Author Topic: Why in the world should I purchase bonds?  (Read 4019 times)

EchoStache

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Why in the world should I purchase bonds?
« on: October 23, 2022, 06:22:06 AM »
First let me say that I am new to the FIRE movement.  My understanding is that one's asset allocation should ideally be made up of something like 80% equities and 20% bonds, or 60/40, etc for optimal long term results.

I am at least 6-7 years out from FI and putting about $100k/year into the market currently.  My current asset allocation is 100% S&P500.  It's very hard for me to see why I shouldn't continue to put 100% into FXAIX while it is down 25% and likely to continue dropping, as we assume a huge upswing in the near future when the market recovers.  I did put $30k into Ibonds due to the crazy inflation rate, so my allocation is actually around 80/20 due to this as I only have about $115,000 in the market.

-Am I making the mistake of recency bias by being reluctant to allocate to bonds?  Are bonds still a worthwhile investment at all?  In other words, have conditions changed fundamentally such that past performance should not make us blindly follow the previously accepted allocation guidelines?
-Should I continue to purchase $20k/year in Ibonds going forward to keep an 80/20 allocation? 
-Should I immediately change to a 60/40 for future investments? 
-Should I wait for the market to rebound and make up all lost ground to switch to 60/40?

Would it make more sense to accumulate 2-3 years worth of "cash" in Ibonds and then 100% equities?  Wouldn't this allow the higher growth and returns of equities while providing the safety cushion needed to weather a down market?

I feel like I have plenty of time to steer the ship in the right direction but 6-7 years is also a relatively short time to try and become FI(from a position of almost 0).

Anyways, I'm asking because I feel compelled to be 100% equities now that I have an emergency fund level of assets in Ibonds and am curious to get input from others who may offer a wiser perspective.  Thanks for reading.




reeshau

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Re: Why in the world should I purchase bonds?
« Reply #1 on: October 23, 2022, 09:36:44 AM »
I have a few responses here, of varying scope:

1)  Bonds haven't done well the last few years because interest rates were rock bottom.  Higher interest rates bode well for bonds in the future, particularly if inflation is tamed, and rates again moderate.

2)  The I bonds you own now have a 0% fixed rate.  So, if inflation is tamed, their rate will drop precipitously.  Stay tuned to see what the Treasury does in November with this.

3)  Keeping large safety cash and 100% equities is sometimes called a barbell strategy.  It is a way to navigate downturns and stay in the stock market.  With such a high stock allocation, you need to be able to stomach those downturns to do this, though.  It also means you will have to replenish your cash when it gets depleted: i.e. just after a recession, perhaps early in a bull cycle.  This is actually what I do, and it works for me.  But I have a very atypical mindset about the stock market.

4)  60/40 is not about maximizing your portfolio growth; it is about getting a good night's sleep during markets like 2022.

And, some questions...You are putting $100k in the market, but have $115k in so far--so you have just started?  In 6-7 years, you will have about $750k.  4% of that is $30k.  You are set for that level of spending, after having earned so much?  I would urge you to research health insurance costs, once you are covering this yourself.

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #2 on: October 23, 2022, 10:00:49 AM »
I have a few responses here, of varying scope:

1)  Bonds haven't done well the last few years because interest rates were rock bottom.  Higher interest rates bode well for bonds in the future, particularly if inflation is tamed, and rates again moderate.

2)  The I bonds you own now have a 0% fixed rate.  So, if inflation is tamed, their rate will drop precipitously.  Stay tuned to see what the Treasury does in November with this.

3)  Keeping large safety cash and 100% equities is sometimes called a barbell strategy.  It is a way to navigate downturns and stay in the stock market.  With such a high stock allocation, you need to be able to stomach those downturns to do this, though.  It also means you will have to replenish your cash when it gets depleted: i.e. just after a recession, perhaps early in a bull cycle.  This is actually what I do, and it works for me.  But I have a very atypical mindset about the stock market.

4)  60/40 is not about maximizing your portfolio growth; it is about getting a good night's sleep during markets like 2022.

And, some questions...You are putting $100k in the market, but have $115k in so far--so you have just started?  In 6-7 years, you will have about $750k.  4% of that is $30k.  You are set for that level of spending, after having earned so much?  I would urge you to research health insurance costs, once you are covering this yourself.

Thanks for your thoughts.  As to your question, yes, I'm just getting started. January 2021, my total assets were about $38,000 in retirement.  I only have $115k in the market now as, since then,  $30k has gone into Ibonds and $30k into savings. And of course the 25% decline would make my contributions seem lower than they have been.  Now that the Ibonds and savings are in place, I'll be putting $100k+ into FXAIX annually moving forward, assuming income remains steady.


maizefolk

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Re: Why in the world should I purchase bonds?
« Reply #3 on: October 23, 2022, 10:12:12 AM »
1) Even if your goal is ultimately a 80/20 stock/bond portfolio at retirement there is no reason couldn't accumulate the 80% of stocks first and then only work on buying bonds when you're 80% of the way to your net worth goal. Typically you'll hit your net worth goal faster if you front load stocks, but sometimes you'll end up working a little longer.

2) Don't assume a huge upswing in the market in the near future. 2009 and 2020 had a sudden fall and fast recovery. 2000 took many years to recover.

Here's an analysis of how likely stocks, bonds, or cash are to provide the best returns over different periods of time.



mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #4 on: October 23, 2022, 10:51:35 AM »
1) Even if your goal is ultimately a 80/20 stock/bond portfolio at retirement there is no reason couldn't accumulate the 80% of stocks first and then only work on buying bonds when you're 80% of the way to your net worth goal. Typically you'll hit your net worth goal faster if you front load stocks, but sometimes you'll end up working a little longer.



This is exactly how I approached, and I think it works very well for maximum growth. Overall, I am very satisfied with the results. But the caveate is that just when I was swithcing a focus to cash/treasuries, the market started tanking.

This resulted in initial angst as the market was falling and I wasn't buying. But eventually, the market did drop to a level that I returned to purchasing equities as that equity bucket wasn't filled anymore.

So, result is that I entered this bear market with mostly stocks that have lost value from the peak, and not a lot of safer money in the event of unemployment, or if I wanted to pull the plug despite the drop that option feels much more risky than if I had 2-3 years in safe money to tide me through the bear market.

I'm largely ok with this because it was only the above average run up that got me to even think I was nearing the end of my savings journey, and I'm not sure how I'd feel if I did have 3 years safe money and pulled the plug not knowing how this recession plays out.

Currently, I have my 401k going to stocks, and extra money from my side gig going for ibonds and treasuries so that I am filling both buckets at once, but prioritizing stocks quite a bit (about a 5-1 ratio). Unlike investing in stocks during the lion's share of my time prepping, saving cash and bonds is slower going....lower returns, and I was much more impatient for the results! YMMV as I have never been in a position to save 6 figures in a year.

Just thought I'd put my 2 cents here for your consideration since I had done what Maizefolks suggests, and it overall worked well, but with a definite hickup at the end!


mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #5 on: October 23, 2022, 10:54:01 AM »
1) Even if your goal is ultimately a 80/20 stock/bond portfolio at retirement there is no reason couldn't accumulate the 80% of stocks first and then only work on buying bonds when you're 80% of the way to your net worth goal. Typically you'll hit your net worth goal faster if you front load stocks, but sometimes you'll end up working a little longer.

2) Don't assume a huge upswing in the market in the near future. 2009 and 2020 had a sudden fall and fast recovery. 2000 took many years to recover.

Here's an analysis of how likely stocks, bonds, or cash are to provide the best returns over different periods of time.



Also a shout out for this graphic! Very good info!

mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #6 on: October 23, 2022, 10:58:51 AM »
Also - to adress the OP question - I am also sour on bonds overall, only doing governement bonds.

Maybe that landscape will change with the higher interest rates? But their performance has been very disappointing, and I wonder about all the boglehead portfolios that were 50/50 or even higher on bonds.....supposedly for safety.

