My favorite authors are turning their backs on Bonds

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JBTX
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Re: My favorite authors are turning their backs on Bonds

Post by JBTX »

For those that are turning their back on bonds, I have to wonder if it stems from some (what I believe to be faulty) assumptions

- focus on nominal returns vs real returns.
- assumption that even though bond returns go down, stock or other asset returns won't.
- assumption that in order to avoid negative real returns, one will/should change their risk profile
- assumption that there is a risk free place to park assets and maintain real value (apart from maybe ibonds)
- failure to realize that low or negative returns may be a rational choice if no other risk adjusted alternative exists.
aristotelian
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

vineviz wrote: Mon Jun 07, 2021 1:13 pm I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
When would high quality short/intermediate duration bonds not reduce volatility compared to 100% stock? There are different kinds of bonds that are suited to different purposes.
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Re: My favorite authors are turning their backs on Bonds

Post by Lee_WSP »

Bogle said the best predictor we have of long term returns on bonds is the current yield to maturity. At a YTM of ~1% for a 10 year bond..... it's a hard pill to swallow. But the alternative isn't necessarily better either.
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vineviz
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Mon Jun 07, 2021 3:13 pm
vineviz wrote: Mon Jun 07, 2021 1:13 pm I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
When would high quality short/intermediate duration bonds not reduce volatility compared to 100% stock? There are different kinds of bonds that are suited to different purposes.
As I said, including bonds in the portfolio USUALLY reduces portfolio volatility.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
dharrythomas
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Re: My favorite authors are turning their backs on Bonds

Post by dharrythomas »

10 year Treasury bonds are yielding 1.569%. That is what you can expect. Inflation target is 3%. The Treasury Secretary just said that the economy would be healthier with higher interest rates. She’s right, there should be some incentive for saving and lending. But there is a great deal of pain between current rates and 6% mortgage. If interest rates do go up, the myth of stable bond prices is revealed.

Falling interest rates have provided a tailwind for portfolios, not only both debt and equity but also real estate, for my investing lifetime. Our first mortgage was in 1988 for 9% (rates had been higher) our second house was in 1999 for 7%. Our kids are under 4% with a 30 year loan.

Equities are priced for low returns at these P/E ratios, bonds are even worse even if rates don’t go up. My parents were buying bonds in the early 1980s, and they made good money.

People who lived through the 1970’s and 1980’s find nothing to like about bonds at these yields.
aristotelian
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

vineviz wrote: Mon Jun 07, 2021 4:55 pm
aristotelian wrote: Mon Jun 07, 2021 3:13 pm
vineviz wrote: Mon Jun 07, 2021 1:13 pm I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
When would high quality short/intermediate duration bonds not reduce volatility compared to 100% stock? There are different kinds of bonds that are suited to different purposes.
As I said, including bonds in the portfolio USUALLY reduces portfolio volatility.
We are just repeating ourselves then but I would say short duration safe bonds reduces volatility full stop and that is a valid purpose for such bonds. What is the scenario where say short Treasuries are more volatile than stocks?
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Munir
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Re: My favorite authors are turning their backs on Bonds

Post by Munir »

As a retiree in the distribution phase, I would ask those disparaging bonds- if not bonds, then what?
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vineviz
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Mon Jun 07, 2021 7:23 pm We are just repeating ourselves then but I would say short duration safe bonds reduces volatility full stop and that is a valid purpose for such bonds. What is the scenario where say short Treasuries are more volatile than stocks?
I specifically said that adding bonds to the portfolio USUALLY reduces portfolio volatility specifically because the word "usually" means what it does. You can add qualifiers to that if you like but it doesn't change the outcome, which is that adding bonds to the portfolio generally but not always reduces the volatility of the portfolio.

It also doesn't change the fact that focusing on portfolio volatility is generally misguided. People save and invest to provide for future consumption and bequests, as a rule, and not to minimize volatility.
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Re: My favorite authors are turning their backs on Bonds

Post by Random Musings »

Paulie turned his back on Henry and it didn't work out well for him.

Turning your back on bonds and replacing it with something else will change a portfolio's risk profile. There is rarely a free lunch.

