would have pulled my average down to 0.43%, and if I had used a vanilla UK gilt index fund, I'd be down at -2.44% per year. So over the period I'm about 5.5-12% better off than I could have been.

My focus at the moment is on government, though I'm not jumping in until all talk of 0.5% and 0.75% rate hikes has been put to bed. I think there may be some downward pressure on corporates, especially high yield, but I did very well out of buying NCYF at a massive discount near the bottom of the Covid crash, and wouldn't rule out doing something similar if another opportunity presents. I'm not keen on buying now as we head into recession and a higher risk free rate of return. This would all be very much tinkering around the edges. The vast majority of my portfolio is invested according to a much more boring strategy.

aroominyork

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences. ISA money could lose its tax status, or you might be stuck trying to partially transfer into a cash ISA with poorer rates than the conventional savings market. Some providers will only allow you to transfer out your whole ISA. Someone with a SIPP is not going to be able to remove money until age 55, and if they do there may be income tax consequences.

aroominyork said:

I am about to receive an inheritance which will take a few years to feed into tax-wrapped accounts. My plan - before thinking about this bond vs. cash issue - was to use a trading account and structure it to minimise dividend, income and capital gains tax.

If I want cash instead of bond funds, I could (in rough terms) hold equities in the tax wrappers, not bother with a trading account, and open a few cash accounts for one year (or other) savings. I will be a basic rate taxpayer so 3.5% becomes 2.8%.

I don't think you are considering all of the options. For example, TN24 would give you a return approaching 4% risk free, mostly as a tax exempt capital gain. I know individual gilts are a pain to transact through a fund supermarket, but it's probably worth the effort if the inheritance is large enough.

As MK62 pointed out 4% doesn't seem correct. With 16 months to run this gilt which is priced at £96.34 on HL will return 3% pa. But as you say, masonic, most of that is an untaxed capital gain which makes it an interesting option rather than cash which, after the savings allowance, would be taxed at 20%.

masonic

aroominyork said:

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences. ISA money could lose its tax status, or you might be stuck trying to partially transfer into a cash ISA with poorer rates than the conventional savings market. Some providers will only allow you to transfer out your whole ISA. Someone with a SIPP is not going to be able to remove money until age 55, and if they do there may be income tax consequences.

aroominyork said:

I am about to receive an inheritance which will take a few years to feed into tax-wrapped accounts. My plan - before thinking about this bond vs. cash issue - was to use a trading account and structure it to minimise dividend, income and capital gains tax.

If I want cash instead of bond funds, I could (in rough terms) hold equities in the tax wrappers, not bother with a trading account, and open a few cash accounts for one year (or other) savings. I will be a basic rate taxpayer so 3.5% becomes 2.8%.

I don't think you are considering all of the options. For example, TN24 would give you a return approaching 4% risk free, mostly as a tax exempt capital gain. I know individual gilts are a pain to transact through a fund supermarket, but it's probably worth the effort if the inheritance is large enough.

As MK62 pointed out 4% doesn't seem correct. With 16 months to run this gilt which is priced at £96.34 on HL will return 3% pa. But as you say, masonic, most of that is an untaxed capital gain which makes it an interesting option rather than cash which, after the savings allowance, would be taxed at 20%.

I misunderstood MK62's point, I thought it was about >12 months being unsuitable rather than my failure to annualise. I was estimating the overall return (not annual) and should have been clearer about this. I stopped at that point because I didn't know when your inheritance would land in your bank account, so maybe it will be less than 16 months by the time you're in a position to invest.

The most recent buy according to LSE was at 16:25 on Friday at £95.982 (and it didn't go above 96.06 all day - HL's chart appears to agree with LSE). I think HL's feed is doing the usual thing when markets are closed. That price would make the running yield 0.130% and you'd get three semi-annual payments if you bought before the next ex-dividend date of 20th Jan 2023. The total return (not annualised) would therefore be 100 - 95.982 + 1.5 * 0.13 * 0.8 = 4.194% net of BR tax. However, if you bought during September then if the price stays the same you'd get 3.15% net, which is equivalent to 3.93% pa savings interest if taxed at 20% as you suggested it would be.

JohnWinder

might a short duration fund change the allocation from, say: 65% equities, 20% bonds, 15% cash, to 65% equities, 15% long duration bonds, 10% short duration bonds, 10% cash.

It would give a bit more flexibility for withdrawals, and I'd imagine the benefits, or detriments, would be small. Cash is quite like a short term bond fund and you're talking about small differences in allocation. Angels, pins etc.

MK62

masonic said:

aroominyork said:

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences. ISA money could lose its tax status, or you might be stuck trying to partially transfer into a cash ISA with poorer rates than the conventional savings market. Some providers will only allow you to transfer out your whole ISA. Someone with a SIPP is not going to be able to remove money until age 55, and if they do there may be income tax consequences.

aroominyork said:

I am about to receive an inheritance which will take a few years to feed into tax-wrapped accounts. My plan - before thinking about this bond vs. cash issue - was to use a trading account and structure it to minimise dividend, income and capital gains tax.

