Taking risk on equity side.

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ChinchillaWhiplash
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Taking risk on equity side.

Post by ChinchillaWhiplash »

Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
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Re: Taking risk on equity side.

Post by lazyinvestor30 »

Has been discussed previously

viewtopic.php?f=10&t=346431
GoneOnTilt
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Re: Taking risk on equity side.

Post by GoneOnTilt »

ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
I did a quick look and it seems emerging market bonds are quite closely correlated with stocks on the downside but not at all closely correlated with them on the upside (stocks vastly outperform, of course). That seems like a terrible investment to me but I am a small investor close to retirement so I'm pretty conservative.

Through trial and error I have come to prefer cash and high-quality bond funds of intermediate duration for my fixed income, which makes up most of my portfolio anyway.
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Re: Taking risk on equity side.

Post by ChinchillaWhiplash »

I don’t know. Looking at something like this makes it seem worthwhile to take the risk. https://www.portfoliovisualizer.com/bac ... tion2_3=50

And then this with EM bonds seems pretty good too. https://www.portfoliovisualizer.com/bac ... tion2_3=50

These funds are high ER but have had really good returns overall. Either return WAY more than TBM index. Even if mixing them all, you came out ahead over several decades
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Re: Taking risk on equity side.

Post by alex_686 »

"Everything should be made as simple as possible. But not simpler" - Albert Einstein

I think this is a case where Bogleheads have gone a step too far. Understanding how a low-return low-risk asset can enhance a portfolio's return is complex and nuanced, involving a fair amount of math and abstraction. It is easier to say that one should take risk on the equity side but it is a step down the wrong path in my opinion.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Taking risk on equity side.

Post by burritoLover »

ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
Why have bonds at all then? Stocks will outperform even high yield bonds in practically any long-term period.
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Re: Taking risk on equity side.

Post by Random Walker »

ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
It’s simply more efficient to take the risk on the equity side. Stuff like high yield bonds have some equity type risk and the correlation to equities will rise at trust the time you do t want it to. To make your decisions, you need to estimate expected returns of the relevant asset classes. After doing that, you can create a combination of equities and high quality bonds that has similar expected return to an allocation with lower equity and includes high yield and EM bonds. Just an example to make the point; don’t take the numbers seriously. Perhaps 80% stocks / 20% high quality bonds has similar expected return to 70% stocks / 30% high yield and EM bonds. The high quality bonds mix better with equities as far as correlations go, and high quality bonds likely cheaper and more tax efficient that the higher risk bonds.

Dave
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Re: Taking risk on equity side.

Post by ChinchillaWhiplash »

burritoLover wrote: Fri May 07, 2021 4:49 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
Why have bonds at all then? Stocks will outperform even high yield bonds in practically any long-term period.
Would you care to say this again once you look at this? https://www.portfoliovisualizer.com/bac ... ion2_2=100

Plus, bonds are a completely different asset class. Correlation is around 0.5 for both AWF and TEI to US Equities.
Last edited by ChinchillaWhiplash on Fri May 07, 2021 5:10 pm, edited 1 time in total.
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Re: Taking risk on equity side.

Post by ChinchillaWhiplash »

Random Walker wrote: Fri May 07, 2021 4:59 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
It’s simply more efficient to take the risk on the equity side. Stuff like high yield bonds have some equity type risk and the correlation to equities will rise at trust the time you do t want it to. To make your decisions, you need to estimate expected returns of the relevant asset classes. After doing that, you can create a combination of equities and high quality bonds that has similar expected return to an allocation with lower equity and includes high yield and EM bonds. Just an example to make the point; don’t take the numbers seriously. Perhaps 80% stocks / 20% high quality bonds has similar expected return to 70% stocks / 30% high yield and EM bonds. The high quality bonds mix better with equities as far as correlations go, and high quality bonds likely cheaper and more tax efficient that the higher risk bonds.

Dave
That makes good sense. I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
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Re: Taking risk on equity side.

Post by delamer »

If I’m understanding Bernstein’s perspective on this, stock-issuing companies’ managements make their decisions based on the best interests of stockholders rather than those of bondholders.

So avoiding that problem by not holding corporate bonds is a factor in “taking risk on the equity side.”
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Re: Taking risk on equity side.

Post by Random Walker »

ChinchillaWhiplash wrote: Fri May 07, 2021 5:08 pm
Random Walker wrote: Fri May 07, 2021 4:59 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
It’s simply more efficient to take the risk on the equity side. Stuff like high yield bonds have some equity type risk and the correlation to equities will rise at trust the time you do t want it to. To make your decisions, you need to estimate expected returns of the relevant asset classes. After doing that, you can create a combination of equities and high quality bonds that has similar expected return to an allocation with lower equity and includes high yield and EM bonds. Just an example to make the point; don’t take the numbers seriously. Perhaps 80% stocks / 20% high quality bonds has similar expected return to 70% stocks / 30% high yield and EM bonds. The high quality bonds mix better with equities as far as correlations go, and high quality bonds likely cheaper and more tax efficient that the higher risk bonds.