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #7 on: October 23, 2022, 11:31:52 AM »
To weigh in on this a bit more, I'm looking at bond funds.  What should I buy now, if I were going to?  With a quick glance, I looked at Fidelity taxable bond index funds.  The YTD returns all look terrible.  Yes, they are less terrible than the S&P or Nasdaq so I can see how they would have lessened losses somewhat.  However, the least bad performing are around -7%, but others are as bad as -35% i.e, worse than equities!!!

Ok, I say to myself, this is about long term performance. Well, every fund is LESS THAN 1% return over the past ten years.  How is that supposed to help?. Seems like I'd be better off in CD's at 4%, or Ibonds, or cash at 2.2% and climbing.

FUMBX, short term treasury bond index fund, looks the most palatable with half the losses or less of other bonds.

On the other hand, perhaps this is the perfect time to start buying bonds while they are down and have been down for years.  Interest rates are rising.

mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #8 on: October 23, 2022, 11:46:12 AM »
To weigh in on this a bit more, I'm looking at bond funds.  What should I buy now, if I were going to?  With a quick glance, I looked at Fidelity taxable bond index funds.  The YTD returns all look terrible.  Yes, they are less terrible than the S&P or Nasdaq so I can see how they would have lessened losses somewhat.  However, the least bad performing are around -7%, but others are as bad as -35% i.e, worse than equities!!!

Ok, I say to myself, this is about long term performance. Well, every fund is LESS THAN 1% return over the past ten years.  How is that supposed to help?. Seems like I'd be better off in CD's at 4%, or Ibonds, or cash at 2.2% and climbing.

FUMBX, short term treasury bond index fund, looks the most palatable with half the losses or less of other bonds.

On the other hand, perhaps this is the perfect time to start buying bonds while they are down and have been down for years.  Interest rates are rising.

look into building a bond or cd ladder instead of doing funds.

mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #9 on: October 23, 2022, 12:06:06 PM »
It also means you will have to replenish your cash when it gets depleted: i.e. just after a recession, perhaps early in a bull cycle.  This is actually what I do, and it works for me.  But I have a very atypical mindset about the stock market.

4)  60/40 is not about maximizing your portfolio growth; it is about getting a good night's sleep during markets like 2022.


Would you mind sharing your strategy in detail? Nords had mentioned keeping 2 years in cash, spending from that, and reassessing at the end of the year to replenish. If the market is up at all, top up to two years. If the market is down, do not replenish and keep spending from cash (I may have a few details off, but that is what I think he said!)

I was planning to follow that, but maybe extend to 3 years for increased safety as I have no pension, etc. Was wondering about doing it on a monthly basis - if market is up, take from stocks, if down take from cash, and so be continuously topped up before any downturn.

Wondering how you approached it?

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #10 on: October 23, 2022, 12:58:10 PM »
OK, here's a video from one of my favorite financial podcasts:
https://youtu.be/ptNIrqNOuZM

Skip to 6:30 if you don't want to watch the entire video.

Summary: It makes a strong case for 60/40.
« Last Edit: October 23, 2022, 01:25:15 PM by UltraStache »

Heckler

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Re: Why in the world should I purchase bonds?
« Reply #11 on: October 23, 2022, 01:08:44 PM »

-Am I making the mistake of recency bias by being reluctant to allocate to bonds? 

I think the mistake you're making is not understanding your risk tolerance and not sticking to your asset allocation. 

https://www.bogleheads.org/wiki/Investment_policy_statement

https://www.bogleheads.org/wiki/Assessing_risk_tolerance

A related personal anecdote on exactly this topic, from when I knew nothing, zero, nada about investing...

2008 to 2009, a coworker and I were both very disappointed with our work's retirement funds.  It seemed the value of our accounts went down by the same amount we put in every paycheck.

I worked to understand low-cost self-directed globally and asset diversified index investing, and he switched all of his high-fee equity funds to bonds, using the same corporate investment bankers (read high fees on bond funds too).

We chatted about it again in 2012 - his 100% bonds had made zero total returns, so he switched his investments to the highly touted mary-jane growth (pun, I mean Cannabis) stocks!

He ended up leaving the west coast for a lower-cost-of-living area where he could afford a one-bedroom apartment.




« Last Edit: October 23, 2022, 01:24:17 PM by Heckler »

Heckler

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Re: Why in the world should I purchase bonds?
« Reply #12 on: October 23, 2022, 01:10:29 PM »
OK, here's a video from one of my favorite financial podcasts:
https://youtu.be/ptNIrqNOuZM

I watched only the first 28 seconds.  Yes!  This.

Heckler

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Re: Why in the world should I purchase bonds?
« Reply #13 on: October 23, 2022, 01:29:19 PM »
« Last Edit: October 23, 2022, 01:34:02 PM by Heckler »

Heckler

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Re: Why in the world should I purchase bonds?
« Reply #14 on: October 23, 2022, 02:45:42 PM »
OK, here's a video from one of my favorite financial podcasts:
https://youtu.be/ptNIrqNOuZM

Skip to 6:30 if you don't want to watch the entire video.

Summary: It makes a strong case for 60/40.

yup.  and that's only a % comparison of the relative start points in time, not including the contributions or rebalancing that you will make to the assets which are at the low point at a given point in time (buy low, sell high).  i.e, I sold high US total market in January for annual 70/30 rebalancing and bought more bonds and EAFE, which leveled out my YTD losses from the S&P500 drop. 

reeshau

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Re: Why in the world should I purchase bonds?
« Reply #15 on: October 24, 2022, 09:13:29 AM »
It also means you will have to replenish your cash when it gets depleted: i.e. just after a recession, perhaps early in a bull cycle.  This is actually what I do, and it works for me.  But I have a very atypical mindset about the stock market.

4)  60/40 is not about maximizing your portfolio growth; it is about getting a good night's sleep during markets like 2022.


Would you mind sharing your strategy in detail? Nords had mentioned keeping 2 years in cash, spending from that, and reassessing at the end of the year to replenish. If the market is up at all, top up to two years. If the market is down, do not replenish and keep spending from cash (I may have a few details off, but that is what I think he said!)

I was planning to follow that, but maybe extend to 3 years for increased safety as I have no pension, etc. Was wondering about doing it on a monthly basis - if market is up, take from stocks, if down take from cash, and so be continuously topped up before any downturn.

Wondering how you approached it?

Well, I am just finishing year 3 of living the dream, so I am still practicing it.  Good thing we have a market downturn, to help me understand all the possibilities!  :)

There are a number of suggestions you can Google for, but the average recession lasts 18 months, so I thought 2 years' cash sounded like a good starting point.  I expected that I would find out how I felt going through the experience, and could adjust (spending, working, etc.) from there, if necessary, through the first time and then through any anomalies, like a longer downturn.

I had the good fortune to come back from an international assignment in May 2020 quite flush with cash:  home equity from my former US house, stashed in CD's, and a "European" severance.  That gave us the flexibility to buy a new house in a competitive market, and still have the starting cash to be retired, rather than laid off.  So far, so good.

This year has been exciting, and not always in a good way.  We did have the opportunity to say a proper goodbye to Ireland and to Europe, spending 7 weeks there--an opportunity we missed out on, due to Covid.  However, we came home to a classic deep South vacation emergency, water in the house.  Add to that some learnings about the coverage provided by our long-time insurer, and it's an expensive lesson.  Still, we approach next year with 1 year in cash left, and I bonds baking in the oven as the first line of defense after that.  I did sell off some AAPL shares, which held up pretty well through the June downturn and the summer bear rally.

I don't have anything more systematic to say about it yet.  But through the chaos that is not just the pandemic, but an intercontinental move, a house purchase in the 2020 market, contemplating FIRE 2 years ahead of schedule or working in a tight labor market, the big vacation and then major disaster, it has seen me through.  These times have not been worry free, but I think I am much, much better off than if I had been working through all this, too.

Must_ache

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Re: Why in the world should I purchase bonds?
« Reply #16 on: October 24, 2022, 10:07:08 AM »
The longer your time frame, the more stocks you will probably want.  I turned 50 not long ago and have traditionally been 100% equities most of my life.  I would have allocated some percentage to bonds in my 40s except for one problem - lower interest rates meant no yield! 

