Stop worrying about the 4% rule

[secondcor521]

If that's not true, please explain where it's not, and what is true in place of that.  Am I wrong about the relative cash flow in bond fund shares in a major stock downturn?

It's possible that in a major downturn, many people get afraid and sell their stocks and buy bonds.  That could provide enough inflows into bond funds where there are net fund inflows.  For people like you who are selling $100 of the fund, they just make an accounting entry and take $100 from the $500 that a scared investor paid into the fund, give it to you, and take the remaining $400 and buy more bonds, not selling any.

I don't know the relative magnitude of the flows.  It could depend on the overall market trend and what is happening on a weekly or daily basis.  There are companies that track fund flows, but I don't think they can do it on an individual fund basis.  The mutual fund company knows of course.

Agreed.  Then again, what are we supposed to do at least once a year?   Rebalance our portfolio!   And if stocks are down, that means rebalancers sell bonds to buy stocks.  That could lead to some big flows out of bonds.  Anytime that a bond holder sells a low interest rate bond early, they lose value off of their bond holding because the bond face value is discounted due to the low rate.  If those bonds were owned by a fund, the fund loses value.  If the person purchasing the bonds is purchasing the bonds IN THE FUND, it's a cash flow wash.  But if the entity purchasing the bonds isn't doing it as a bond fund shareholder, but instead is purchasing the entire bond to hold in their own right, it's a loss for the bond fund value.

Does that make sense?

Sure.

The other thing you might not be considering in your analysis is mark to market.  I am fairly certain that mutual funds, including bond funds, have to price their assets at market value every day and reflect that in the NAV.  So in the example you're talking about here, the loss of value in that low interest bond due to rising market interest rates gets reflected gradually in the NAV as interest rates rise.  When it actually gets sold (perhaps to meet redemptions), it's just an exchange of cash for a bond, and the NAV doesn't drop as a result of the sale.

So in the end, that loss of value happens gradually over time as the worth of the fund's assets declines due to rising rates.  It isn't due to the sales of any bonds to meet redemptions.

There is another effect which could happen, which is if a bond fund has to meet an extremely large and extremely quick amount of redemptions.  If they have to sell so many bonds at once, that would flood the market and they wouldn't be able to get what they thought they could.  I don't know if that has ever happened to a bond fund, but it could.  I would think this would happen only if there were some sort of scandal or market shock, like if the Fed chair died or something.  In the normal course of ebbs and flows, I think this would be a non-issue.

[Must_ache]

So, about the bond returns being separated from stock returns.

If I buy an individual bond, and I hold it to maturity, it will pay exactly what it is supposed to.  (Assuming the company doesn't go out of business, etc.)

So, if my bond holdings are in individual bonds, my returns should be largely independent of the stock market.  If I needed to sell a bond early, the price should go up or down based on the relative interest rates that the bond pays versus newly issued bonds offered.

That's how I understand it.

But putting lots of money into buying a single bond has its own risk.  The company could go belly up and make the bond worth much less.   Plus, it takes a lot of money at one time to buy the bond.   So, people buy into a bond fund to solve those two problems.

And that's where I think it defeats the purpose of bond results being separated from stock results.
....
Do y'all think I've got it right?  If not, what did I miss?

I don't think you're not talking about why stocks are different from bonds, you're just talking about diversification.  People also can buy funds rather than put all their eggs in a few baskets.

Bonds and stocks are entirely different securities.  A bond provides a steady, relatively known return, except for the probability of impairment.  If things go south for the company you could lose half or all of your principal.  If you get an AA bond, the default rate is 0.38%.  If you get a BBB bond, the default rate is 1.02%.  Stocks are part ownership in a company.

Another reason they are kept separately is because they have very different expected returns and standard deviations.  The risk (std dev) and reward (expected return) for stocks are higher.  You can look on a 20-yr chart and see the different between stocks and bonds.  The theory is that you should have some combination of the two depending on your risk appetite.  If you are 20 years old you want 100% stocks.  If you are 60 you might want 25%-40% bonds because you have accumulated your wealth and don't want to put your nest egg through as much risk.

[vand]

Ben Felix is not usually known for sprouting bullshit numbers - he says (citing a far more rigorous study) 2.7% may be the true SWR at the 5% failure rate when you account for:

Cherry picked US dataset the Bengen study was done on and how things could have unfolded in alternate reality, as well as life expectancy distributions.

It's not a new point but has always been glossed over. Yes, 4% is based around a bad-outcome scenario but in historical context it is a bad outcome from an already very favourable dataset.

https://youtu.be/1FwgCRIS0Wg

[MDM]

...how things could have unfolded in alternate reality....

Once we move from historical reality to alternate reality, anything is possible.

[vand]

...how things could have unfolded in alternate reality....

Once we move from historical reality to alternate reality, anything is possible.

But in terms of the reward delivered for the amount of risk implied (the equity risk premium), the US has outperformed - that could easily have not happened had more of the risk been realised.  The other reality is just one where the US performs in line with expectation.

[MDM]

But in terms of the reward delivered for the amount of risk implied (the equity risk premium), the US has outperformed - that could easily have not happened had more of the risk been realised.  The other reality is just one where the US performs in line with expectation.

That would depend on expectations, and those can be subjective things.  As has been said, predictions are difficult, especially about the future.

If one believes the future will be worse than the worst of the past - as measured by the datasets used - then one is of course free to act on those beliefs.