Dave
That makes good sense. I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
Just reread my post above. Sorry for the misspellings-didn’t proofread it :-). I really don’t see purpose in the high risk bonds. Something a lot of Bogleheads do when it comes to splitting up bond allocations, is split the bonds between nominal bonds and TIPs. And of course if you want to juice expected returns on the equity side, consider tilting to size and value and having substantial allocations to Int and EM.

Dave
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Re: Taking risk on equity side.

Post by Random Walker »

ChinchillaWhiplash wrote: Fri May 07, 2021 5:05 pm Plus, bonds are a completely different asset class. Correlation is around 0.5 for both AWF and TEI to US Equities.
Overall bonds tend to be uncorrelated with stocks. As stated above, the correlations of higher risk bonds to equities tends to be higher. Very significant though is when correlations change. When equities tank, the correlation of high quality bonds to stocks tends to turn strongly negative, just when you would want it to. The overall correlation is one thing; how correlations tend to change during flights to quality and liquidity is another. I believe the lower quality bonds will display their equity like characteristics with rising correlations to equities just at the wrong times.

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Re: Taking risk on equity side.

Post by alex_686 »

Random Walker wrote: Fri May 07, 2021 6:05 pm Overall bonds tend to be uncorrelated with stocks. As stated above, the correlations of higher risk bonds to equities tends to be higher. Very significant though is when correlations change. When equities tank, the correlation of high quality bonds to stocks tends to turn strongly negative, just when you would want it to. The overall correlation is one thing; how correlations tend to change during flights to quality and liquidity is another. I believe the lower quality bonds will display their equity like characteristics with rising correlations to equities just at the wrong times.
I will contest this on multiple points.

What you want specifically is a diversifying asset - not a asset with a low correlation. This is important because too many people use correlations as a test for diversification.

Correlations assume constant volatility. When stocks tank volatility increases. Correlations are increasing because volatility is increasing. In this case the test is spitting out garbage data. There cases out there were correlations increase yet the assets are still diversifying.

The drivers of bonds, equities, and HY vary over time. Interest rates, inflation rates, earnings growth, equity risk premium, volatility, etc. These change over time. Correlations between bonds, equities, and HY vary by time. Sometimes when the stock market goes down bonds go up. Sometimes they go down.
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Re: Taking risk on equity side.

Post by corp_sharecropper »

If you believe that risk is compensated by a proportional amount of reward, which from my time on Bogleheads I believe a majority here at least think they believe this, then it doesn't matter as all assets have the same Sharpe ratio viewed over a long enough time interval. This is actually a very common academic/theoretical view of the world. With such a world view it makes no difference "where" you take risk, it's your overall risk that matters.

I do not believe that all assets have the same Sharpe. Empirically, it appears bonds consistently have an outsized Sharpe compared to riskier assets over the longest recorded time-frames. In which case the logical thing is to lever up bonds to an equal volatility to equities (or whatever level desired). I don't think that's actually the best plan for reasons relating to how that would be done in the real world.

I'm just pointing out that the idea of taking risk in specific assets flies in the face of other "absolute truths" espoused around here and in fact also is sometimes not correct in the more messy real world
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Re: Taking risk on equity side.

Post by Beensabu »

ChinchillaWhiplash wrote: Fri May 07, 2021 5:08 pm I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
I've done this. I did it because I dramatically decreased equity risk overall. I thought I'd have a decent shot at nearing the "expected" 10-year return of equities with a lot less volatility along the way. I guess I'll see.
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Re: Taking risk on equity side.

Post by burritoLover »

ChinchillaWhiplash wrote: Fri May 07, 2021 5:05 pm
burritoLover wrote: Fri May 07, 2021 4:49 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
Why have bonds at all then? Stocks will outperform even high yield bonds in practically any long-term period.
Would you care to say this again once you look at this? https://www.portfoliovisualizer.com/bac ... ion2_2=100

Plus, bonds are a completely different asset class. Correlation is around 0.5 for both AWF and TEI to US Equities.
Yeah, the S&P 500 outperformed even a bond fund with 82% in BB and below and even in one of the longest bond bull markets in history and even including the dot com bubble burst, the lost decade in US stocks, the GFC, and the covid crisis. Not to mention that bond fund dropped 46% during the GFC so it was highly correlated with equities during a crisis when you need bonds the most.
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Re: Taking risk on equity side.

Post by Tamalak »

I've always been attracted to high risk bonds, and part of me has always wondered if they're gonna end up underpriced because the standard boglehead portfolio has no place for them..
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Re: Taking risk on equity side.