Now that I have accumulated over $1M, I probably only need to work another 5+ years to reach my retirement goals.  I don't need as much risk; if I can just earn as little as 5%/yr on my investments I think be all set, and if I make more than great.  So I'm willing to buy more bonds than usual to keep the goal closer to 5% and the standard deviation lower.  I don't need to hit it out of the park to enjoy retirement, what I have to do is not put it at great risk either.

So, in the next 6-12 months I'm planning to buy $300K of an assortment of Treasuries in the 5/10/20yr ranges.  At this point I'm happy to load up on some 4-5% risk-free returns.

But I plan to retire at 57 and maybe my time horizon is 25 years, or 30.  If I still had that same $1M at retirmement I would have 25 x $40K even without stock returns.  But if you are retiring earlier in life and have a longer time horizon, you're going to have to rely more on stocks to get capital gains.

ChpBstrd

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Re: Why in the world should I purchase bonds?
« Reply #17 on: October 24, 2022, 12:13:18 PM »
I am on the fence regarding stocks vs. bonds, but there are plenty of reasons to think bonds might do better than stocks in the coming decade. It happens sometimes, and this would represent the reversal of a decades-long trend. We should keep in mind that trends always reverse!

Remember that the last 40 years have featured several equities-boosting macro changes that probably cannot happen again:

1) Globalization reduced the price of everything, enabling high trade and government deficits, while also expanding US export markets and lowering deadweight losses (economists' term for tariffs and taxes). Globalization is now in full reverse with broken supply chains due to COVID, broken supply chains due to the Russian war, and the re-communism of China. Trade barriers are going up and higher-cost local production is being preferred around the world.

2) Tax rates fell over the past 40 years, creating huge national debts in most industrialized countries that seem to be exacerbating the effects of economic cycles. Continuation of low-tax policies may lead to issues such as illiquidity in government bonds or rapid currency collapses like we've seen with the once-mighty British pound and Japanese yen. So there might be growing resistance to trading more instability for the promise of more jobs if we only cut taxes.

3) The labor force participation rate for women increased several percentage points due to cultural change between the 1980s and 2010s. Now the trend is downward. https://fred.stlouisfed.org/series/LNS11300002

4) Corporate profit margins may have peaked after a two-decade rise and are on their way down due to higher demands from labor, taxes, bondholders, etc. This Economist article summarizes many of the reasons: https://www.economist.com/business/2022/10/09/have-profits-peaked-at-american-businesses Similarly, union membership was cut in half between the 80's and today, but there may be signs of that trend reversing too.

5) Information technology is no longer delivering productivity breakthroughs at the same pace as we enjoyed in the era when people learned to use the word processor and spreadsheet. Investment seems to be flowing into applications like social media and entertainment, which reduce productivity rather than enhance it, and which look like a race to the bottom in terms of margins for content delivery.

6) The Shiller PE ratio is still around 28, even after the bear market of 2022. The mean is about 17. In terms of PE ratios, the S&P500 is still about 23% above its mean. So when we talk about the "average" long-term total return of stocks, we must keep in mind that on "average" valuations were much, much lower.

7) The U.S. overall labor force participation rate peaked at 60% in 1999, has fallen to only 56.8% today, and is highly likely to fall further due to demographic aging and millions of long-COVID disabilities. https://fred.stlouisfed.org/series/LNS11300002 This means the dependency ratio will go higher, and the US could get stuck in a Japan-like stagnation where people refuse to spend money out of a fear they'll need it to care for their parents. Recall what happened to the Japanese stock market since about 1990, and realize that buying bonds would probably have been a better bet for Japanese investors. The labor force participation trend for Japan looks similar to the US, just a couple of years ahead: https://fred.stlouisfed.org/series/JPNLFPRNA

There are also some strategic reasons to take a hard look at bonds for the first time in one's investing lifetime:

8) My bond screener shows lots of investment-grade bonds from well-established corporations yielding 7-8%. For stocks to outperform bonds, stocks will have to beat today's higher bond yields at the same time their interest expenses are going way up and probably at the same time as they divert cash flow toward de-leveraging, and at the same time their customers are also paying higher interest rates and de-leveraging. The Federal Reserve might not cut interest rates immediately during the next recession, because that's the behavior which got us into so much trouble in the 1970s, when inflation bounced back after each recession / rate cutting cycle. 

9) If you foresee a recession in our near future, with inflation falling and interest rates being cut, then bonds might be the place to be. Depending on duration, they might not be as volatile as stocks on the way down. Then, as soon as rates are cut, they will appreciate. E.g. If rates and inflation are heading back to 2%, your bonds yielding 6-7% will be in high demand. When interest rates bottom, that's a great time to sell your bonds and rotate back into stocks, which will probably still be beaten down. Historically, stocks have taken years to recover from recessions because their earnings take years to recover, but bonds tend to be much more immediately sensitive to interest rates.

10) Bonds as an asset class are inherently safer than stocks, due to their senior claim to assets in a bankruptcy and the legal necessity of interest being paid. In the scenario above, where inflation falls to 2-3% over the next few years, then those holding long-duration bond-heavy portfolios yielding 6-7% will be enjoying coupon yields with about a 4% premium over inflation - while holding an asset class less susceptible to Sequence of Returns Risk. These yields would represent a perpetually safe 4% withdraw rate with no drawdown of principal - the goal of ALL our busy talk about asset allocation, flexible spending strategies, safety funds, contingency plans, market timing, etc. We don't have to talk about that stuff anymore, because you can just go out and buy a 4% WR now and the only way that fails is in a scenario where inflation outruns yields AND exhausts principal. E.g. a decade of the WR increasing at 10%/year would probably kill it, but not much else. And that particular high-inflation scenario is not a scenario a stock-heavy portfolio would likely survive either. When we think about other scenarios, the strategy shines: The strategy does well if we endure Japanification, a long period of low or negative growth, a series of crises like the past two decades, OR steady economic growth amid falling interest rates.

11) Most models forecast a recession in 2023 - the depth of which we cannot know in advance. We can, however, look at a chart of interest rates or CPI and see that recessions tend to result in falling inflation and falling rates. This means just as bonds collapsed in resale value due to rising interest rates in 2022, they could rise just as quickly in resale value when the rate cuts come. Recall that a bond bought at time x will increase in value if rates are cut in a future time, and will decrease in value if rates are raised in a future time. Thus you can "buy the dip" in bonds and ride them out, earning yield the whole time, until a future date when rates are lower.
https://fred.stlouisfed.org/series/FEDFUNDS
https://fred.stlouisfed.org/series/CPIAUCSL (Edit > Units > switch to % change from a year ago)

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #18 on: October 24, 2022, 12:39:57 PM »
If this turns out to be a good time to start building a 60/40 portfolio, I'm feeling pretty lost as to what a good strategy would be.  Total market fund?  10 year treasury fund?  Various duration treasurys?  Corporate? Municipal? Taxable?  Equitys seem easier i.e. FXAIX or VTI; golden.

Heckler

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Re: Why in the world should I purchase bonds?
« Reply #19 on: October 24, 2022, 03:36:22 PM »
If this turns out to be a good time to start building a 60/40 portfolio, I'm feeling pretty lost as to what a good strategy would be.  Total market fund?  10 year treasury fund?  Various duration treasurys?  Corporate? Municipal? Taxable?  Equitys seem easier i.e. FXAIX or VTI; golden.

K.I.S.S

https://www.bogleheads.org/wiki/Two-fund_portfolio


( from a guy with 5 holdings spread across 10 accounts and wishes' he'd Kept It Simple.  At least I've ditched my short term bonds holding to combine it as cash)
« Last Edit: October 24, 2022, 03:39:53 PM by Heckler »

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #20 on: October 24, 2022, 05:31:52 PM »
I'm having trouble understanding bond funds vs actual bonds.  Seems like the relationship is nothing like a stock vs an index fund of stocks, which are basically the same thing just with diversity.  But a bond fund doesn't seem to represent how an actual bond works, at all.  Why risk huge negative returns when we can choose 100% guaranteed returns that are +4-8% with no risk?

