Help Please - Bonds Asset Allocation

JamTomorrow

I'm currently being really indecisive over how I will choose and allocate to Bonds in my Portfolio for retirement.  Looking at ~35% allocation to bonds.

Currently 7 years away from retirement, and expect to draw down from that pension for rest of my life, some potential for an annuity purchase during my lifetime but no longer certain on that.

I think I want the bonds to serve as ballast to equities and counter correlate and provide mitigation if a large equity correction (30%+) occurred in the couple of years leading up to my retirement.  I also wantthem to serve as mitigation against inflation.

I have been reading and researching but I am sitll procrastinating over whether I need bonds to be
1. domestic vs global hedged to GBP
2. Index linked vs not
3. Short v Medium v Long duration
4. Individual GILTs vs Funds

With all these options I don't know which to pick / prioritise and dont want 6+ bond funds in my portfolio to tick all bases.  I also want simplicity and try to restrict to 2-3 bond funds.

Any tips / guidance to move me towards making a decision on which bond funds to invest in?

SVaz

A 10 year collapsing Gilt ladder would be my choice - it gives certainty.  You could leave the rest in equities to grow. 
I almost set one up but I need the bulk of my income from 2028-2032 so I gambled on interest rates not dropping below 3% ( which is the break even point with Gilts for those years) and went for a short term money market fund instead. 
Rates 7 years out and beyond for Gilts aren’t bad if you buy them now. 
I was badly burned by the bonds fiasco, lost 25% within a week of buying them on a ‘good’ bond fund so even though a similar event may be unlikely, there is no way on earth I will hold them again,  once I’m 67 the income from my investments will suffice.  

Obviously you have a much longer timeframe to consider so bond funds might be better for you. 

SVaz

An index linked 10 year ladder starting in 2032, with £10k a year income is currently £84440. 

£85k in a STMMF for 7 years at 2.5% results in £101k but that’s obviously not index linked,  you would need more like 4.6% to get the same amount. 

Linton

I think that 35% of your total investment held as "ballast" is a waste and that you should look for positive reasons for investing in bonds.  This should help you in deciding which bonds to buy.

Possible reasons
 - At the moment fixed gilts are providing sufficient returns as  savings to more than mitigate expected long term inflation. IL gilts are generally trading below par so will provide returns greater than inflation. This is unlikely to continue indefinitely.
 - Do you need extra ongoing income?  Gilts can provide a lower income than annuities with the same high level of guaranteed safety but are much more flexible if your needs change over time - you cannot sell an annuity.  Corporate bonds can provide significantly higher income though of course at a somewhat higher risk. 
 
Risks
 - Your selling price is only guaranteed at maturity.  Far from maturity the price can be quite volatile but as they get closer to maturity it approaches £100.  This should be considered before buying long term bonds. Also it is a factor when considering bond funds as when you sell most of the underlying holdings will not be near maturity unless the fund specifically holds short dated bonds.

Ideally you should hold bonds with a maturity date close to when you expect to sell.

Other options
You can protect yourself against short/medium term equity crashes in other ways.  In particular you can set up your finances so that you would have no need to sell equity in the short term.  This is a significant topic in its own right and does require a moderate level of understanding of investing. 

leosayer

If the main purpose of your bond holdings is to mitigate sequence risk then you shouldn't expect a meaningful real return or a perfect negative correlation to equities.  The only real safe bonds are one which have the lowest issuer and currency risk which for UK/GBP residents means gilts.

My approach to determining my low risk (ie. bond/cash) allocation is to work out the £ value in bonds that will prevent me from abandoning my retirement plans if equities were to crash. To do this, you need a reasonable plan for how much income you need in retirement.

For example, if your income needs are £20k per year then you might determine that £100k in low risk investments will give you the security you need. That might require an allocation to bonds of 20% or 30% or whatever. How you get there depends on what you are planning to save for the next 7 years. 

Having a %-based allocation to bonds means that you need to periodically rebalance back to your chosen allocation if it drifts too far from your target. In other words, if equities crash then you sell bonds and buy equities cheap.

Do you have an expected income requirement?

How do you know you are 7 years from retirement?

If you have a lot of certainty then a gilt ladder might do the trick but otherwise a gilt fund  gilt fund with average duration of your time horizon can be held and/or built up as you approach retirement.

If you are targetting an annuity for some or all of your pension then a different strategy will be required because then you're also exposed to the risk of annuity rates dropping.

JamTomorrow

Thanks for helpful thoughts and suggestions.

This has moved me towards building a bond ladder such that if I hold to maturity I am certain it will generate ~£50k/year for 5 years seeing me through to 2037 / Age 62.  In my mind that then gives me certainty of withdrawal from my SIPP up to the £50,270 tax threshold each year which would be my intention on retirement.

The remainder of my portfolio can then be left either 100% in a Global Equity tracker or an 80%/20% bond split; the plan then being each year from 2032 to replenish the bond ladder to realise ~£50k in 5 years time.

QrizB

JamTomorrow said:
This has moved me towards building a [5 year] bond ladder ...
The remainder of my portfolio can then be left either 100% in a Global Equity tracker or an 80%/20% bond split; the plan then being each year from 2032 to replenish the bond ladder to realise ~£50k in 5 years time.

My ambitions are more modest than yours, but I've done something similar. A 5-year gilt ladder to cover basic needs with the rest left invested, intending to extend the ladder until I claim my DB.

