As we're almost ready to FIRE, I've been thinking a lot about our long-term asset allocation strategy. So, this discussion of stocks vs. bonds is very relevant to me. I'm not considering substituting dividend stocks or REITs for bonds. I'm not planning on buying any bonds at all. But I want to make sure I'm doing the right thing...
All through the accumulation phase, since I was 21 years old, I've been invested in 100% stocks. In 2008, when the market tanked, I just continued dumping all of my excess money into the stock market. I have absolutely no problem with big draw downs in my accounts. So, I don't need bonds for any psychological reasons. I only want to buy bonds if they will, in some way, add actual value to my investing strategy.
A few months ago I quit working. After we sell our house, sometime next year, we will be FIRE. I don't want to ever
have to work at a job again.
One third of our net worth is invested (100% stocks) in tax deferred tIRAs, Roths and 401k accounts. Two thirds of our net worth is tied up in our house, which we're about to put onto the market in the next couple of months. We've also got around one year's worth of living expenses in savings and checking accounts which is what we are living off of now.
When we sell our house in 2016 we will have ~$600K in cash to invest. My inclination is to put all of it into VTSAX. If we had to, we could live on only the dividends from VTSAX, but we'd obviously like to spend more if market returns support that.
No matter how many scenarios I run on cFIREsim, the same results appear: the more bonds in my portfolio, the higher probability I will run out of money in fewer than 40 years. To me, this is the only thing that matters. I don't want to run out of money!
Would someone please explain to me why bonds make a portfolio safer? People keep saying that bonds in their portfolios make it easier for them to sleep at night. WTF? Why would knowing that you are more likely to run out of money make you sleep better at night? I understand that bonds smooth out volatility in a portfolio, and I can see how a very small percentage of bonds, say up to 10%, actually increases CAGRs. But, overall, higher percentages of bonds in my portfolio correlate with a higher probability of running out of money before we run out of life. This is what the data tell me. Am I missing something here? If so, please explain.
Sorry this is getting long, but one more thing. The other day I was listening to a podcast on
econtalk.org, and in the comments someone posted a recent quote from one of Warren Buffet's letters to his Berkshire Hathaway shareholders. When I read WBs letter it pretty much confirmed what I'd been thinking all along - holding cash is NOT safe. Short term t-bills are paying less than inflation right now. Sorry, I'm not interested. Anyway, check out WBs letter, and I'll be interested to hear what you guys have to say. Any advice on my particular situation will also be greatly appreciated, as I'm a little scared to dump a big chunk of change into the stock market right now, but it's the only thing I can think of to do with it that makes any sense to me.
Here's WBs letter:
"Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13¢ in 1965 (as measured by the Consumer Price Index).
There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”
The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.
For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities."