If I have a 60/40 of VTI/VBTLX(total bond fund)  I would have a YTD return of .6(-20.6) + .4(-16.8)= -19.08%. So instead of down 20.6%, we are down 19.08%.

Why wouldn't I buy actual bonds that have a guaranteed return.  For example:
1 year US treasuries are 4.63%.  So 60/40 VTI/1 year treasury is -10.58% combined. 
I see a 2 year corporate A/A yielding 7.03%, for -9.5% combined in a 60/40.  Is this safe enough?  Too much risk?

I understand these are just two examples, but if I'm supposed to buy bonds to guarantee some return in order to offset losses of my equities, I don't see why I'd buy bond funds rather than actual bonds.  I'm sure there's something I'm missing, hence why I'm posting.  Thanks.
« Last Edit: October 24, 2022, 05:36:51 PM by UltraStache »

mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #21 on: October 24, 2022, 06:44:32 PM »
I'm having trouble understanding bond funds vs actual bonds.  Seems like the relationship is nothing like a stock vs an index fund of stocks, which are basically the same thing just with diversity.  But a bond fund doesn't seem to represent how an actual bond works, at all.  Why risk huge negative returns when we can choose 100% guaranteed returns that are +4-8% with no risk?

If I have a 60/40 of VTI/VBTLX(total bond fund)  I would have a YTD return of .6(-20.6) + .4(-16.8)= -19.08%. So instead of down 20.6%, we are down 19.08%.

Why wouldn't I buy actual bonds that have a guaranteed return.  For example:
1 year US treasuries are 4.63%.  So 60/40 VTI/1 year treasury is -10.58% combined. 
I see a 2 year corporate A/A yielding 7.03%, for -9.5% combined in a 60/40.  Is this safe enough?  Too much risk?

I understand these are just two examples, but if I'm supposed to buy bonds to guarantee some return in order to offset losses of my equities, I don't see why I'd buy bond funds rather than actual bonds.  I'm sure there's something I'm missing, hence why I'm posting.  Thanks.

well, any treasuries you owned at the beginning of the year wouldn't be 4.63%. Now is a good time to buy treasuries, and probably bond funds, with new money anyway....and tomorrow maybe better.

its an intriguing idea that bond may outperform the stock market in the next 10 years. Not sure I am willing to bet a whole lot on that idea, but definitely something to think about. I was not a fan of bonds, but maybe this is the time?

SilentC

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Re: Why in the world should I purchase bonds?
« Reply #22 on: October 24, 2022, 09:06:04 PM »
I am on the fence regarding stocks vs. bonds, but there are plenty of reasons to think bonds might do better than stocks in the coming decade. It happens sometimes, and this would represent the reversal of a decades-long trend. We should keep in mind that trends always reverse!

Remember that the last 40 years have featured several equities-boosting macro changes that probably cannot happen again:

1) Globalization reduced the price of everything, enabling high trade and government deficits, while also expanding US export markets and lowering deadweight losses (economists' term for tariffs and taxes). Globalization is now in full reverse with broken supply chains due to COVID, broken supply chains due to the Russian war, and the re-communism of China. Trade barriers are going up and higher-cost local production is being preferred around the world.

2) Tax rates fell over the past 40 years, creating huge national debts in most industrialized countries that seem to be exacerbating the effects of economic cycles. Continuation of low-tax policies may lead to issues such as illiquidity in government bonds or rapid currency collapses like we've seen with the once-mighty British pound and Japanese yen. So there might be growing resistance to trading more instability for the promise of more jobs if we only cut taxes.

3) The labor force participation rate for women increased several percentage points due to cultural change between the 1980s and 2010s. Now the trend is downward. https://fred.stlouisfed.org/series/LNS11300002

4) Corporate profit margins may have peaked after a two-decade rise and are on their way down due to higher demands from labor, taxes, bondholders, etc. This Economist article summarizes many of the reasons: https://www.economist.com/business/2022/10/09/have-profits-peaked-at-american-businesses Similarly, union membership was cut in half between the 80's and today, but there may be signs of that trend reversing too.

5) Information technology is no longer delivering productivity breakthroughs at the same pace as we enjoyed in the era when people learned to use the word processor and spreadsheet. Investment seems to be flowing into applications like social media and entertainment, which reduce productivity rather than enhance it, and which look like a race to the bottom in terms of margins for content delivery.

6) The Shiller PE ratio is still around 28, even after the bear market of 2022. The mean is about 17. In terms of PE ratios, the S&P500 is still about 23% above its mean. So when we talk about the "average" long-term total return of stocks, we must keep in mind that on "average" valuations were much, much lower.

7) The U.S. overall labor force participation rate peaked at 60% in 1999, has fallen to only 56.8% today, and is highly likely to fall further due to demographic aging and millions of long-COVID disabilities. https://fred.stlouisfed.org/series/LNS11300002 This means the dependency ratio will go higher, and the US could get stuck in a Japan-like stagnation where people refuse to spend money out of a fear they'll need it to care for their parents. Recall what happened to the Japanese stock market since about 1990, and realize that buying bonds would probably have been a better bet for Japanese investors. The labor force participation trend for Japan looks similar to the US, just a couple of years ahead: https://fred.stlouisfed.org/series/JPNLFPRNA

There are also some strategic reasons to take a hard look at bonds for the first time in one's investing lifetime:

8) My bond screener shows lots of investment-grade bonds from well-established corporations yielding 7-8%. For stocks to outperform bonds, stocks will have to beat today's higher bond yields at the same time their interest expenses are going way up and probably at the same time as they divert cash flow toward de-leveraging, and at the same time their customers are also paying higher interest rates and de-leveraging. The Federal Reserve might not cut interest rates immediately during the next recession, because that's the behavior which got us into so much trouble in the 1970s, when inflation bounced back after each recession / rate cutting cycle. 

9) If you foresee a recession in our near future, with inflation falling and interest rates being cut, then bonds might be the place to be. Depending on duration, they might not be as volatile as stocks on the way down. Then, as soon as rates are cut, they will appreciate. E.g. If rates and inflation are heading back to 2%, your bonds yielding 6-7% will be in high demand. When interest rates bottom, that's a great time to sell your bonds and rotate back into stocks, which will probably still be beaten down. Historically, stocks have taken years to recover from recessions because their earnings take years to recover, but bonds tend to be much more immediately sensitive to interest rates.

10) Bonds as an asset class are inherently safer than stocks, due to their senior claim to assets in a bankruptcy and the legal necessity of interest being paid. In the scenario above, where inflation falls to 2-3% over the next few years, then those holding long-duration bond-heavy portfolios yielding 6-7% will be enjoying coupon yields with about a 4% premium over inflation - while holding an asset class less susceptible to Sequence of Returns Risk. These yields would represent a perpetually safe 4% withdraw rate with no drawdown of principal - the goal of ALL our busy talk about asset allocation, flexible spending strategies, safety funds, contingency plans, market timing, etc. We don't have to talk about that stuff anymore, because you can just go out and buy a 4% WR now and the only way that fails is in a scenario where inflation outruns yields AND exhausts principal. E.g. a decade of the WR increasing at 10%/year would probably kill it, but not much else. And that particular high-inflation scenario is not a scenario a stock-heavy portfolio would likely survive either. When we think about other scenarios, the strategy shines: The strategy does well if we endure Japanification, a long period of low or negative growth, a series of crises like the past two decades, OR steady economic growth amid falling interest rates.