JamTomorrow

QrizB said:

JamTomorrow said:
This has moved me towards building a [5 year] bond ladder ...
The remainder of my portfolio can then be left either 100% in a Global Equity tracker or an 80%/20% bond split; the plan then being each year from 2032 to replenish the bond ladder to realise ~£50k in 5 years time.

My ambitions are more modest than yours, but I've done something similar. A 5-year gilt ladder to cover basic needs with the rest left invested, intending to extend the ladder until I claim my DB.

Thank you.

A question on the 'left rest invested' - do you have and bond funds in whats left or you all in equities / another asset allocation with that portion of your portfolio?  I am considering whether to hold the rest as 100% equity or an 80:20 split.

In addiiton, whe you come to extend your ladder, and add a 6th year when year 1 returns the principal, then do you just consider it noise that you will accumulate some coupon payments over the 5 years before the return of principal?

leosayer

JamTomorrow said:

QrizB said:

JamTomorrow said:
This has moved me towards building a [5 year] bond ladder ...
The remainder of my portfolio can then be left either 100% in a Global Equity tracker or an 80%/20% bond split; the plan then being each year from 2032 to replenish the bond ladder to realise ~£50k in 5 years time.

My ambitions are more modest than yours, but I've done something similar. A 5-year gilt ladder to cover basic needs with the rest left invested, intending to extend the ladder until I claim my DB.

Thank you.

A question on the 'left rest invested' - do you have and bond funds in whats left or you all in equities / another asset allocation with that portion of your portfolio?  I am considering whether to hold the rest as 100% equity or an 80:20 split.

In addiiton, whe you come to extend your ladder, and add a 6th year when year 1 returns the principal, then do you just consider it noise that you will accumulate some coupon payments over the 5 years before the return of principal?

The idea behind a gilt ladder is that the maturity dates are in line with when you need the money for spending.

So in your case, your gilts would have maturity date in 2032,2033,2034 etc to meet your annual spending need in retirement.

QrizB

JamTomorrow said:

A question on the 'left rest invested' - do you have and bond funds in whats left or you all in equities / another asset allocation with that portion of your portfolio?  I am considering whether to hold the rest as 100% equity or an 80:20 split.

My gilts are currently ~25% of my pot. The other 75% in equities, one of my pension provider's passive funds.

I'm not going to claim I've made the best choice for me, let alone for you!

JamTomorrow said:

In addiiton, whe you come to extend your ladder, and add a 6th year when year 1 returns the principal, then do you just consider it noise that you will accumulate some coupon payments over the 5 years before the return of principal?

Th first "rung" of my ladder will mature in October 2026, and (if everything's gone to plan) will be taken as UFPLS. At that time I'll sell enough of my equities that, together with whatever coupons and other odds 'n' sods of cash are in my account, I can buy the 6th rung. Then repeat in 2027 with the 2nd rung maturing and buying the 7th rung. And so on, gradually turning equities into gilts until the ladder reaches the age at which I'm planning to draw my DB (which will replace it).
If it turns out that the AI bubble has burst and we're all living in some sort of a Mad Max dystopia, I might have to re-think

JamTomorrow

Thanks for the helpful comments which have helped me to determine the bonds position in my portfolio.

 

I like the thought suggested of having a positive reason to hold bonds, rather than just ballast, and along with the comments on a bond ladder I have decided that holding a bond ladder (as described by leosayer) that provides some certainty over my first 5 years of retirement (starting in 7 years) is the right strategy for me.  I am going to couple that within a 3 bucket strategy that should see me not having to make an active decision on my portfolio over the next 7 years, and potentially up to 12 years if the market conditions are not right to add a new rung to my bond ladder from my equity holding.  My asset allocation / portfolio strategy will be as follows, and happy to hear critiques or concerns with this from the contributors on this forum :

 

Bucket 1 – Near Term 1 Year requirements in a MM fund – will start at 0 today but build up to ~£50k using coupons from Bucket 2 (0% today rising to £50k in 7 years)

Bucket 2 – 6 individual UK GILTs - 5 year GILT ladder from 2033 to 2038 delivering ~£50k as I intend to withdraw to the 20% Tax band each year (and do not expect this to rise with inflation), plus single GILT to deliver TFLS in 2032 which I am assuming will still be there and unchanged from the £268k it is today (Total ~30% of current portfolio).  On withdrawal the TFLS will be used to add £40k/year to mine and Wifes ISA, with the balance being held in Wifes name who has no income.

Bucket 3 – Either 70% VWRP, or split with XUSE if I conclude based on CAPE that the US is overweight and I want to dampen down my US holding : I will use this bucket to add additional rungs to the bond ladder; this could be as early as 2033 or as late as 2038 allowing me to ride out an equity downturn.  I will continue to contribute into this bucket over the next 7 years.

 

The way I look at this is that I really do not need to do too much at all over the next 7 years.  Just move coupons into a MM fund, invest regularly into VWRP (hopefully buying a dip at some point over the next years) and adding to my GILT rungs on the ladder if the 20% tax band changes.

 

My main risks are inflation eroding the £50k GILTS ladder (but if tax bands don’t change that doesn’t matter) and if they do then I will top up my rungs from bucket 3.  A collapse in UK GILTS raising rates would not impact me as holding to maturity.  I see UK Govt default as very low and even if happened still have 70% of my portfolio in equities.

 

Any other risks I am missing or concerns with this approach?

 

Thanks for insights.