Role of High Yield Bonds in a Portfolio

[ThisDinosaur]

High Yield Junk Bonds are not as anti-correlated with stocks as government bonds are. During recession/stock market decline, defaults should increase and bond prices may drop with stock prices. So, if you want to diversify out of stocks, but AAA bond yields are less than your debt interest, what do you do?

Until recently I was dividing my savings between liquid investments and paying down my mortgage and student loans. Mortgage interest is higher than student loan interest, and both are higher than 20yr bonds. I do not intend to keep this house after I hit my FI number. So that has me looking at higher yield.

[George the original one]

Until recently I was dividing my savings between liquid investments and paying down my mortgage and student loans. Mortgage interest is higher than student loan interest, and both are higher than 20yr bonds. I do not intend to keep this house after I hit my FI number. So that has me looking at higher yield.

Since you're planning on selling the property, are you including capital appreciation/depreciation for the housing investment? To me, I would do so and see how that offsets the higher rate of interest. Yes it is a fuzzy number compared to interest rates, so assign a range and some probabilities. After all, junk bonds are not exactly a guaranteed return, either.

From an efficiency perspective, I'd pay down the mortgage instead of adding to bonds if you want bond performance; the return is more guaranteed than even AAA bonds. From a current cash-flow perspective and even though it's less efficient in theory, I'd probably want to pay down the student loan instead of the mortgage since the mortgage will disappear when you sell.

[Dragline]

I agree with GTOO.

The reason to own treasuries is their negative correlation with the stock market, especially when stocks are at their worst. Many other bonds do not behave the same way, especially junk corporate. But the interest rate on LT treasuries is not high now (and won't be), so you would not buy them for that reason. Think of them as a weird, volatile, "negative Dow" stock that goes the opposite way of everything else and pays a decent dividend.

[ThisDinosaur]

I realize that this is essentially two questions that are only related in my specific set of circumstances.

The first is the way to use high yield bonds. Portfoliocharts.com doesn't seem to like them as a counterweight for any asset class. Also, they seem high risk, low reward. I'm curious if anyone here has them and what role they play in your portfolio.

The other question is about my house. @George, I'm fairly certain I overpaid for my house. I have accepted the possibility I may even lose money when I sell. I also don't think its worth it to realize that loss until I move away from this area (plan to quit and move to another area when I have "enough" liquid assets). If I either (a) planned on staying here for a decade or more, or (b)got at least a fair deal on this place, then I would keep paying down debt as a hedge. The fact that the debt on the bad-investment/house is higher than the student loans complicates things even further.

@Dragline. Yeah, I see LTTs as a stock hedge with a yield. But the liquidity premium is so low, I'd rather just hold straight up cash. Which I totally would, if I didn't have debt. I'm wicked indecisive about this.

[classical_Liberal]

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[Noedig]

The problem with treasuries/gilts, is that QE artificially depresses their yield to the point that it is almost zero.

This is a straightforward steal by the govts of the West, from savers.

The logical response, is to either eschew the state fixed interest market (unless going for outliers like Ukraine, with sovereign risk), or going high-yield.

Plenty of bank bonds and prefs around with 6-7% yields in the UK. Not looked elsewhere.

Unless FI already and a taker of the view that "Once you have finished playing, take the chips off the table", I'd stay heavy in equities and do the old Age-as-%age-of-bonds-in-portfolio rule, but with High Yield. It's more risk, but the reward free risk offered by treasuries, is worth avoiding.

[ThisDinosaur]

https://personal.vanguard.com/us/funds/bonds/bonddesk
Muni bond interest is tax free, and the yield is higher than Treasuries, even at the highest grade.

Here is how I see my options:

(1)mortgage at 2.75%, (2)student loans at 2.65%, (3)30y muni bonds at 3.83%, (4)30y treasuries at 3.01% minus taxes

Vanguard's Long Term Bond funds are all lower yield to maturity than my debt, PLUS they have an expense ratio and most are taxed as income.

Assuming these are all equally "guaranteed return" so to speak, I would lean toward (3).

Any suggestions?

[IlliniDave]

For a 1% differential, I would pay down the student loan and maybe even the mortgage. Just not enough wiggle room there for me to feel like the expected outcome would be to come out ahead. LT bonds expose you to the potential for capital loss if you have to sell during rising interest rates, even though the coupon is reliable. The reason muni bond interest is higher is because there is a greater chance that they will default. May not matter, but muni interest may be taxable at the state level (usually the case for muni bonds issued in another state).

[George the original one]

IlliniDave - you're figuring the wrong %... it's approximately a 39% increase in monies.

[classical_Liberal]

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[IlliniDave]

IlliniDave - you're figuring the wrong %... it's approximately a 39% increase in monies.

Nope. Not enough differential for me to carry the debt. For that I look at the difference in return versus interest rates, not their ratio. But I'm quite debt averse. If I could get treasuries paying maybe 6.5-7% or more with much shorter term/duration, then maybe I preserve the debt to buy the treasuries. But at ~3.5% vs 2.5% just not enough upside when considering the capital fluctuation risk with 30-year bonds.