11) Most models forecast a recession in 2023 - the depth of which we cannot know in advance. We can, however, look at a chart of interest rates or CPI and see that recessions tend to result in falling inflation and falling rates. This means just as bonds collapsed in resale value due to rising interest rates in 2022, they could rise just as quickly in resale value when the rate cuts come. Recall that a bond bought at time x will increase in value if rates are cut in a future time, and will decrease in value if rates are raised in a future time. Thus you can "buy the dip" in bonds and ride them out, earning yield the whole time, until a future date when rates are lower.
https://fred.stlouisfed.org/series/FEDFUNDS
https://fred.stlouisfed.org/series/CPIAUCSL (Edit > Units > switch to % change from a year ago)

Pretty much this.  Also it seems foolish to think that the S&P and US real estate, which have dunked on essentially all other asset classes for more than a decade, should continue being the only game in town.  Investment grade corporates that pay you 6%-7% nominal could end up looking amazing in hindsight.  International might look great.  Commodities might look great.  I’ll be at least 2 of those outperform S&P and US real estate over the next decade.

reeshau

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Re: Why in the world should I purchase bonds?
« Reply #23 on: October 25, 2022, 02:40:07 AM »
I understand these are just two examples, but if I'm supposed to buy bonds to guarantee some return in order to offset losses of my equities, I don't see why I'd buy bond funds rather than actual bonds.  I'm sure there's something I'm missing, hence why I'm posting.  Thanks.

There are two parts to bond funds' performance being wonky.  First, they have to mark their assets to market.  Bond prices are inversely related to the interest rate, so as rates have increased drastically this year, all bonds issued when they were lower are essentially marked down, so that the yield is the same.  (that makes them tradeable--any bond you buy will have "today's" yield, but you may pay more or less than the face value)

This is a matter of understanding financial reporting, and if left to itself wouldn't make that much difference.  If bond funds held until maturity, it would come out in the wash.

The second part, though, is when a bond fund underperforms, then faces redemptions large enough to cause it to need to sell assets to raise cash.  This means that those market prices now become realized, and the remaining fund holders are left to rack up the loss.

As to why you wouldn't buy bonds yourself?  First, they are relatively larger than stocks:  an individual bond will be denominated in $1,000 or $5,000 increments.  So, it would be hard for most to DCA their way each paycheck.  Second, of course, is the indexing argument:  with just a few bonds, you are taking the risk of their issuers being solvent until its time to cash them in.  You at least need a large enough portfolio to gain some diversity.  You also need to research the bonds, and keep up with company news and ratings agency actions and comments.  For many, that's too much work.

habanero

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Re: Why in the world should I purchase bonds?
« Reply #24 on: October 25, 2022, 01:27:42 PM »
I understand these are just two examples, but if I'm supposed to buy bonds to guarantee some return in order to offset losses of my equities, I don't see why I'd buy bond funds rather than actual bonds.  I'm sure there's something I'm missing, hence why I'm posting.  Thanks.

If you own individual bonds instead of a bond fund you are faced with a couple of practical problems besides risk consentration and the risk of your specific bond going down the toilet due to a credit event (not relevant if you own treasuries). A bond will pay you a semiannual coupon, if you want to have that as "income" to do whatever you want with then fine, but if not it can be hard to reinvest the proceeds in bonds because the coupon you recieve might be smaller than the minimum amount you can buy the same bond or another bond in. Also as time progresses the bond you own will look less and less like the bond you purchased in the first place - the duration will get shorter and shorter, its sensitivity to interest movements will get lower as duration shortens and you will roll down the issuers credit curve - generally means decreasing risk premium. And with 6 months remaining all you have waiting for you is one coupon payment and the return of principal. When you get the big principal back you have to reinvest it somehwere, and the yield at which you can reinvest can be significantly different from where you bought the bond in the first place due to interest rates going up or down in the meantime. For the reinvestment risk you get outsized exposure to one specific point in time - when the principal is repaid.

There is nothing inherently wrong in owning individual bonds, but unless you do treasuries getting and maintaining sufficient diversification can be challenging. And you will most likely have outsized exposure to a credit event in one of your specific holdings as there might be a limit to how many bonds you can own unless you have a lot of money invested in the asset class due to minium denominaions bonds are traded in.

If you want guaranteed income in any case you have to go for treasuries, those are the only bonds actually "guaranteeing" you anything. For this actual guarantee and the non-risk of a default you get a lower yield than bonds without this guarantee. A bond fund is one way of mitigating the specific risk while collecting higher yield than what treasuries offer.

In many ways bonds are much more complex instruments than equities. If you want to buy Apple equity outright you have a total of one instrument to invest in - Apple Stock. If you want to invest in Apple bonds you have a wide array of bonds with different coupions, different yields, different maturities and different credit risks (due to differences in maturity) and also different currencies (prob not very relevant for a US based investor). Depending on exactly which bond you pick at which point in time your risk, your coupons, your returns and its price movements and the reinvestment risk over time will vary considerably. If you buy treasuries you take out the credit risk component but you are still left with all the other factors.
« Last Edit: October 25, 2022, 01:34:31 PM by habanero »

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #25 on: October 25, 2022, 03:54:04 PM »
Thanks all for the great information.  I'm starting to gain a better understanding about the pros and cons of buying individual bonds.  Definitely some drawbacks when it comes to anything other than simple treasury bonds.  Although it appeals to me to be able to purchase a well rated (A/A) corporate bond paying 7%, which would be *almost* guaranteed(??), vs a bond fund that is losing 10-35% and could continue losing, the hassle seems more than I'd want to mess with over time.  I dunno.

So if I choose to put some money into bonds for the remainder of the year to get to 60/40 I could:

-Purchase 6 month Treasury Bonds @ 4.43% for guaranteed rate with the short term allowing me to "upgrade" soon if rates shoot up.  Or substitute 6 month CD @ 4.2% with the same reasoning.

-Purchase longer term Treasury Bonds locking roughly the same rate for a longer term.

-Purchase a bond fund to "make it easy", all of which seem to have negative returns for the past several years with little to no net return over the previous ten years and may continue to go further negative?

-Purchase bond funds now or in the near future once all the rate hikes are in place i.e. after Nov 1.  Since they've been dropping for years, perhaps its a great time to be a new bond fund investor?

-Does a bond fund have the potential to suddenly start returning much higher than the guaranteed ~4.5% of Treasury Bonds?  I assume this would be the reason to consider them.  Have things changed in the world such that a bond fund is unlikely to perform as they have in the past 40 years?  Or is 60/40 still the safe, somewhat sure thing its always been. 

I don't have the information in my head yet that makes me ready to pull the trigger on anything, but, perhaps due to my lack of knowledge, I'd have to lean towards just purchasing somewhat short duration Treasuries if I were going to place an order today.





mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #26 on: October 26, 2022, 07:54:07 AM »
-Does a bond fund have the potential to suddenly start returning much higher than the guaranteed ~4.5% of Treasury Bonds?  I assume this would be the reason to consider them.  Have things changed in the world such that a bond fund is unlikely to perform as they have in the past 40 years?  Or is 60/40 still the safe, somewhat sure thing its always been. 


I was also thinking along these lines, but looking into it bond funds that have lost a lot of value still have pretty low interest rates. the tlt bond fund that there is a thread about is down 30% - but the yeild is still only 2.5%. Much lower than recently auctioned  treasuries. 20 years at treasurydirect are over 3%.

I guess it makes sense if I'm understanding how this works.....a bond would need to halve in face value for the yeild to double. And the funds are full of super low yeild bonds.


mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #27 on: October 26, 2022, 07:59:32 AM »


I don't have the information in my head yet that makes me ready to pull the trigger on anything, but, perhaps due to my lack of knowledge, I'd have to lean towards just purchasing somewhat short duration Treasuries if I were going to place an order today.

Everyones been on the ibond train for a year or two, so look into that depending on you time horizon.

kenaces

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Re: Why in the world should I purchase bonds?
« Reply #28 on: October 26, 2022, 08:29:19 AM »
Thanks all for the great information.  I'm starting to gain a better understanding about the pros and cons of buying individual bonds.  Definitely some drawbacks when it comes to anything other than simple treasury bonds.  Although it appeals to me to be able to purchase a well rated (A/A) corporate bond paying 7%, which would be *almost* guaranteed(??), vs a bond fund that is losing 10-35% and could continue losing, the hassle seems more than I'd want to mess with over time.  I dunno.

