Author Topic: Bonds Aren’t as Wretched an Investment as They Seem  (Read 9055 times)

AdrianC

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Bonds Aren’t as Wretched an Investment as They Seem
« on: July 18, 2016, 07:08:38 AM »
Another Jason Zweig article:

http://blogs.wsj.com/moneybeat/2016/07/15/bonds-arent-as-wretched-an-investment-as-they-seem/

Conclusion:
The generation-long bull market in bonds is probably drawing to a close. But high-quality bonds are still the safest way to counteract the risk of holding stocks, as this year’s returns for both assets have shown. Even at today’s emaciated yields, bonds are still worth owning.

Emphasis mine on "probably".

I've been slowly coming around to the usefulness of bonds in our portfolio as I slowly transition into FIRE. Short-term bonds, mind you. Not those 10-20-30 year things.

MichaelB

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #1 on: July 18, 2016, 08:22:12 AM »
Yes, for people who are going to start drawing from their investments, bonds are going to be a very important hedge. A big market correction right when you quit work actually hurts you quite a bit more than a correction 5 or 10 years after you start drawing down.

Cottonswab

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #2 on: July 18, 2016, 08:44:16 AM »
They seem relatively wretched to me.  With interest rates and inflation far below historical norms, interest less than stock dividends, I would be shocked and appalled if bonds outperform stocks over the next 5-10-20 years. 

I keep my emergency fund in money markets, savings accounts, and short-term CDs.  My investment money is all in stocks.

forummm

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #3 on: July 18, 2016, 09:19:24 AM »
They seem relatively wretched to me.  With interest rates and inflation far below historical norms, interest less than stock dividends, I would be shocked and appalled if bonds outperform stocks over the next 5-10-20 years. 

The purpose of bonds is not to outperform stocks over the medium to long term. It's to reduce portfolio volatility. As you draw down, volatility can exhaust your portfolio more quickly. In the short or medium term, bonds can (and do) outperform stocks somewhat frequently.

It's fine to go 100% stocks (if you will stick with it for the rest of your life and not switch to bonds during a downturn). But more risky, and more volatile. To help reduce extra damage to your portfolio, you should be prepared to dramatically reduce your expenditures if the market drops a lot.

Cottonswab

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #4 on: July 18, 2016, 11:00:19 AM »

The purpose of bonds is not to outperform stocks over the medium to long term. It's to reduce portfolio volatility. As you draw down, volatility can exhaust your portfolio more quickly. In the short or medium term, bonds can (and do) outperform stocks somewhat frequently.

It's fine to go 100% stocks (if you will stick with it for the rest of your life and not switch to bonds during a downturn). But more risky, and more volatile. To help reduce extra damage to your portfolio, you should be prepared to dramatically reduce your expenditures if the market drops a lot.

You make a good point, but the value of bonds can and does decrease as interest rates rise.  Therefore, the risk adjusted expected return on bonds will very likely be less than inflation until interest rates revert to the mean.

Another point to consider is that volatility becomes less and less important as the dividends from equities approach your spending levels.  This minimizes amount that would need to be withdrawn during periods where equities are undervalued.  For me, I would not expect to have to withdraw more than 1% of my assets, after accounting for dividends, in any given year.  Given that my emergency fund covers 2 years of expenses, short term volatility in the stock market would be highly unlikely to result in me selling undervalued equities to cover living expenses. 
« Last Edit: July 18, 2016, 07:38:54 PM by Cottonswab »

forummm

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #5 on: July 18, 2016, 12:38:15 PM »
The purpose of bonds is not to outperform stocks over the medium to long term. It's to reduce portfolio volatility. As you draw down, volatility can exhaust your portfolio more quickly. In the short or medium term, bonds can (and do) outperform stocks somewhat frequently.

It's fine to go 100% stocks (if you will stick with it for the rest of your life and not switch to bonds during a downturn). But more risky, and more volatile. To help reduce extra damage to your portfolio, you should be prepared to dramatically reduce your expenditures if the market drops a lot.

You make a good point, but the value of bonds can and does decrease as interest rates rise.  Therefore, the risk adjusted expected return on bonds will very likely be less than inflation until interest rates revert to the mean.

Another point to consider is that volatility becomes less and less important as the dividends from equities approach your spending levels.  This minimizes amount that would need to be withdrawn during periods where equities are undervalued.  For me, I would not expect to have to withdraw more than 1% of my assets, after accounting for dividends, in any given year.  Given that my emergency fund covers 2 years of expenses, short term volatility in the stock market would be highly unlikely to result in me selling undervalued equities to cover living expenses. 

