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How Should I Build a Bond Portfolio in My IRA?

Question: Currently 40% of my retirement funds are in cash because I fear interest rates can only go up.  I’m earning only 1% and I realize this money should probably be invested in bonds.  I would prefer ETFs, but am open to managed funds.  Whatever funds I use would be within my IRA.  I am 64, but do not anticipate needing this money for a very long time, if ever.  My first question is allocation: Is a total bond market ETF adequate, or should I also invest in a foreign fund, high-yield fund, and/or TIPs?  What funds would you recommend, and what allocation?  My second question is even more important to me.  How do I get from cash to bond funds or ETFs?  All at once?  Two percent a month for 50 months? Short, intermediate, or long term?

-John Duft, St. Jacob, Ill.

Answer: You could use a single bond fund, but most advisers recommend a slightly more nuanced strategy that layers an index fund with a couple of actively-managed funds. Tom Orecchio, a financial adviser with Modera Wealth Management in Westwood, N.J., suggests putting 75% of your portfolio into a broad index fund like the Vanguard Total Bond Market Index fund (VBTLX or BND), which aims to match the returns of broader bond market – not to outperform, and not to underperform. That will give you market performance at a very low cost (in this case, for an investment over $10,000, expenses are 0.11% per year).

Because index funds are required to match an index (typically the Barclays Capital U.S. Aggregate Bond Index), they may be required to hold bonds that could bring down your overall performance—which, right now, would include Treasurys or long-dated bonds, both of which are sensitive to losses if interest rates rise. For a chance to do a little better, Orecchio suggests allocating the remaining 25% to an actively managed bond fund. Like an index fund, it will invest in all different kinds of bonds, but in this case, a professional manager will choose the proportions with an eye toward outperformers, says Orecchio.

Among the options, you’ll find very different strategies and wide risk profiles. For example, the Baird Core Plus Bond fund (BCOSX) invests about 20% in bonds rated BBB or below, which increase the fund’s yield – and the chance of volatility.  The J.P. Morgan Core Bond fund (PGBOX), on the other hand, holds more bonds with higher credit quality and gets kudos from fund-tracker Morningstar for its stability, but it has had lower returns than the Baird fund: 7.9% per year for the last three years, compared to 9.3%, according to Standard & Poor’s.

If you’re interested in an actively-managed fund, visit the fund’s website to get a sense of the manager’s strategy, and look for funds with a reasonable expense ratio that won’t eat too much into the fund’s returns. (Also see How to Choose a Bond fund for more information.)

To your question of timing, when you move the money into bonds isn’t as important with as it would be if you were investing in equities, which are more volatile. But nervous investors can build their positions by moving over the cash into bonds in equal amounts monthly over six months, says Dean Junkans, chief investment officer for Wells Fargo Private Bank.

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    • Catherine AMEN!!! We have the same family plhiosophy! In fact, we just last night returned from 3 weeks of traveling through Europe with our always homeschooled girls (ages 12 and 14). I have followed your blog since before you started on your trip and enjoy very much your photos and stories. If you’re ever in Houston, we’d love to have you stay with us.-Catherine-[]

    • Short term ETF Bond funds would probably be the best if you insist on having bonds.

    • It’s been pretty well decided that interest rates aren’t going up until at least 2013 by the Feds, so that issue has been laid to rest. Still, Bond Yields can’t get much lower so the Yields could go up when stocks are rallying. I moved most of my stocks to bonds before the recent crash, and dodged the bullet while making some gains.
      @donner; while I sometimes criticize the advice given in article’s, the entire point is missed if you don’t say what you believe the problem is.

    • what terrible advice if you can call this advice! i’d tell her to run not walk away from that advice and this column!

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