So if I choose to put some money into bonds for the remainder of the year to get to 60/40 I could:

-Purchase 6 month Treasury Bonds @ 4.43% for guaranteed rate with the short term allowing me to "upgrade" soon if rates shoot up.  Or substitute 6 month CD @ 4.2% with the same reasoning.

-Purchase longer term Treasury Bonds locking roughly the same rate for a longer term.

-Purchase a bond fund to "make it easy", all of which seem to have negative returns for the past several years with little to no net return over the previous ten years and may continue to go further negative?

-Purchase bond funds now or in the near future once all the rate hikes are in place i.e. after Nov 1.  Since they've been dropping for years, perhaps its a great time to be a new bond fund investor?

-Does a bond fund have the potential to suddenly start returning much higher than the guaranteed ~4.5% of Treasury Bonds?  I assume this would be the reason to consider them.  Have things changed in the world such that a bond fund is unlikely to perform as they have in the past 40 years?  Or is 60/40 still the safe, somewhat sure thing its always been. 

I don't have the information in my head yet that makes me ready to pull the trigger on anything, but, perhaps due to my lack of knowledge, I'd have to lean towards just purchasing somewhat short duration Treasuries if I were going to place an order today.

Corporate bonds are NOT the same as treasury bonds!  They have a higher overall risk, and that is why their interest rate is much higher.

Right now CDs pay less than T-bills/bonds.  You should also know that you don't have to pay state taxes on T-bills/bonds but you do on CDs.

Nothing wrong with buying some short-term treasuries while you educate yourself.  You can buy new issues on treasurydirect.com or via an online broker(fidelity, vanguard, Schwab...) for no fee.

In general the "right/best" investment plan is the one you can stick with in good and bad times.  I would suggest you study a few books about investing over the next few months and slowly build up your portfolio as you learn.  Check out - The Elements of Investing: Easy Lessons for Every Investor, Winning The Losers Game, and A Random Walk Down Wall Street(new edition coming this Jan)








MustachioedPistachio

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Re: Why in the world should I purchase bonds?
« Reply #29 on: October 26, 2022, 08:30:22 AM »
Thanks all for the great information.  I'm starting to gain a better understanding about the pros and cons of buying individual bonds.  Definitely some drawbacks when it comes to anything other than simple treasury bonds.  Although it appeals to me to be able to purchase a well rated (A/A) corporate bond paying 7%, which would be *almost* guaranteed(??), vs a bond fund that is losing 10-35% and could continue losing, the hassle seems more than I'd want to mess with over time.  I dunno.

You only lose when you sell.

Bond funds show you what the market value of their individual bond holdings are *today*. It would be very similar to asking how much someone would buy your individual bonds for *today* (assuming you had individual bonds). I think you'd be surprised to find out that your individual bonds would also have "lost" 10-35% if you attempted to sell them.

Not sure if anyone else has mentioned this, but do you have an Investment Policy Statement (IPS)?
https://www.bogleheads.org/wiki/Investment_policy_statement

Must_ache

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Re: Why in the world should I purchase bonds?
« Reply #30 on: October 26, 2022, 09:25:15 AM »
Suppose a 1-yr corporate bond yields 7% rather than a 1-yr risk-free rate of 4%, and that is the probability of default.
The default rate should be so that you are indifferent between the two investments.
When you buy a Treasury for $1,000 you know that it is going to be worth $1,040 the following year.
For the corporate bond, X% of the time it will default and you end up with nothing, and (100-X)% of the time you will end the year with $1,070.
Some basic algebra:
$0 x X + $1,070 x (1-X) = $1,040
X = 2.8% probability of default

However this is exaggerated because typically a bond has a longer life than one year, and there is a probability of default across each year, and the chance that you get all the payments, or some of them.  That makes the math more complicated.  But I thought the simple example was worth mentioning.

FIPurpose

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Re: Why in the world should I purchase bonds?
« Reply #31 on: October 26, 2022, 10:15:39 AM »
Thanks all for the great information.  I'm starting to gain a better understanding about the pros and cons of buying individual bonds.  Definitely some drawbacks when it comes to anything other than simple treasury bonds.  Although it appeals to me to be able to purchase a well rated (A/A) corporate bond paying 7%, which would be *almost* guaranteed(??), vs a bond fund that is losing 10-35% and could continue losing, the hassle seems more than I'd want to mess with over time.  I dunno.

You only lose when you sell.

Bond funds show you what the market value of their individual bond holdings are *today*. It would be very similar to asking how much someone would buy your individual bonds for *today* (assuming you had individual bonds). I think you'd be surprised to find out that your individual bonds would also have "lost" 10-35% if you attempted to sell them.

Not sure if anyone else has mentioned this, but do you have an Investment Policy Statement (IPS)?
https://www.bogleheads.org/wiki/Investment_policy_statement

Your bonds would have lost value, but in actual practice your position is about the same.

If bond rates are 5% then a $100 bond is worth $105 in a year.

If bond rates rise to 10%, then a $100 bond is worth $110 in a year.

So now your 5% bond isn't as valuable. You'll have to sell it for $95 to make it equivalent to the 10% bond.

Of course if you sell your bond for $95 and then buy a 10% bond with those $95, you're in the exact same position (being up $5 in a year) as you were before selling even though the value decreased.

The value of bonds going down doesn't matter if you have no plans on selling. They'll rise as the bonds in the portfolio flip to the new rates, (and may go even higher if rates fall again in the future)

habanero

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Re: Why in the world should I purchase bonds?
« Reply #32 on: October 26, 2022, 10:49:35 AM »

Your bonds would have lost value, but in actual practice your position is about the same.

If bond rates are 5% then a $100 bond is worth $105 in a year.

If bond rates rise to 10%, then a $100 bond is worth $110 in a year.

Say you have 100 bucks in a bond

If a 1y bond has a 5% coupon and a yield of 5% its value today is $100
If yields rise to 10%, the bond drops in value to $95 ($95.45 to be precise)

So if you sell your 5% bond at $95.45 you buy $95.45 of a 10% bond. Total proceeds in 1y is $105 (so eqivalent to previous situation). The value of the new bond today is $100, but you only own $95.45 of it

So total cashflow in 1y is the same after this rise in yields if you switch into a new bond with higher coupon or still stick to the one you already have. You still get $105 ($95.45 * 1.1 for the new or 100+5 on the old.

The better position to have would be to not have bought the 5% bond for $100 but rather buy the 10% bond for $100 after the yield rise. Then you would be due $110 in 1y for the same initial $100 investment.

So the switching in itself doesnt add or remove any value (if we assume 0 transaction costs). But you are still better off if you buy after yields rise.

We prob don't disagree, this was just meant as a clarification.

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #33 on: October 26, 2022, 11:25:40 AM »
Ok, thanks everyone, this is helping.  So, even if bonds have a sucky year, it only hurts if you are drawing down.  If still accumulating, it won't matter, because they are (somewhat) guaranteed to preserve value and generate some yield over a longer time horizon once the crappy bonds are ditched and replaced by the current, better bonds.  Still can't say I'm ready to pull the trigger on a total bond market fund.  I'm 7-8 years out from FI in a perfect world so I just need to decide how soon I want to transition from 100% equities to 60/40.  Even though I'm understanding how the bond funds can show the negative returns they are, and that in the long run it shouldn't matter, I still can't say I feel good about buying them currently.  Decisions decisions.

Will be investing another $20k into my brokerage account over the remainder of the year. 

habanero

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Re: Why in the world should I purchase bonds?
« Reply #34 on: October 26, 2022, 11:47:57 AM »
If you buy a bond and hold to maturity your cash flow is unaffected by market movements. But your market value is. That also means, by extension that when you buy matters. If a bond has dropped in value you get its future cash flows (coupons + principal) but you get those for a lower initial investment that someone who bought at a higher price so your returns (or yield if you like) will be higher.

So you can’t just buy a bond at any given time and be indifferent. The price you buy (or sell) at matters. Someone who buys 30y treasuries now will have much higher returns than someone who bought 2 years ago. In hindsight long bonds bought two years ago turned out to be bad timing. Can turn out ok in the end but outcome much better if bought today assuming buying and holding until same maturity.