Post by abuss368 »

ChinchillaWhiplash wrote: Fri May 07, 2021 1:05 pm Hear this a lot. Isn’t better to take risk over a wide diversified portfolio in all asset classes that you hold if you are in the accumulation phase? Seems like you would be more likely to increase your portfolio growth this way. I totally understand derisking your portfolio to preserve capital close to retirement age, but until you get there, why not take on more risk through high yield municipal bonds or EM bonds or something similar that are not closely correlated with equities to boost returns when you need your investments to grow the most?
It all depends on your goals, timeframe, and risk tolerance. Your asset allocation is the mist important decision you could make. If you are in the accumulation phase, I would simply buy Total Stock and invest as much as I could in that fund. Over time, you can include bonds.

The compounding effect would be as Warren Buffett has said: a snowball going downhill.

Tony
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Fri May 07, 2021 8:09 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 5:08 pm I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
I've done this. I did it because I dramatically decreased equity risk overall. I thought I'd have a decent shot at nearing the "expected" 10-year return of equities with a lot less volatility along the way. I guess I'll see.
Moving part of the portfolio from stocks to high yield bonds doesn't decrease equity risk so much as it moves the risk from your stock fund to your bond fund.
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Re: Taking risk on equity side.

Post by tibbitts »

Tamalak wrote: Sat May 08, 2021 7:19 am I've always been attracted to high risk bonds, and part of me has always wondered if they're gonna end up underpriced because the standard boglehead portfolio has no place for them..
Well, no, because Bogleheads make up a completely inconsequential portion of the investing population.

However I do think that de-selecting HY, or EM, or whatever as "less efficient" is a slippery slope, since you can then invest only in... let's say micro-cap or frontier markets or dividend aristocrats or whatever some measurements determine are the "most efficient" equities. But it goes with the general Boglehead theme of buying what turns out to be only a carefully selected part of the haystack, while still pretending it's the entire haystack.
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sat May 08, 2021 7:39 am
Beensabu wrote: Fri May 07, 2021 8:09 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 5:08 pm I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
I've done this. I did it because I dramatically decreased equity risk overall. I thought I'd have a decent shot at nearing the "expected" 10-year return of equities with a lot less volatility along the way. I guess I'll see.
Moving part of the portfolio from stocks to high yield bonds doesn't decrease equity risk so much as it moves the risk from your stock fund to your bond fund.
Lol. Yes, it is exchanging types of risk. However, it does in fact decrease equity risk. That's what happens when you lower your stock allocation. Of course it increases bond risk. High yield bonds are risky. That's why they're "high yield". They're still bonds though, not stocks.
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sat May 08, 2021 2:00 pm
vineviz wrote: Sat May 08, 2021 7:39 am
Beensabu wrote: Fri May 07, 2021 8:09 pm
ChinchillaWhiplash wrote: Fri May 07, 2021 5:08 pm I was thinking of having bonds split up into the high risk and treasuries. Definitely smooths things out a bit while retaining higher gains and lower costs.
I've done this. I did it because I dramatically decreased equity risk overall. I thought I'd have a decent shot at nearing the "expected" 10-year return of equities with a lot less volatility along the way. I guess I'll see.
Moving part of the portfolio from stocks to high yield bonds doesn't decrease equity risk so much as it moves the risk from your stock fund to your bond fund.
Lol. Yes, it is exchanging types of risk. However, it does in fact decrease equity risk. That's what happens when you lower your stock allocation. Of course it increases bond risk. High yield bonds are risky. That's why they're "high yield". They're still bonds though, not stocks.
The credit risk of high yield bonds is effectively identical to that of stocks, in nature even if not in amount. That’s why high yield bonds aren’t effective diversifiers.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sat May 08, 2021 3:56 pm The credit risk of high yield bonds is effectively identical to that of stocks, in nature even if not in amount.
It's not though. It's credit risk. It's the risk of default. A high yield bond fund is not the same as a single junk bond. There are also differences in overall quality and type of debt held by various high yield bond funds.

Then again, maybe it is, when stock prices are built on debt. So avoid high yield bonds issued by the same companies/sectors that are driving equity prices up.
That’s why high yield bonds aren’t effective diversifiers.
Not when held alone as one's sole bond allocation. Who would do that? As part of a bond allocation, they can have a place and be effective, as long as you know what they are, what they're doing there, and how they're supposed to work with everything else.

But yeah, they're not the best idea if you have an aggressive AA. That's the point. "Take risk on the equity side" is increase the equities allocation rather than add risk to the bond allocation. But you can do the opposite if you want to. Just don't do both at the same time.
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sat May 08, 2021 5:01 pm
vineviz wrote: Sat May 08, 2021 3:56 pm The credit risk of high yield bonds is effectively identical to that of stocks, in nature even if not in amount.
It's not though. It's credit risk. It's the risk of default.

Which is effectively the same as equity risk.

Beensabu wrote: Sat May 08, 2021 5:01 pm
That’s why high yield bonds aren’t effective diversifiers.
Not when held alone as one's sole bond allocation. Who would do that? As part of a bond allocation, they can have a place and be effective, as long as you know what they are, what they're doing there, and how they're supposed to work with everything else.
That aren’t effective diversifiers in any case. They bring nothing to a portfolio that stocks and investment grade bonds (or stocks and Treasuries) don’t already bring.
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Re: Taking risk on equity side.