Stock downturns tend to be anticorrelated with increases in interest rates. So you aren't usually experiencing declines in both stocks and bonds at the same time. If you have a WR under 3% (2% divs + 1% share sales, on top of 2 years in cash), that's incredibly conservative. It doesn't really matter what stocks do at that point. And 2 years in cash is a pretty intense emergency fund. Over time the drag of inflation on those funds will significant, unless you can get a higher yield savings account.

k9

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #6 on: July 18, 2016, 02:26:59 PM »
Stock downturns tend to be anticorrelated with increases in interest rates.
Sounds suspicious. When interest rates increase, bonds become more attractive than they were, so investors tend to buy more of them, to the detriment of stocks.

forummm

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #7 on: July 18, 2016, 07:23:57 PM »
Stock downturns tend to be anticorrelated with increases in interest rates.
Sounds suspicious. When interest rates increase, bonds become more attractive than they were, so investors tend to buy more of them, to the detriment of stocks.

When stock markets tank, it tends to be because of a recession. And during a recession the government lowers interest rates to stimulate the economy. Lower interest rates leads to higher bond returns (price return). Also, when stocks tank, people market time and flee to the safety of bonds, which also leads to higher bond returns (again price return).

k9

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #8 on: July 19, 2016, 02:26:08 AM »
Yes, price return, but you were talking about interest rates.

AdrianC

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #9 on: July 19, 2016, 08:10:14 AM »
Another point to consider is that volatility becomes less and less important as the dividends from equities approach your spending levels.  This minimizes amount that would need to be withdrawn during periods where equities are undervalued.  For me, I would not expect to have to withdraw more than 1% of my assets, after accounting for dividends, in any given year.  Given that my emergency fund covers 2 years of expenses, short term volatility in the stock market would be highly unlikely to result in me selling undervalued equities to cover living expenses.

Dividends can be cut. They tend to get cut when the economy is poor and the markets are down.

Were you an investor in 2008?

dividendman

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #10 on: July 19, 2016, 11:19:04 AM »
There is something satisfying about BND. It doesn't go up very much, but if you look at the chart it steadily rises (although it has beaten both VEU and VTI over the last 12 months) and plops out interest payments every month. It just sits there doing it's thing. I get that it's yield is only 2.4% and over the long run it's somewhat of a drag on things but I love it.

I have 20% of my portfolio in it and for some reason I love it the most. Whenever I have to rebalance into BND I get a bit happier and whenever I rebalance out I get a little sad.

Is that weird?

Cottonswab

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #11 on: July 19, 2016, 09:39:08 PM »

Dividends can be cut. They tend to get cut when the economy is poor and the markets are down.

Were you an investor in 2008?

Yes.  I am well aware of the fact that dividends can be cut.  From the 2008 high to 2009 low, the dividend payout decreased 22%.  The dividend payout did not reach 2008 highs until 2012.  If this same event were to happen again, I would need to draw down on my emergency fund, but I would not need to sell any of my equity investments. So, I am still not very concerned about dividend cuts. I can also provide more goods or services to earn more money, should I want to take advantage of cheap stocks during a crash

I think some readers may be missing my main point, which is that bonds have a poor expected ROI, relative to stocks currently and bonds historically.  I am not arguing that they will not reduce portfolio volatility or that that stock market crashes will not inflate the value of bonds.

What is important is that you calculate the ROI for these different scenarios and then weight them by the probability of those scenarios occurring to determine an "expected" ROI. 

If I may make an analogy, it is for this same reason that I have not invested in bunkers, guns, and ammo.  While this would be the best investment for several possible scenarios, I don't think these scenarios are likely enough for the expected ROI of buying bunkers, guns, and ammo to be better than the alternatives.

Seppia

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Bonds Aren’t as Wretched an Investment as They Seem
« Reply #12 on: July 20, 2016, 12:02:05 AM »
I agree.
As the great Buffet said, bonds today seem to provide return free risk.

AdrianC

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #13 on: July 20, 2016, 05:47:48 AM »

Dividends can be cut. They tend to get cut when the economy is poor and the markets are down.

Were you an investor in 2008?

Yes.  I am well aware of the fact that dividends can be cut.  From the 2008 high to 2009 low, the dividend payout decreased 22%.  The dividend payout did not reach 2008 highs until 2012.  If this same event were to happen again, I would need to draw down on my emergency fund, but I would not need to sell any of my equity investments. So, I am still not very concerned about dividend cuts. I can also provide more goods or services to earn more money, should I want to take advantage of cheap stocks during a crash

We were invested 100% in stocks in 2007, and 2008, and 2009. We bought more when we could.

It would have been so much better to have had 20% or more in short term bonds in 2007.

How did you do in 2008/2009?


AdrianC

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #14 on: July 20, 2016, 05:48:38 AM »
I agree.
As the great Buffet said, bonds today seem to provide return free risk.

That needs some context. Berkshire holds 10s of billions in short term bonds.

