Help Please - Bonds Asset Allocation

Lowtrawler

JamTomorrow said:

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.

Sounds a sensible approach for the needs you describe. You have described the main tax allowance risks and how you will address them which is good. I suggest you consider an IL Gilt ladder for the 2033 to 2038 period. Pricing is only marginally worse than conventional gilts and will cover the inflation risk.

For bucket 3, my go to fund is MWEP. It's an equal weighted worldwide fund investing in over 1,300 companies - If you put £1,300 into MWEP, you effectively get £1 in each of the 1,300 companies making up the fund. I have been concerned at the weight from Tesla / Apple etc and this is one way to overcome that risk.

JamTomorrow

Lowtrawler said:

Sounds a sensible approach for the needs you describe. You have described the main tax allowance risks and how you will address them which is good. I suggest you consider an IL Gilt ladder for the 2033 to 2038 period. Pricing is only marginally worse than conventional gilts and will cover the inflation risk.

For bucket 3, my go to fund is MWEP. It's an equal weighted worldwide fund investing in over 1,300 companies - If you put £1,300 into MWEP, you effectively get £1 in each of the 1,300 companies making up the fund. I have been concerned at the weight from Tesla / Apple etc and this is one way to overcome that risk.

I did consider IL GILTs but I want the maturing GILT to match the 20% Tax band of £50,270 as this is the amount I will withdraw to from my SIPP.  Therefore I did not think an IL GILT will achieve that goal - if tax bands are raised over the next 7 years I will add to my current rungs to match the 20% threshold.

I will look into MWEP as I have used XDWE as a S&P500 Equal Weight option.  I suspect i could end up playing with a few tilts in my 70% equity allocation but part of me just wants to keep it simple and go with one equity ETF or fund. 

Lowtrawler

JamTomorrow said:

Lowtrawler said:

Sounds a sensible approach for the needs you describe. You have described the main tax allowance risks and how you will address them which is good. I suggest you consider an IL Gilt ladder for the 2033 to 2038 period. Pricing is only marginally worse than conventional gilts and will cover the inflation risk.

For bucket 3, my go to fund is MWEP. It's an equal weighted worldwide fund investing in over 1,300 companies - If you put £1,300 into MWEP, you effectively get £1 in each of the 1,300 companies making up the fund. I have been concerned at the weight from Tesla / Apple etc and this is one way to overcome that risk.

I did consider IL GILTs but I want the maturing GILT to match the 20% Tax band of £50,270 as this is the amount I will withdraw to from my SIPP.  Therefore I did not think an IL GILT will achieve that goal - if tax bands are raised over the next 7 years I will add to my current rungs to match the 20% threshold.

I will look into MWEP as I have used XDWE as a S&P500 Equal Weight option.  I suspect i could end up playing with a few tilts in my 70% equity allocation but part of me just wants to keep it simple and go with one equity ETF or fund. 

By making an appropriate inflation estimate, you can buy IL Gilts that will match the £50,270 you want if the inflation estimate is matched. Obviously, if inflation is higher, you will exceed £50,270 and vice versa if it is lower. In reality, I think it is unlikely thresholds will be frozen all the way through to 2033 and Labour have previously said they plan to index link them after 2027/28. I can see the freeze being extended but not for 6 years.

JamTomorrow

Okay, I thnk I get this but it may add a layer of complexity I am not prepared for just yet.  

If I understand correctly comparing TG33 (matures 31/7/33) v T33 (matures 22/11/33) then these have a Gross Redemption Yield of 4.5% and 1.4%, with a 3.1% difference.  So if I expect inflation to exceed 3.1% on average over the ~8 years to redemption then I would be wise to make an extra payment now to purchase T33 vs TG33.

My calculations indicate it would cost £38,135 today to get £50k in nominal terms when TG33 matures, versus £43,602 to get £50k in real terms from T33.

I calculated the £43,602 as follows -

£50,000 / Index ratio of 1.09136 = £45,814 of nominal bonds required

£45,814 / 100 *Clean Price of £95.17 = £43,602 cost today

Not sure if this is correct.  It makes my head hurt which is a good enough reason at this stage not to add something I don't fully understand but a great suggestion and one I will keep in mind from when I am adding rungs to the ladder in future.

Lowtrawler

JamTomorrow said:

Okay, I thnk I get this but it may add a layer of complexity I am not prepared for just yet.  

If I understand correctly comparing TG33 (matures 31/7/33) v T33 (matures 22/11/33) then these have a Gross Redemption Yield of 4.5% and 1.4%, with a 3.1% difference.  So if I expect inflation to exceed 3.1% on average over the ~8 years to redemption then I would be wise to make an extra payment now to purchase T33 vs TG33.

My calculations indicate it would cost £38,135 today to get £50k in nominal terms when TG33 matures, versus £43,602 to get £50k in real terms from T33.

I calculated the £43,602 as follows -

£50,000 / Index ratio of 1.09136 = £45,814 of nominal bonds required

£45,814 / 100 *Clean Price of £95.17 = £43,602 cost today

Not sure if this is correct.  It makes my head hurt which is a good enough reason at this stage not to add something I don't fully understand but a great suggestion and one I will keep in mind from when I am adding rungs to the ladder in future.

You can use the ladder tool at https://lategenxer.streamlit.app/Gilt_Ladder to do the calculations for you. If you assume 3.0% inflation and want the bond proceeds on 1/4/2033, you would roughly need to buy 20,000 T32 for IL @ a dirty price of 188.31 = £37.7k or 40,400 TR33 for conventional @ a dirty price of 93.08 = £37.6k

For IL gilts using the tool, the output and input is in money of today and so you have to work out for yourself what that means. In your case, you want £50,270 on 1 April 2033 and so, in money of today, that is 7.5 years meaning you need proceeds of £50,270 / (1.03^7.5) = £40,275. If you think inflation will be 3.5%, you replace 1.03^7.5 with 1.035^7.5 and if you think it will be 2.5%, you replace it with 1.025^7.5

As you can see, there is virtually no difference in the pricing if you believe there will be 3% inflation and it removes the inflation risk. IMV, if you are paying a similar price for IL Gilts v Conventional, you are getting inflation protection for free. Note, you always pay the dirty price for both IL Gilts and Conventional gilts. There is usually not much difference between dirty and clean for conventionals but the same is not true for IL

JamTomorrow

Fantastically explained Lowtrawler, I was able to recreate using the numbers you quoted and understand the maths and logic behind it now. 

I have moved into the first 2 rungs of my GILT ladder for 2033 and 2034 but will sleep on whether to replac some or all of the GILT ladder for years 3-5 with a mix towards Index Linked.  With the breakeven inflation being 3% then I can see the atrraction of these linkers.

If I think to potential future regrets I feel I would definitely have more regret from not holding linkers if we got 1970s levels of inflation versus if inflation ran at only 1% for the next 7 to 12 years.

Thank you.