Post by okwriter »

ChinchillaWhiplash wrote: Fri May 07, 2021 4:10 pm I don’t know. Looking at something like this makes it seem worthwhile to take the risk. https://www.portfoliovisualizer.com/bac ... tion2_3=50

And then this with EM bonds seems pretty good too. https://www.portfoliovisualizer.com/bac ... tion2_3=50

These funds are high ER but have had really good returns overall. Either return WAY more than TBM index. Even if mixing them all, you came out ahead over several decades
PEDIX (extended duration treasury fund) outperforms them all. It also has a lower correlation with stocks.
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Re: Taking risk on equity side.

Post by TropikThunder »

burritoLover wrote: Sat May 08, 2021 6:47 am
ChinchillaWhiplash wrote: Fri May 07, 2021 5:05 pm Would you care to say this again once you look at this? https://www.portfoliovisualizer.com/bac ... ion2_2=100

Plus, bonds are a completely different asset class. Correlation is around 0.5 for both AWF and TEI to US Equities.
Yeah, the S&P 500 outperformed even a bond fund with 82% in BB and below and even in one of the longest bond bull markets in history and even including the dot com bubble burst, the lost decade in US stocks, the GFC, and the covid crisis. Not to mention that bond fund dropped 46% during the GFC so it was highly correlated with equities during a crisis when you need bonds the most.
Well when you put it like that ......
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sat May 08, 2021 5:10 pm
Beensabu wrote: Sat May 08, 2021 5:01 pm
vineviz wrote: Sat May 08, 2021 3:56 pm The credit risk of high yield bonds is effectively identical to that of stocks, in nature even if not in amount.
It's not though. It's credit risk. It's the risk of default.
Which is effectively the same as equity risk.
Oh, come on... That's like saying literally any kind of risk premium over the risk-free rate is effectively the same as equity risk...
Beensabu wrote: Sat May 08, 2021 5:01 pm
That’s why high yield bonds aren’t effective diversifiers.
Not when held alone as one's sole bond allocation. Who would do that? As part of a bond allocation, they can have a place and be effective, as long as you know what they are, what they're doing there, and how they're supposed to work with everything else.
That aren’t effective diversifiers in any case. They bring nothing to a portfolio that stocks and investment grade bonds (or stocks and Treasuries) don’t already bring.
I'm pretty sure they wouldn't exist if that was actually the case ¯\_(ツ)_/¯
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sat May 08, 2021 11:24 pm Oh, come on... That's like saying literally any kind of risk premium over the risk-free rate is effectively the same as equity risk...
I’m not speaking of ANY kind of risk. I’m speaking specifically about THIS particular risk.

Beensabu wrote: Sat May 08, 2021 5:01 pm
That aren’t effective diversifiers in any case. They bring nothing to a portfolio that stocks and investment grade bonds (or stocks and Treasuries) don’t already bring.
I'm pretty sure they wouldn't exist if that was actually the case ¯\_(ツ)_/¯
This is a non-sequitur.

Clearly they do exist and just as clearly they offer no benefits to the rational long-term investor.
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Re: Taking risk on equity side.

Post by AlohaJoe »

Tamalak wrote: Sat May 08, 2021 7:19 am I've always been attracted to high risk bonds, and part of me has always wondered if they're gonna end up underpriced because the standard boglehead portfolio has no place for them..
I wouldn't say I'm "attracted" to them but I sympathize with your contrary-to-Bogleheads take on them. Bogleheads philosophy sometimes struggle to articulate "the efficient markets properly price most assets" while also saying "except for junk bonds, the efficient market with trillions of dollars is totally wrong about those". With regular, non-junk bonds I've seen the argument that the regulations (like for insurance companies or pension funds that have to take risk on the bond side because they can't just invest in equities) kind of distorts that market is large ways that don't apply to individual investors. But I've never really heard a similar explanation for why the junk bond market is so wrong other than some vague handwaving about irrational reach for yield but I find that hard to square with an $8 trillion market.

Also look at the increasing number of blue chip companies that have realized they don't need to maintain super-high bond ratings and are pretty close to junk status. McDonald's is BBB-rated, just barely out of "junk bond" territory. Things like that make me feel like the whole debt market has undergone some kind of regime change that maybe no one fully understands yet.

When I have PortfolioVisualizer run a factor performance attribution on VWEAX (Vanguard's high-yield bond) it says that over the last 36 months there's 1.02% of alpha that can't be attributed to four-factor equity + term/credit fixed income factor model.

If I run the Match Factor Exposure it tells me that a portfolio of 63% VFITX (intermediate treasury) + 36% VTSAX (total stock market) is equivalent to VWEAX. But when I look at the 12- and 36-month rolling excess returns it seems a lot less clear that they are especially equivalent. Look at June 2010 through June 2013 as a particularly big diverge between them. Or 1997-2002 as another pretty big divergence the other way.