Seppia

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #15 on: July 20, 2016, 12:25:33 PM »
Very very very short term.
You're right, buffet is referring to longer term stuff.
What Berkshire holds almost equates to cash.
He is anti bonds for sure in general, even more now

AdrianC

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #16 on: July 20, 2016, 04:45:28 PM »
Buffett:

Well, I didn’t lay out my whole will. . . . I did explain, because I laid out what I thought the average person who is not an expert on stocks should do. And my widow will not be an expert on stocks. And I wanna be sure she gets a decent result. She isn’t gonna get a sensational result, you know? And since all my Berkshire shares are going to philanthropy, the question becomes what does she do with the cash that’s left to her? Part of it goes outright, part of it goes to a trustee. But I’ve told the trustee to put 90% of it in an S&P 500 index fund and 10% in short-term governments. And the reason for the 10% in short-term governments is that if there’s a terrible period in the market and she’s withdrawing 3% or 4% a year you take it out of that instead of selling stocks at the wrong time. She’ll do fine with that. And anybody will do fine with that. It’s low-cost, it’s in a bunch of wonderful businesses, and it takes care of itself.



LAGuy

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #17 on: July 20, 2016, 06:08:26 PM »
Another Jason Zweig article:

http://blogs.wsj.com/moneybeat/2016/07/15/bonds-arent-as-wretched-an-investment-as-they-seem/

Conclusion:
The generation-long bull market in bonds is probably drawing to a close. But high-quality bonds are still the safest way to counteract the risk of holding stocks, as this year’s returns for both assets have shown. Even at today’s emaciated yields, bonds are still worth owning.

Emphasis mine on "probably".

I've been slowly coming around to the usefulness of bonds in our portfolio as I slowly transition into FIRE. Short-term bonds, mind you. Not those 10-20-30 year things.

Ugh... I feel like I'm betting against the house by buying government bonds right now.  All the central banks are trying to boost growth and if they succeed rates rise and I get hosed.  And if they fail and there is deflation aren't I better off in high quality corporate bonds???  VCLT has provided pretty good offset on risk-off days but that may be getting long in the tooth as well.  When do I win with longer term govt bonds... some horrible deflation where the world ends???

Bonds aren't for winning. They're for not losing.

LAGuy

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #18 on: July 20, 2016, 07:26:42 PM »
Ok, I'll try again.

Bonds are not an investment geared towards making money. They are an investment geared towards capital preservation. If your idea of investing is to make money, maybe don't invest in bonds?

thunderball

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #19 on: July 20, 2016, 07:47:25 PM »
"Bonds are not an investment geared towards making money. They are an investment geared towards capital preservation."

This is exactly why I have a good portion of the stache in short, intermediate, long, and muni bonds.  Better than lying dormant, the stache will make more return than sitting in a money market (assuming I hold through rate increases).

<edit> the percentages favor the shorter terms: I have 3x in short, 2x in intermediate, and 1x each in long, muni, and money market.
« Last Edit: July 20, 2016, 07:56:59 PM by thunderball »

mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #20 on: July 21, 2016, 03:42:48 AM »
at this stage bonds are a bet on capital gains if rates go negative .

for 36 years bond rates only went down with some speed bumps on the way . when bond rates flip there will be losses , no question .


mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #21 on: July 21, 2016, 03:48:27 AM »
Another Jason Zweig article:

http://blogs.wsj.com/moneybeat/2016/07/15/bonds-arent-as-wretched-an-investment-as-they-seem/

Conclusion:
The generation-long bull market in bonds is probably drawing to a close. But high-quality bonds are still the safest way to counteract the risk of holding stocks, as this year’s returns for both assets have shown. Even at today’s emaciated yields, bonds are still worth owning.

Emphasis mine on "probably".

I've been slowly coming around to the usefulness of bonds in our portfolio as I slowly transition into FIRE. Short-term bonds, mind you. Not those 10-20-30 year things.

Ugh... I feel like I'm betting against the house by buying government bonds right now.  All the central banks are trying to boost growth and if they succeed rates rise and I get hosed.  And if they fail and there is deflation aren't I better off in high quality corporate bonds???  VCLT has provided pretty good offset on risk-off days but that may be getting long in the tooth as well.  When do I win with longer term govt bonds... some horrible deflation where the world ends???

Bonds aren't for winning. They're for not losing.


if you are a long term investor bonds are a short term solution to a temporary  problem ,that leads to a permanent reduction in gains over the long term .

when you think about the logic of holding bonds when a typical accumulation stage runs 30-40 years and mitigating a temporary drop  , and what you give up typically over the long haul  permanently holding bonds the logic is not there .

bonds are good for money that has time restraints to recover , not when growing money long term .

you would think holding bonds which decreases volatility would keep those with less pucker factor in the game longer  . but study's show folks exhibit bad investor behavior just as much with balanced funds as growth funds . the human mind hates losing money more then making money so a loss ends up being a loss to many small investors .

that is why the investor returns vs the funds returns on morningstar are generally lower across the board .

