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.