The carnage in bonds aren’t just pixels on a screen changing. Same with stocks if you buy a stock and hold forever you are entitled to whatever cash flows the stock pays out one way or another. The cash flow is only dependent on how many shares you buy, but the lower the price bought at the higher return due to lower initial investment for same number of stocks.

If you bought the long us treasury 2 years ago you get the 1.25 coupon and principal at the end. If you bought same bond today you get the same cash flow (less already paid and accrued interest) but you pay half the price for it as it’s value is 50. If you buy a recent issue you get a much higher coupon.
« Last Edit: October 26, 2022, 11:54:37 AM by habanero »

EchoStache

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Re: Why in the world should I purchase bonds?
« Reply #35 on: October 27, 2022, 03:24:04 AM »
If you buy a bond and hold to maturity your cash flow is unaffected by market movements. But your market value is. That also means, by extension that when you buy matters. If a bond has dropped in value you get its future cash flows (coupons + principal) but you get those for a lower initial investment that someone who bought at a higher price so your returns (or yield if you like) will be higher.

So you can’t just buy a bond at any given time and be indifferent. The price you buy (or sell) at matters. Someone who buys 30y treasuries now will have much higher returns than someone who bought 2 years ago. In hindsight long bonds bought two years ago turned out to be bad timing. Can turn out ok in the end but outcome much better if bought today assuming buying and holding until same maturity.

The carnage in bonds aren’t just pixels on a screen changing. Same with stocks if you buy a stock and hold forever you are entitled to whatever cash flows the stock pays out one way or another. The cash flow is only dependent on how many shares you buy, but the lower the price bought at the higher return due to lower initial investment for same number of stocks.

If you bought the long us treasury 2 years ago you get the 1.25 coupon and principal at the end. If you bought same bond today you get the same cash flow (less already paid and accrued interest) but you pay half the price for it as it’s value is 50. If you buy a recent issue you get a much higher coupon.

Ok, this makes sense as well.  As far as giving income in retirement, as long as you aren't cashing bonds in but just taking the interest payments to live off of, whether a bond fund is up or down doesn't matter to the amount of interest paid out?  I've never really thought about the draw down phase yet, but it would seem that a 60/40 would allow you to draw the interest in bonds and dividends on equities and possibly not even touch any shares.

One of the FIRE principles is to not time the market, but for someone who doesn't have a bond allocation yet(other than recent Ibonds), it seems like the timing may just happen to be quite good for buying into bonds.

habanero

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Re: Why in the world should I purchase bonds?
« Reply #36 on: October 27, 2022, 05:47:02 AM »

Ok, this makes sense as well.  As far as giving income in retirement, as long as you aren't cashing bonds in but just taking the interest payments to live off of, whether a bond fund is up or down doesn't matter to the amount of interest paid out?  I've never really thought about the draw down phase yet, but it would seem that a 60/40 would allow you to draw the interest in bonds and dividends on equities and possibly not even touch any shares.

In the long run the interest payout will vary because the bonds the fund hold will change over time. As the market fluctuates they will buy bonds with different coupons depending on market conditions when a purchase is made. The only way to ensure a guarnteed stable nominal payoff over 30 years is to buy a 30y treasury bond and hold until maturity.  If you buy a new 10y bond every 10 years your income in year 1-10,11-20 and 21-30 will most likely be different, potentially significantly so. How the real return will differ is another story of course.

Malossi792

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Re: Why in the world should I purchase bonds?
« Reply #37 on: October 27, 2022, 08:03:35 AM »
First of all, welcome!
I didn't read the whole thread, but I would start reading ERN's safe withdrawal rate series (just Google it), then come back with specific questions.
People won't really answer how much of what you should buy because of potential liability claims.
Good luck!

brandon1827

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Re: Why in the world should I purchase bonds?
« Reply #38 on: October 27, 2022, 01:33:15 PM »
There is so much demand for people trying to lock in the 9.62% that it crashed the site, lol

habanero

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Re: Why in the world should I purchase bonds?
« Reply #39 on: October 27, 2022, 01:34:33 PM »
One of the FIRE principles is to not time the market, but for someone who doesn't have a bond allocation yet(other than recent Ibonds), it seems like the timing may just happen to be quite good for buying into bonds.

I don't believe in timing the market when it comes to equities and not really bonds either. I have, however, had zero interest (phun intended) in buying long-dated bonds offering almost no yield. That's a lot of risk and no returns.

harvestbook

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Re: Why in the world should I purchase bonds?
« Reply #40 on: October 28, 2022, 07:02:03 AM »
As a semi-retired person fortunate enough to not have to dip into investments yet, iBonds look like a good second-tier emergency fund. I've never been a big fan of bonds because it seemed the biggest advocates were those who'd spent the last 40 years in a bond bull market. I didn't see much use in buying ten-year bonds paying 1 percent.

In my head I thought, "Well, if 10-year hits 3 percent, that's okay." Except when inflation is 7 or 8 percent, it's not so okay. iBonds looked like a way to get a guaranteed break-even in real terms. I'm going to do three more years to have a five-year tent to get to SS but I wouldn't want to be too iBond heavy, especially right now when everybody's doing it. When everybody's doing something, it usually means everybody isn't right. In five years, a guaranteed break-even probably won't look so good unless you're retired.

That said, I'd be okay keeping half my bond portion in iBonds and the other half in a total bond fund (or intermediate tax-exempt in taxable, where we used to hold our second-tier emergency fund.) iBonds are great in scary markets and not so great the other 90 percent of the time.

Also a note that we all have our own personal inflation rates. Based on my lifestyle, I'd say my personal inflation rate is less than half the published inflation rate since we have no rent/debt, produce much of our food, stay/work at home for the most part, and just aren't really consumers. So it 'feels" like I'd get ahead with iBonds.

« Last Edit: October 28, 2022, 07:05:56 AM by harvestbook »

Radagast

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Re: Why in the world should I purchase bonds?
« Reply #41 on: October 28, 2022, 08:18:04 AM »
-Does a bond fund have the potential to suddenly start returning much higher than the guaranteed ~4.5% of Treasury Bonds?  I assume this would be the reason to consider them.  Have things changed in the world such that a bond fund is unlikely to perform as they have in the past 40 years?  Or is 60/40 still the safe, somewhat sure thing its always been. 


I was also thinking along these lines, but looking into it bond funds that have lost a lot of value still have pretty low interest rates. the tlt bond fund that there is a thread about is down 30% - but the yeild is still only 2.5%. Much lower than recently auctioned  treasuries. 20 years at treasurydirect are over 3%.

I guess it makes sense if I'm understanding how this works.....a bond would need to halve in face value for the yeild to double. And the funds are full of super low yeild bonds.
OK this is not correct, a bond or stock fund is exactly made of its underlying securities. The 20-30-year yield curve is usually mostly flat so looking at yields on the the 20 and 30 year treasuries and subtracting the fund's expense ratio should give a very good idea what the yield on TLT is. You can check the SEC yield https://www.ishares.com/us/products/239454/ishares-20-year-treasury-bond-etf for the best indicator of the fund's yield, but even that is based on trailing 30-day distributions and is a bit stale.

Radagast

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Re: Why in the world should I purchase bonds?
« Reply #42 on: October 28, 2022, 08:20:50 AM »
When everybody's doing something, it usually means everybody isn't right.
I think that only applies to markets, where when everybody piles in it means future cash flow is reduced relative to what you paid because of higher prices. I-bonds are not marketable, so this wouldn't be a problem.

ChpBstrd

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Re: Why in the world should I purchase bonds?
« Reply #43 on: October 28, 2022, 09:01:14 AM »
I don't believe in timing the market when it comes to equities and not really bonds either. I have, however, had zero interest (phun intended) in buying long-dated bonds offering almost no yield. That's a lot of risk and no returns.