I dunno. Admittedly I consider all of the above mostly academic because despite my misgivings I still don't really think typical retail Bogleheads investors have any particular need to invest in junk bonds. The pro-junk bonds white papers I've read don't make an especially compelling argument for their side of things, either. I've never seen them even try to rebut the "but just invest in treasuries + equities" argument, for instance.
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Re: Taking risk on equity side.

Post by grok87 »

weird time to be thinking about getting into junk bonds since spreads are super tight right now
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vineviz
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Re: Taking risk on equity side.

Post by vineviz »

AlohaJoe wrote: Sun May 09, 2021 3:11 am
Tamalak wrote: Sat May 08, 2021 7:19 am I've always been attracted to high risk bonds, and part of me has always wondered if they're gonna end up underpriced because the standard boglehead portfolio has no place for them..
I wouldn't say I'm "attracted" to them but I sympathize with your contrary-to-Bogleheads take on them. Bogleheads philosophy sometimes struggle to articulate "the efficient markets properly price most assets" while also saying "except for junk bonds, the efficient market with trillions of dollars is totally wrong about those". With regular, non-junk bonds I've seen the argument that the regulations (like for insurance companies or pension funds that have to take risk on the bond side because they can't just invest in equities) kind of distorts that market is large ways that don't apply to individual investors. But I've never really heard a similar explanation for why the junk bond market is so wrong other than some vague handwaving about irrational reach for yield but I find that hard to square with an $8 trillion market.
The reasons that most Bogleheads (which I'm using as a proxy for long-term oriented individual investors) can safely omit high-yield bonds from their portfolio aren't related to markets being inefficient somehow. In fact, it is precisely because markets are efficient that they can be avoided.

As you allude to, heterogeneity of investor preferences is what leads to this result. There are groups of investors who face constraints which limit the amount of common equity they can hold. Some of these constraints are purely rational (e.g. insurance companies, pensions, endowments, etc.) and some are behavioral (e.g. individual investors who prefer "income" from interest and dividends).

Investors who cannot or will not own stocks might rationally allocate a majority of their portfolio to high-yield bonds, bidding up the price (and bidding down expected returns) in the process.

Other investors, who do NOT face the same constraints, will rationally allocate less-than-market-weight to high-yield bonds as a result.

The only place market inefficiency comes into play is for investors who don't NEED to own high-yield bonds at market weight (or above) but choose to do so anyway.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Taking risk on equity side.

Post by ajcp »

ChinchillaWhiplash wrote: Fri May 07, 2021 5:05 pm
burritoLover wrote: Fri May 07, 2021 4:49 pm Why have bonds at all then? Stocks will outperform even high yield bonds in practically any long-term period.
Would you care to say this again once you look at this? https://www.portfoliovisualizer.com/bac ... ion2_2=100

Plus, bonds are a completely different asset class. Correlation is around 0.5 for both AWF and TEI to US Equities.
Not the person you replied to, but I'll happily repeat it as well, because comparing a cherry picked active bond fund to an index stock fund is not a refutation. If you want to compare apples to apples, well then

https://www.portfoliovisualizer.com/bac ... ion2_2=100
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sat May 08, 2021 11:50 pm
Beensabu wrote: Sat May 08, 2021 11:24 pm Oh, come on... That's like saying literally any kind of risk premium over the risk-free rate is effectively the same as equity risk...
I’m not speaking of ANY kind of risk. I’m speaking specifically about THIS particular risk.
All bonds have default risk. US Treasuries are considered "risk-free" as carrying the lowest risk of default. Other sovereign bonds have a greater risk of default. Corporate bonds have a greater risk of default than most sovereign bonds. High-yield bonds have a greater risk of default than investment-grade bonds. But all bonds have default risk.
Beensabu wrote: Sat May 08, 2021 5:01 pm
I'm pretty sure they wouldn't exist if that was actually the case ¯\_(ツ)_/¯
This is a non-sequitur.

Clearly they do exist and just as clearly they offer no benefits to the rational long-term investor.
Okay. They have less interest rate risk than treasuries. They have moderate correlation to equities and low correlation to treasuries (particularly long-term treasuries). The diversification benefits they offer may not appeal to you, but that does not mean they have none.

High-yield bonds are not a new financial product. They have been around for a very long time.
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sun May 09, 2021 12:36 pm
vineviz wrote: Sat May 08, 2021 11:50 pm I’m not speaking of ANY kind of risk. I’m speaking specifically about THIS particular risk.
All bonds have default risk.
Yes. And?

All I’m trying to explain is that you don’t benefit from adding MORE of this PARTICULAR risk to your portfolio via junk bonds if you have access to stocks.

