Author Topic: Is it beneficial to have bonds just for the sake of re-balancing in downturns?  (Read 1170 times)

FIREngine

  • 5 O'Clock Shadow
  • *
  • Posts: 1
So I'm basically all in on stock indices(95% stocks), but with this recent downturn, I am left wondering if there is an advantage to keeping some value in cash or bonds just for the sake of the re-balancing. Is there something I'm missing? Or does this factor help tilt the equation slightly towards not having everything in VTSAX?

IsThisAGoodUsername

  • 5 O'Clock Shadow
  • *
  • Posts: 66
  • Location: USA
What does your Investment Philosophy Statement say? Does it say stay the course or to react emotionally? (That's somewhat snarky and tongue-in-cheek, but in essence my point is you're in it for the long haul. Remember that.)

Stick to your desired Asset Allocation. Rebalance accordingly on whatever quarterly/annual schedule meets your needs.

mjr

  • Bristles
  • ***
  • Posts: 419
  • Age: 54
  • Location: Brisbane, Qld
  • Retired at 52
OP's asking for advice on what the asset allocation should be, not the ol' "stick your IPS" response.

If you can handle the volatility, you'll get a better return from having most money in equities, but the extra risk/return tradeoff becomes more marginal at > 80-85% equities

LuigiNMario

  • 5 O'Clock Shadow
  • *
  • Posts: 11
OP's asking for advice on what the asset allocation should be, not the ol' "stick your IPS" response.

If you can handle the volatility, you'll get a better return from having most money in equities, but the extra risk/return tradeoff becomes more marginal at > 80-85% equities

This is somewhat true, but you should have at least 10% in bonds. While it's not necessarily an easy read, William Bernstein's "The Intelligent Asset Allocator" is a great book (or his Four Pillars book) and his analysis points that between a 100% equity PF and a 90%/10% equity/bonds PF, you will have at least an equal or higher return and certainly lower risk with the 90/10 portfolio provided you rebalance on a regular basis (not more often than quarterly).

It is also what Warren Buffet recommends his heirs (90/10):
https://www.marketwatch.com/story/warren-buffett-to-heirs-put-my-estate-in-index-funds-2014-03-13

There are many Vanguard Bond ETFs that make it easy to invest in bonds. The more short-term and the higher the credit quality, the less volatile the fund will be.

Radagast

  • Handlebar Stache
  • *****
  • Posts: 1715
  • One Does Not Simply Work Into Mordor
It is debatable. I'd recommend not ever having more than 90% in stocks as a general principle, because markets can do strange things. That said, if you have $10k in a checking account, $90k in VTSAX, and a $2k paycheck coming on Friday, I would say you are less than 90% stocks, and I'd grant quite a few other flexibilities as well.

For cash, probably no, it will drag you down by too much to benefit except for some rare occasions after you start living off your money. For longer term bonds, maybe some times.

I keep a 5%ish allocation to extremely volatile long term government bonds for this reason. Between dollar cost averaging and rebalancing, I think they will not hurt my mean or median chances. They will hurt the best chances, but improve the worst. So I think that is a fair trade.

Mighty-Dollar

  • Bristles
  • ***
  • Posts: 412
"The investor should never have less than 25% or more than 75% of his funds in common stocks." -- Benjamin Graham
https://www.bogleheads.org/wiki/Graham_75-25_rule

BikeLover

  • 5 O'Clock Shadow
  • *
  • Posts: 28
Let's say you have 90% in stocks, the other 10% in bonds or cash, and rebalance once a year. Assume you have $100,000 in stocks, $10,000 in bonds or cash at the beginning of the year. If the stock market drops 50% (after account for reinvested dividends), you'll have $45,000 in stocks, $10,000 in bonds, for a net value of $55,000. To rebalance, you would sell $4,500 of the bonds, and purchase $4,500 of the stocks. So you would end up purchasing $4,500 of stocks at the 50% discounted value.

If you're still in the accumulation period, and saving/investing $20,000 per year with a monthly investment of $1666, over the course of the year you'll also have bought a bunch of stocks at discounted values.

At least in the accumulation phase, if you're saving 10%-20% of your stache's value each year, you'll likely fare better being all in on stocks than a mix of stocks and bonds.

Putting the numbers into the calculator at https://engaging-data.com/fire-calculator/, assuming income of $40,000 and a savings rate of 50% or $20,000 as well as annual spending of $20,000 in retirement, then based on historical simulations, investing in 100% stocks with the above figures gives a median time to retirement (growth of the stache to $535,0000) of 11.1 years and a maximum of 17.9.
Investing in 90% stocks gives a median time of 11.3 years and a maximum of 17.9.

In effect, the continual investment of new savings provides a benefit comparable to having a portion of the portfolio in bonds.