Ah, but sometimes bonds do offer significant yield and now is one of those times. Last week I bought several IG bonds from profitable and not-too-leveraged companies yielding 7-8%, with lots of duration. I'm placing a bet that inflation over the next 10-20 years will be less than that, and if I'm right I'll have locked in significant real returns. My price for being wrong if high inflation persists forever is negative real returns, but less negative than if I had held cash or invested in stocks. Because this long-duration bonds choice yields the best outcome regardless of future conditions, it is what game theorists might call a "dominant strategy." However, as the ads say, these deals may not last! When recession hits and the markets start expecting rate cuts, the yields on these bonds could drop precipitously, and it will be too late to get 7-8% any more.

Maybe that's not market timing like we use the term with stocks, because I'm not necessarily expecting to buy the dip and sell to a greater fool, I'm accepting a certain fixed return on my money that I think will be attractive in the future. However, you have to make a move at some point when the yields present themselves. Most likely, this will be a fleeting opportunity.

I didn't see much use in buying ten-year bonds paying 1 percent.

In my head I thought, "Well, if 10-year hits 3 percent, that's okay." Except when inflation is 7 or 8 percent, it's not so okay. iBonds looked like a way to get a guaranteed break-even in real terms. I'm going to do three more years to have a five-year tent to get to SS but I wouldn't want to be too iBond heavy, especially right now when everybody's doing it. When everybody's doing something, it usually means everybody isn't right. In five years, a guaranteed break-even probably won't look so good unless you're retired.

That said, I'd be okay keeping half my bond portion in iBonds and the other half in a total bond fund (or intermediate tax-exempt in taxable, where we used to hold our second-tier emergency fund.) iBonds are great in scary markets and not so great the other 90 percent of the time.


People aren't buying iBonds for big real yields; iBonds' fixed rate is 0.00%. People are buying them as a relatively safe way to obtain a 0% real yield for the next year or two until this inflation thing works itself out. You'll see a wave of iBond redemptions within 2 years if inflation comes down. It's actually not a bad cyclical play: hold iBonds to preserve purchasing power through the recession, then redeem and pivot into stocks as they start their recovery. If that plan doesn't work out and inflation stays high for years amid government ineptitude (i.e. a Turkiye scenario), you can hold your iBonds up to 30 years and your 0% real return would be better than any alternatives.

I didn't see much of a point in bonds for the past several years either, because the yields were so low and I got the sense most people didn't understand the concepts of duration risk or bond convexity. I've been shunning bonds for over a decade, but now I think they are starting to get attractive, even if real yields are still around zero, or even negative.

The reason bonds were unattractive a year ago was that they were all downside. A 1% or 2% yielding 10 year treasury has a lot of room to fall if rates go up to, say, 4% or 5%, but it does not have any room to gain because rates cannot go much lower than the zero bound. Today's bonds, however, are approaching a range where there's balance in the upside potential and the downside potential. AND... if the market's long-term inflation forecasts turn out to be correct, anyone sitting in a non-defaulted bond purchased in 2022 will probably be very satisfied with their decision.
https://fred.stlouisfed.org/series/T5YIE/

habanero

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Re: Why in the world should I purchase bonds?
« Reply #44 on: October 28, 2022, 12:32:59 PM »
Ah, but sometimes bonds do offer significant yield and now is one of those times. Last week I bought several IG bonds from profitable and not-too-leveraged companies yielding 7-8%, with lots of duration.

Yeah - I agree. I was referring to close to zero nominal yield which is hard to see work out great with a long duration.

Bonds have moved from something I wouldnt touch at with a 10-foot pole to something thats gotten interesting. There are obviously no guarantees, but the odds are better now imo.

What we haven't had yet, that we might or might not get is a big, fat ugly credit spread blowout. The last one, during covid, lasted so short that if you blinked, you missed it. It sorta was over when the Fed basically said noone is gonna go belly up on their bonds.

Its risky, but if one manage to time high-yield bonds reasonably well around a blowout the returns can be massive  - these can trade at truly depressed prices in a fire sale when everyone is offloading risk. (I've never done it or tried to do it myself for good order)

Quote
I got the sense most people didn't understand the concepts of duration risk or bond convexity.
Amen to that.


ixtap

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Re: Why in the world should I purchase bonds?
« Reply #45 on: October 28, 2022, 08:48:59 PM »
I chose an 80/20ish allocation from when I started my 401a at my last job. DH started with 100/0 and only moved to a joint 70/30 as we achieved lean FI, when we had already need together for several years.

I certainly don't see any reason for someone young and still accumulating to move to 60/40. I liked 80/20 just because some allocation quiz hit on that as moderately aggressive or some similar wording. I was surprised when DH hit on 70/30 as our joint AA and we don't have any plans to move to a more conservative allocation ever.

As to the ibonds, if you are going to have any bond allocation, they will keep up with inflation, which makes them as good as most options. The vast majority of our bonds are in a total bond fund in 401k just for simplicity, but we have been moving $10k each into ibonds as we are able.
« Last Edit: October 28, 2022, 08:52:02 PM by ixtap »

Nords

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Re: Why in the world should I purchase bonds?
« Reply #46 on: October 29, 2022, 05:39:19 AM »
Would you mind sharing your strategy in detail? Nords had mentioned keeping 2 years in cash, spending from that, and reassessing at the end of the year to replenish. If the market is up at all, top up to two years. If the market is down, do not replenish and keep spending from cash (I may have a few details off, but that is what I think he said!)

I was planning to follow that, but maybe extend to 3 years for increased safety as I have no pension, etc. Was wondering about doing it on a monthly basis - if market is up, take from stocks, if down take from cash, and so be continuously topped up before any downturn.
You have it right, @mistymoney

You could use a three-year cash stash if it helps you sleep better at night, but two years’ expenses in cash is good enough to cover most recessions.  Three years is financial overkill.

Sequence of returns risk is highest during the first decade of financial independence.  At the end of the first decade, especially with a high-equity asset allocation, your investments will probably have grown faster than inflation while your spending is rising at (or slower than) inflation. 

At the end of the first decade you could check your 10th year’s withdrawal against the latest value of your investments.  If your withdrawal rate has dropped below 4% then you’re probably no longer vulnerable to the sequence of returns risk and no longer need to keep a cash stash.

I hear you on pension income.  For most Americans who are eligible for Social Security, that inflation-adjustment annuity is all of the longevity insurance you need— and since it’s not part of the original analysis that developed the 4% Safe Withdrawal Rate, it’s a backup to the 4% SWR that avoids financial failure.

mistymoney

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Re: Why in the world should I purchase bonds?
« Reply #47 on: October 29, 2022, 12:38:26 PM »
Would you mind sharing your strategy in detail? Nords had mentioned keeping 2 years in cash, spending from that, and reassessing at the end of the year to replenish. If the market is up at all, top up to two years. If the market is down, do not replenish and keep spending from cash (I may have a few details off, but that is what I think he said!)

I was planning to follow that, but maybe extend to 3 years for increased safety as I have no pension, etc. Was wondering about doing it on a monthly basis - if market is up, take from stocks, if down take from cash, and so be continuously topped up before any downturn.
You have it right, @mistymoney

You could use a three-year cash stash if it helps you sleep better at night, but two years’ expenses in cash is good enough to cover most recessions.  Three years is financial overkill.

Sequence of returns risk is highest during the first decade of financial independence.  At the end of the first decade, especially with a high-equity asset allocation, your investments will probably have grown faster than inflation while your spending is rising at (or slower than) inflation. 

At the end of the first decade you could check your 10th year’s withdrawal against the latest value of your investments.  If your withdrawal rate has dropped below 4% then you’re probably no longer vulnerable to the sequence of returns risk and no longer need to keep a cash stash.

I hear you on pension income.  For most Americans who are eligible for Social Security, that inflation-adjustment annuity is all of the longevity insurance you need— and since it’s not part of the original analysis that developed the 4% Safe Withdrawal Rate, it’s a backup to the 4% SWR that avoids financial failure.

Thank you!  After being very aggressive in my investments for 20 years, I am probably overthinking the needs for security now due a downturn as I was just about to enter 4% WR territory.

This gives me a lot to think about! Hopefully I can still pull the plug soon. :)