« Last Edit: July 21, 2016, 03:54:43 AM by mathjak107 »

AdrianC

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #22 on: July 21, 2016, 05:57:50 AM »
Your view of bonds may change as you approach FIRE.

Those working towards FI who can take the volatility should consider being mainly in stocks, IMO. I was. 

Those already FIRE, or slowly transitioning into FIRE as I am, we have a different goal. The goal isn't to maximize the stash. The goal is to maintain the withdrawal rate. Bonds can help. Short-term bonds. 5 years max.

mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #23 on: July 21, 2016, 06:02:53 AM »
i am retired and my portfolio is structured so it matches a volatility range i am comfortable with .

while right now equitys are 35% , 1/3 the bond budget is high yield which when we bought in was a far better value then stocks . so the high yield is actually a proxy for some of the equity's . this year it has double digit returns with a beta of just about 1/2 the s&p 500 .

so rather then a fixed allocation i will balance out the portfolio by beta . if i add more equity's i may hold  more cash to offset that as an example .

it works well and it keeps things from becoming to volatile . don't forget portfolio volatility has grown since 2000 . if you signed on for a 60/40 mix in 2008 -2009 you saw way more in swings then typical . today you may need a 50/50 mix to match the 60/40 of old .

k9

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #24 on: July 21, 2016, 06:29:58 AM »
2.  No inflation or deflation--you preserved capital but nothing else.  In the 20th century I'm not sure there was ever a decade in the U.S. with no inflation by the way so do you think this is likely?
No, and there has not been a decade with two big bear markets (> 40%). So it is unlikely we see such a decade in the 21st century, right ? Oh, wait...

Quote
So the closer rates go to zero the more investing in a long term government bond is like stuffing cash in your mattress.  Except when rates go up you can always go to the mattress early and invest that cash at the new higher rate... it will be too late for your long term government bond which will have tanked in fair value.
It's already been addressed, but what's the point of growing your stash when you're FIREd ? More precisely, what's the point in risking to lose a substantial amount of your stash for a potential rise ? Heads you lose, tails... well, you win the right to be the richest guy in the cemetery.

Historical withdrawal success rates are higher with a 75/25 portfolio than with a 100/0, and there's a good reason for that.

mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #25 on: July 21, 2016, 06:56:43 AM »
but 75/25 did better then 50/50 going out 40 years .
« Last Edit: July 21, 2016, 07:00:15 AM by mathjak107 »

k9

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #26 on: July 21, 2016, 07:22:48 AM »
Yep. Apparently the best outcomes are when you have stocks as the basis of your pf but some bonds with them anyway.

mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #27 on: July 21, 2016, 07:29:38 AM »
at 5% withdrawals 100% equity's did better so it isn't just the amount of bonds  .  there really may not be all that much of an actual correlation as much as how the time frames themselves overlapped .
all those time frames starting out strong likely did better with equity's  , those that started out weak likely did better with more bonds

« Last Edit: July 21, 2016, 07:42:32 AM by mathjak107 »

MichaelB

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #28 on: July 21, 2016, 12:27:25 PM »
all those time frames starting out strong likely did better with equity's  , those that started out weak likely did better with more bonds

Hence the need for bonds when FI/RE is right around the corner. Yes, if you're firmly in the accumulation phase, bonds will mostly hold you back over the long run. But when you're getting close to retirement, you need bonds to reduce your volatility because you can't predict when downturns will happen.

mathjak107

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #29 on: July 21, 2016, 01:04:58 PM »
yep , that was my point . bonds are handy when you will bump time restraints .  but they can be a heavy weight when you are in the stage of your life where you have no time restraints .

they are an answer to a problem , that is not really a problem and instead become the problem  as they inhibit growth .

Curbside Prophet

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #30 on: July 21, 2016, 06:07:34 PM »
In the "Age of the Fed" you buy bonds for appreciation and stocks for income.  Sad but true.

faramund

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Re: Bonds Aren’t as Wretched an Investment as They Seem
« Reply #31 on: July 21, 2016, 11:03:25 PM »
I have thought, in the context of, say there's a market boom, and for whatever reason I decide its not a good time to be stocks (lets just skip over the details of that for now), and I've paid off all my high interest debt (and in a bubble - there's a good chance all debt will be high interest debt)

Then I think it would be a good time to buy bonds - as others have said, after a bubble, interest rates drop, which means bonds gain value, and then you can sell them and buy shares cheap. But at the moment, even if there's a bubble, which is contentious and in any case I doubt there is one now, how are interest rates going to get cheaper than they are now?

Personally, I'm waiting for the first of the deflationary economies (Japan/EU) to pull the trigger on helicopter money - and IMHO this age of ultra-low interest rates will pass.