Beensabu wrote: Sat May 08, 2021 5:01 pm High-yield bonds are not a new financial product. They have been around for a very long time.
Sure they have. That’s not a reason to own them.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sun May 09, 2021 1:59 pm
Beensabu wrote: Sun May 09, 2021 12:36 pm
vineviz wrote: Sat May 08, 2021 11:50 pm I’m not speaking of ANY kind of risk. I’m speaking specifically about THIS particular risk.
All bonds have default risk.
Yes. And?

All I’m trying to explain is that you don’t benefit from adding MORE of this PARTICULAR risk to your portfolio via junk bonds if you have access to stocks.
And that's what "taking risk on the equity side" is all about.

I am saying it is an option to reduce risk on the equity side and add some to the bond side in this way if you want to.

The only reason I got into this whole back and forth with you is because you were equating the risk of high yield bonds with equity risk. They are different risks. High yields bonds go down with stocks in a crash at a lesser magnitude. Nobody is saying anything different. High yield bonds are not for safety. They are for income. And they are a diversifier.

Here is a PV thing from Jan 1997 because that's as far back as it goes with these funds:

https://www.portfoliovisualizer.com/bac ... tion5_1=25

Tell me again how reducing equity risk and adding high yield bonds to a portfolio hasn't been of benefit to a long-term investor.
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sun May 09, 2021 2:26 pm
vineviz wrote: Sun May 09, 2021 1:59 pm

All I’m trying to explain is that you don’t benefit from adding MORE of this PARTICULAR risk to your portfolio via junk bonds if you have access to stocks.
And that's what "taking risk on the equity side" is all about.

I am saying it is an option to reduce risk on the equity side and add some to the bond side in this way if you want to.
This option involves simply moving the risk from one fund to another, resulting in a portfolio which has the same overall risk it had before and lower expected returns.

Who does that benefit besides the junk bond fund manager?
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Re: Taking risk on equity side.

Post by abuss368 »

vineviz wrote: Sun May 09, 2021 2:36 pm
Beensabu wrote: Sun May 09, 2021 2:26 pm
vineviz wrote: Sun May 09, 2021 1:59 pm

All I’m trying to explain is that you don’t benefit from adding MORE of this PARTICULAR risk to your portfolio via junk bonds if you have access to stocks.
And that's what "taking risk on the equity side" is all about.

I am saying it is an option to reduce risk on the equity side and add some to the bond side in this way if you want to.
This option involves simply moving the risk from one fund to another, resulting in a portfolio which has the same overall risk it had before and lower expected returns.

Who does that benefit besides the junk bond fund manager?
Vince -

I would suspect that an investor could achieve the same results, and avoid having an additional fund in the portfolio (junk bonds) by simply holding a little higher stock allocation combined with high quality bonds.

Tony
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sun May 09, 2021 2:36 pm
Beensabu wrote: Sun May 09, 2021 2:26 pm
vineviz wrote: Sun May 09, 2021 1:59 pm

All I’m trying to explain is that you don’t benefit from adding MORE of this PARTICULAR risk to your portfolio via junk bonds if you have access to stocks.
And that's what "taking risk on the equity side" is all about.

I am saying it is an option to reduce risk on the equity side and add some to the bond side in this way if you want to.
This option involves simply moving the risk from one fund to another, resulting in a portfolio which has the same overall risk it had before and lower expected returns.

Who does that benefit besides the junk bond fund manager?
Once again:

Here is a PV thing from Jan 1997 because that's as far back as it goes with these funds:

https://www.portfoliovisualizer.com/bac ... tion5_1=25

Reducing equity risk and adding high yield bonds to a portfolio has been of benefit to a long-term investor. The example I have indicated with 25% US stock, 25% Intl stock, 25% LTT, and 25% HY shows the same return over 24 years as 100% global equities portfolio, while nearly halving the volatility. That's not insignificant. It's worth consideration and discussion.

Please explain why the future may differ from the past. I'm sure you can. And that I would be interested to hear. Not the same tired "taking risk on the equities side" refrain. We've heard that for the entire time it's actually not been true. So how about something new?
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sun May 09, 2021 4:03 pm Please explain why the future may differ from the past. I'm sure you can. And that I would be interested to hear.
I doubt the future will be radically different from the past.

The problem with your argument is that the past is different from your description of it. Your comparison portfolios are equal risky: putting the high yield bonds in a riskier portfolio is Luke putting a thumb on the scale.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Taking risk on equity side.

Post by Beensabu »

vineviz wrote: Sun May 09, 2021 4:38 pm
Beensabu wrote: Sun May 09, 2021 4:03 pm Please explain why the future may differ from the past. I'm sure you can. And that I would be interested to hear.
I doubt the future will be radically different from the past.

The problem with your argument is that the past is different from your description of it. Your comparison portfolios are equal risky: putting the high yield bonds in a riskier portfolio is Luke putting a thumb on the scale.
I'm not sure I follow. A 50/50 portfolio is equally as risky as a 100/0 or 70/30 portfolio, simply through inclusion of high yield bonds? Or is it because the fixed income is split between long term treasuries and high yield bonds?