If I want cash instead of bond funds, I could (in rough terms) hold equities in the tax wrappers, not bother with a trading account, and open a few cash accounts for one year (or other) savings. I will be a basic rate taxpayer so 3.5% becomes 2.8%.

I don't think you are considering all of the options. For example, TN24 would give you a return approaching 4% risk free, mostly as a tax exempt capital gain. I know individual gilts are a pain to transact through a fund supermarket, but it's probably worth the effort if the inheritance is large enough.

As MK62 pointed out 4% doesn't seem correct. With 16 months to run this gilt which is priced at £96.34 on HL will return 3% pa. But as you say, masonic, most of that is an untaxed capital gain which makes it an interesting option rather than cash which, after the savings allowance, would be taxed at 20%.

I misunderstood MK62's point, I thought it was about >12 months being unsuitable rather than my failure to annualise. I was estimating the overall return (not annual) and should have been clearer about this. I stopped at that point because I didn't know when your inheritance would land in your bank account, so maybe it will be less than 16 months by the time you're in a position to invest.

The most recent buy according to LSE was at 16:25 on Friday at £95.982 (and it didn't go above 96.06 all day - HL's chart appears to agree with LSE). I think HL's feed is doing the usual thing when markets are closed. That price would make the running yield 0.130% and you'd get three semi-annual payments if you bought before the next ex-dividend date of 20th Jan 2023. The total return (not annualised) would therefore be 100 - 95.982 + 1.5 * 0.13 * 0.8 = 4.194% net of BR tax. However, if you bought during September then if the price stays the same you'd get 3.15% net, which is equivalent to 3.93% pa savings interest if taxed at 20% as you suggested it would be.

You'd also need to account for dealing costs and/or custody charges.........

masonic

MK62 said:

masonic said:

aroominyork said:

masonic said:

aroominyork said:

What do you mean by "normal savings accounts are beyond reasonable reach"?

If your capital is currently within a S&S ISA or a SIPP, pulling it out to place into the retail savings market is going to present some challenges or at least some undesirable consequences. ISA money could lose its tax status, or you might be stuck trying to partially transfer into a cash ISA with poorer rates than the conventional savings market. Some providers will only allow you to transfer out your whole ISA. Someone with a SIPP is not going to be able to remove money until age 55, and if they do there may be income tax consequences.

aroominyork said:

I am about to receive an inheritance which will take a few years to feed into tax-wrapped accounts. My plan - before thinking about this bond vs. cash issue - was to use a trading account and structure it to minimise dividend, income and capital gains tax.

If I want cash instead of bond funds, I could (in rough terms) hold equities in the tax wrappers, not bother with a trading account, and open a few cash accounts for one year (or other) savings. I will be a basic rate taxpayer so 3.5% becomes 2.8%.

I don't think you are considering all of the options. For example, TN24 would give you a return approaching 4% risk free, mostly as a tax exempt capital gain. I know individual gilts are a pain to transact through a fund supermarket, but it's probably worth the effort if the inheritance is large enough.

As MK62 pointed out 4% doesn't seem correct. With 16 months to run this gilt which is priced at £96.34 on HL will return 3% pa. But as you say, masonic, most of that is an untaxed capital gain which makes it an interesting option rather than cash which, after the savings allowance, would be taxed at 20%.

I misunderstood MK62's point, I thought it was about >12 months being unsuitable rather than my failure to annualise. I was estimating the overall return (not annual) and should have been clearer about this. I stopped at that point because I didn't know when your inheritance would land in your bank account, so maybe it will be less than 16 months by the time you're in a position to invest.

The most recent buy according to LSE was at 16:25 on Friday at £95.982 (and it didn't go above 96.06 all day - HL's chart appears to agree with LSE). I think HL's feed is doing the usual thing when markets are closed. That price would make the running yield 0.130% and you'd get three semi-annual payments if you bought before the next ex-dividend date of 20th Jan 2023. The total return (not annualised) would therefore be 100 - 95.982 + 1.5 * 0.13 * 0.8 = 4.194% net of BR tax. However, if you bought during September then if the price stays the same you'd get 3.15% net, which is equivalent to 3.93% pa savings interest if taxed at 20% as you suggested it would be.

You'd also need to account for dealing costs and/or custody charges.........

Good point. I'll leave that to aroominyork as I don't know the amount or platform involved. Hopefully custody would be zero if using any of the platforms with a cap on exchange traded instruments, or iWeb which is zero for all holdings.

aroominyork

I'm very grateful to masonic for mentioning TN24. I have never bought an individual gilt and hadn't envisaged doing so, but I wanted to tie up some cash until late 2023/early 2024. I will exhaust my personal savings allowance next FY so a gilt that pays minimal interest and a CGT-free capital gain suits my perfectly. Dealing costs were £7.99 (not a problem given the quantity I bought) and I use Interactive Investor so there is no marginal custody charge.