Mr. Frugal Pharmacist

  • 5 O'Clock Shadow
  • *
  • Posts: 15
    • Mr. Frugal Pharmacist
100% stocks at all times is the way to go.

ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 2259
Yes if you plan to spend down the retirement funds by equally drawing from all sources and maintaining a constant asset allocation.

No if you plan to spend from your stocks during economic good times and use your bonds/cash in the event of major corrections so that you don't have to sell stocks.

These two strategies have different risk functions and will do better than the other in different circumstances.

Padonak

  • Pencil Stache
  • ****
  • Posts: 699
Yes if you plan to spend down the retirement funds by equally drawing from all sources and maintaining a constant asset allocation.

No if you plan to spend from your stocks during economic good times and use your bonds/cash in the event of major corrections so that you don't have to sell stocks.

These two strategies have different risk functions and will do better than the other in different circumstances.

Can you explain it a little bit more? Especially about different risk functions and different circumstances? My strategy is the second strategy: to have a bond + cash "cushion" i can use during downturns.

ChpBstrd

  • Handlebar Stache
  • *****
  • Posts: 2259
Yes if you plan to spend down the retirement funds by equally drawing from all sources and maintaining a constant asset allocation.

No if you plan to spend from your stocks during economic good times and use your bonds/cash in the event of major corrections so that you don't have to sell stocks.

These two strategies have different risk functions and will do better than the other in different circumstances.

Can you explain it a little bit more? Especially about different risk functions and different circumstances? My strategy is the second strategy: to have a bond + cash "cushion" i can use during downturns.

If you are a rebalancer, your best case scenario is (1) stocks drop and bonds rise, (2) you sell bonds high and buy stocks low, and then (3) stocks and bonds go back to the prices they previously had. During this time, spending is withdrawn proportionally so that the overall AA is unaffected. So a retiree with an 80/20 portfolio making their monthly draw extracts 80% of the draw from stocks and 20% from bonds. Thus, that 80% of their monthly draw involves selling stocks relatively low. Regardless of how long the downturn lasts, the AA and riskiness of the portfolio stays constant.

If you are an emergency fund keeper, a drop in the stock market of x% or some similar metric triggers you to switch from making your monthly draw from stocks to instead make your monthly draw from cash/bonds, per your carefully written Investment Policy Statement. Ideally, the downturn is brief (let’s say < 3 years) and no stocks are sold at relatively low prices. When the downturn has passed (as defined in the IPS) the emergency fund keeper sells stock relatively high to replenish the emergency fund. The portfolio’s AA changes during the downturn, becoming more and more stock-heavy and risky as it goes on.

The rebalancer is probably in a more sustainable position to survive a prolonged 8-10 year downturn, like the 1930s. The stock they sell “low” could always go much “lower”. If that happened, they would be glad to have sold stock instead of cash/bonds. However, for a routine recession involving a 1-2 year recovery, they will underperform the emergency fund keeper, who held all their stock through the dip. However, the emergency fund keeper would suffer dearly if the downturn continued because once the emergency fund is spent they would be selling their stock at even lower average prices than the rebalancer got. Even worse, they’re now in a volatile 100% stock portfolio with potentially years of declines still to come, and meanwhile they’re getting older and more vulnerable to risk.

Of course, routine 1-3 year corrections are far more common than decade-long slumps, so maybe over the course of a 30-40 year retirement the emergency fund keeper comes out ahead. It depends on the timing of market returns. Before a 2 year correction to be followed by a stock rally, I’d rather be an emergency fund keeper. Prior to a decade-long slump, I’d rather be a rebalancer.

dougstash

  • 5 O'Clock Shadow
  • *
  • Posts: 63
  • Age: 25
  • Location: Pittsburgh
Short answer: It can be beneficial. It can also slow your growth down.

It all depends on what time frame you are  talking about.  Consider this… The year is 2007 and you have an asset allocation of 80% stock and 20% bonds and then the market tanks. You rebalance by selling bonds and buying stocks to maintain your AA. This helped accelerate your portfolios growth. Because your were able to convert your relatively stable bonds into stocks.

Scenario two: It is now March 2009. You currently hold an asset allocation of 80% stocks and 20% bonds. You hold the bonds so you can convert them to stock if market continues to crash so you can take advantage of some more bargain stock prices. This however didn’t happen. Instead your bonds will be a drag on your portfolio over the next decade as the market begins to go up and you sell shares of stock to buy bonds as the market rises to maintain your 80/20 AA

I do believe there were some studies that a small percentage of bonds can help a portfolio but by an extremely tiny amount. I’d imagine the time frame would make a difference too. For me it’s just not worth it.  I’m a working guy who just buys more stock with my income whenever I get paid.