The comparison portfolios are:

(2) 50% US stock / 50% Intl stock

(3) 35% US stock / 35% Intl stock / 30% Total US Bond

Are you saying that one or both of these comparison portfolios are equally risky as the below portfolio?

(1) 25% US stock / 25% Intl stock / 25% LTT / 25% HY

And if so, how are you defining/measuring risk? Because it's certainly not by standard deviation.

(1) CAGR 7.64% / Stdev 8.91%
(2) CAGR 7.62% / Stdev 16.01%
(3) CAGR 7.22% / Stdev 11.02%

Portfolio 1 has the same return as portfolio 2 over the last 24 years, with nearly half the volatility. The max drawdown of portfolio 1 over that period is nearly half the max drawdown of portfolio 2. What exactly makes it equally risky?
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Re: Taking risk on equity side.

Post by okwriter »

Beensabu wrote: Sun May 09, 2021 5:02 pm
vineviz wrote: Sun May 09, 2021 4:38 pm
Beensabu wrote: Sun May 09, 2021 4:03 pm Please explain why the future may differ from the past. I'm sure you can. And that I would be interested to hear.
I doubt the future will be radically different from the past.

The problem with your argument is that the past is different from your description of it. Your comparison portfolios are equal risky: putting the high yield bonds in a riskier portfolio is Luke putting a thumb on the scale.
I'm not sure I follow. A 50/50 portfolio is equally as risky as a 100/0 or 70/30 portfolio, simply through inclusion of high yield bonds? Or is it because the fixed income is split between long term treasuries and high yield bonds?

The comparison portfolios are:

(2) 50% US stock / 50% Intl stock

(3) 35% US stock / 35% Intl stock / 30% Total US Bond

Are you saying that one or both of these comparison portfolios are equally risky as the below portfolio?

(1) 25% US stock / 25% Intl stock / 25% LTT / 25% HY

And if so, how are you defining/measuring risk? Because it's certainly not by standard deviation.

(1) CAGR 7.64% / Stdev 8.91%
(2) CAGR 7.62% / Stdev 16.01%
(3) CAGR 7.22% / Stdev 11.02%

Portfolio 1 has the same return as portfolio 2 over the last 24 years, with nearly half the volatility. The max drawdown of portfolio 1 over that period is nearly half the max drawdown of portfolio 2. What exactly makes it equally risky?
You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
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Re: Taking risk on equity side.

Post by Beensabu »

okwriter wrote: Sun May 09, 2021 5:33 pm You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
Nice! Will you look at that? Indeed you can, and it certainly does :)

Guess that's a pretty good argument for reducing equities and pairing LTT with your Total Bond fund.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Re: Taking risk on equity side.

Post by grok87 »

Beensabu wrote: Sun May 09, 2021 5:59 pm
okwriter wrote: Sun May 09, 2021 5:33 pm You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
Nice! Will you look at that? Indeed you can, and it certainly does :)

Guess that's a pretty good argument for reducing equities and pairing LTT with your Total Bond fund.
I agree that High Yield bonds are not worth it and you can just increase your equity instead.

but i would be very cautious about the allocation to Long term treasuries (LTT) based on a back test from 1997. Interest rates have declined since then so of course LTT looks good. my advise is to split your bonds 50/50 between tips and treasuries, and to use market duration funds for both. so that would point to intermediate treasuries. or you could barbell your treasury allocation and have some in cash and some in long term treasuries.
cheers,
grok
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Re: Taking risk on equity side.

Post by BuyAndHoldOn »

EM Sovereign bonds don't have the same risk profile as the generally referred to high-yield bonds. EM bonds may be more volatile than US treasuries, particularly if they are local currency, but they aren't subject to "stock market" events (e.g., US economy slowing or profit margins shrinking). They are also less volatile than stocks in *most* time periods.

Consider the early 2000s recession / stock market meltdown: EM bonds were unaffected.
*I realize EM bonds sold off in 1994 and 1998; they have their own idiosyncratic risks, especially at a country level (e.g., Turkey).

So they are [or can be considered] diversifiers, just not with a negative correlation. Just have to know what you own, and why.
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Re: Taking risk on equity side.

Post by grok87 »

BuyAndHoldOn wrote: Sun May 09, 2021 6:52 pm EM Sovereign bonds don't have the same risk profile as the generally referred to high-yield bonds. EM bonds may be more volatile than US treasuries, particularly if they are local currency, but they aren't subject to "stock market" events (e.g., US economy slowing or profit margins shrinking). They are also less volatile than stocks in *most* time periods.

Consider the early 2000s recession / stock market meltdown: EM bonds were unaffected.
*I realize EM bonds sold off in 1994 and 1998; they have their own idiosyncratic risks, especially at a country level (e.g., Turkey).

So they are [or can be considered] diversifiers, just not with a negative correlation. Just have to know what you own, and why.
right but em stocks are available. so just buy those and skip the em bonds
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Re: Taking risk on equity side.

Post by Robot Monster »

grok87 wrote: Sun May 09, 2021 7:05 pm
BuyAndHoldOn wrote: Sun May 09, 2021 6:52 pm EM Sovereign bonds don't have the same risk profile as the generally referred to high-yield bonds. EM bonds may be more volatile than US treasuries, particularly if they are local currency, but they aren't subject to "stock market" events (e.g., US economy slowing or profit margins shrinking). They are also less volatile than stocks in *most* time periods.

Consider the early 2000s recession / stock market meltdown: EM bonds were unaffected.
*I realize EM bonds sold off in 1994 and 1998; they have their own idiosyncratic risks, especially at a country level (e.g., Turkey).

So they are [or can be considered] diversifiers, just not with a negative correlation. Just have to know what you own, and why.
right but em stocks are available. so just buy those and skip the em bonds
I looked up the Vanguard Managed Allocation Fund just to confirm that fund, which is like an everything bagel allocating to 14 different asset classes, doesn't even have EM bonds! But it does. 3% EM bonds.
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Re: Taking risk on equity side.

Post by BuyAndHoldOn »

grok87 wrote: Sun May 09, 2021 7:05 pm
BuyAndHoldOn wrote: Sun May 09, 2021 6:52 pm EM Sovereign bonds don't have the same risk profile as the generally referred to high-yield bonds. EM bonds may be more volatile than US treasuries, particularly if they are local currency, but they aren't subject to "stock market" events (e.g., US economy slowing or profit margins shrinking). They are also less volatile than stocks in *most* time periods.

Consider the early 2000s recession / stock market meltdown: EM bonds were unaffected.
*I realize EM bonds sold off in 1994 and 1998; they have their own idiosyncratic risks, especially at a country level (e.g., Turkey).

So they are [or can be considered] diversifiers, just not with a negative correlation. Just have to know what you own, and why.
right but em stocks are available. so just buy those and skip the em bonds
Everything I am saying below is covered in other threads on EM bonds, and those other threads probably do a better job in the explanation. The point is that the country exposure, and also the goal of investing in bonds vs stocks, makes EM bonds a different strategic holding than EM equities (particularly if we are talking the standard MSCI EM Index, or similar).

I am [for what it's worth] overweight EM stocks, but the index / most active funds for EM stocks are very different from what you get in EM Bond funds (active and passive). You can get a significant weighting in [for example] Russia and Mexico in bond funds, and both are investment grade sovereigns with (depending on the market conditions) attractive yields, which is good for a bond fund. Whereas the EM stock indices, and most active funds, are heavily overweight East Asia [concentrated in big Chinese, Korean, and Taiwanese companies].

China is the largest Local Currency issuer at present, however; the $USD EM bond universe is quite different (more oil producing countries).
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Re: Taking risk on equity side.

Post by vineviz »

Beensabu wrote: Sun May 09, 2021 5:59 pm
okwriter wrote: Sun May 09, 2021 5:33 pm You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
Nice! Will you look at that? Indeed you can, and it certainly does :)

Guess that's a pretty good argument for reducing equities and pairing LTT with your Total Bond fund.
Or omitting Total Bond fund altogether using simply a combination of equities and Treasuries.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: Taking risk on equity side.

Post by UpperNwGuy »

vineviz wrote: Sun May 09, 2021 7:36 pm
Beensabu wrote: Sun May 09, 2021 5:59 pm
okwriter wrote: Sun May 09, 2021 5:33 pm You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
Nice! Will you look at that? Indeed you can, and it certainly does :)

Guess that's a pretty good argument for reducing equities and pairing LTT with your Total Bond fund.
Or omitting Total Bond fund altogether using simply a combination of equities and Treasuries.
I guess you don't like corporate bonds.
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Re: Taking risk on equity side.

Post by vineviz »

UpperNwGuy wrote: Sun May 09, 2021 7:41 pm
vineviz wrote: Sun May 09, 2021 7:36 pm
Beensabu wrote: Sun May 09, 2021 5:59 pm
okwriter wrote: Sun May 09, 2021 5:33 pm You could replace HY bonds with Total Bond in portfolio (1) and achieve the same results by increasing the stock allocation a little. This supports vineviz's claim that HY bonds offer no additional benefits to a portfolio.

29% US stock / 29% Intl stock / 25% LTT / 17% Total US Bond
results in
CAGR 7.64% / Stdev 8.86%

PV link
Nice! Will you look at that? Indeed you can, and it certainly does :)

Guess that's a pretty good argument for reducing equities and pairing LTT with your Total Bond fund.
Or omitting Total Bond fund altogether using simply a combination of equities and Treasuries.
I guess you don't like corporate bonds.
I like them just fine in the right circumstances. But I'm not a fan of total bond market funds.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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