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Re: My favorite authors are turning their backs on Bonds

Post by Explorer »

To each their own.. bonds have a specific purpose in my portfolio and they are playing that role admirably.
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Re: My favorite authors are turning their backs on Bonds

Post by reln »

BogleBuddy12 wrote: Sun Jun 06, 2021 11:09 pm I just bought Charley Ellis’ 8th Edition of “Winning the Loser’s Game.” It was released in May 2021.

In this 2021 edition, Burton Malkiel writes the foreword where he praises Ellis for revising the book to include concerns about “financial repression” and the low bond interest rates. Ellis discusses his concerns with bonds. It seems they both will no longer recommend a classic portfolio such as 60% stocks / 40% bonds.

My concern is that the book touts “timeless strategies.” 60/40 was thought to be a great, long-term way to invest. Many of the authors who pioneered index funds believed in holding a Total Bond Market fund. I don’t believe many of them wrote that bonds are meant for growth, but rather safety and security.

It seems Ellis has shifted his views on the purpose of bonds, due to the fact that they are currently paying very little if anything. Should the current interest rate environment be changing the “timeless strategies” we have relied on, namely the 60/40 portfolio?
Yes. Investors shouldn't ignore relevant information. And there's nothing special about 60/40.
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Re: My favorite authors are turning their backs on Bonds

Post by jdb »

Nicolas wrote: Mon Jun 07, 2021 8:57 am
snackdog wrote: Mon Jun 07, 2021 8:42 am My favorite authors have never mentioned bonds or stocks as far as I know,
Mine have. Mark Twain mentioned them. Gold and Silver mining stocks figured prominently in Roughing It, one of my favorite books by one of my favorite authors.
Anthony Trollope, one of my favorite authors, dealt with investments in The Way We Live Now. But they were fraudulent railroad stocks. Investors in 19th century London better off with gilts, government issued bonds denominated in sterling. None of my favorite authors knew about MPT. Good luck.
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dogagility
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Re: My favorite authors are turning their backs on Bonds

Post by dogagility »

BolderBoy wrote: Mon Jun 07, 2021 10:09 am
Devil's Advocate wrote: Mon Jun 07, 2021 8:59 amBut once again, bonds are for preserving wealth, not for growing it.
This is the key point when one cuts through all the anti-bond noise.
And (if this generalization was true) the reason a person with a long timeline prior to portfolio withdrawal (i.e. the accumulator) should not be investing in bonds.

Perhaps bonds are for psychological comfort only (for the accumulator; not the retiree) which should be seen as a headwind for portfolio growth.
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Re: My favorite authors are turning their backs on Bonds

Post by valleyrock »

aristotelian wrote: Mon Jun 07, 2021 3:13 pm
vineviz wrote: Mon Jun 07, 2021 1:13 pm I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
When would high quality short/intermediate duration bonds not reduce volatility compared to 100% stock? There are different kinds of bonds that are suited to different purposes.
Back during the great recession (2008-2009), stocks plunged and Treasury bonds rose a fair amount. That seems to illustrate the non-correlating asset mix in a nutshell, showing the (relative) safety of bonds, especially in a crisis. We can't predict the next crisis, but I suppose it's safe to say there will be one.
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Re: My favorite authors are turning their backs on Bonds

Post by valleyrock »

aristotelian wrote: Mon Jun 07, 2021 3:13 pm
vineviz wrote: Mon Jun 07, 2021 1:13 pm I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
When would high quality short/intermediate duration bonds not reduce volatility compared to 100% stock? There are different kinds of bonds that are suited to different purposes.
Back during the great recession (2008-2009), stocks plunged and Treasury bonds rose a fair amount. That seems to illustrate the non-correlating asset mix in a nutshell, showing the (relative) safety of bonds, especially in a crisis. We can't predict the next crisis, but I suppose it's safe to say there will be one.
Greg in Idaho
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Re: My favorite authors are turning their backs on Bonds

Post by Greg in Idaho »

vineviz wrote: Mon Jun 07, 2021 1:13 pm
SteadyOne wrote: Mon Jun 07, 2021 12:14 pm Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
hmmm...I thought the purpose of bonds is a function of why the investor is holding them...
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vineviz
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

Greg in Idaho wrote: Tue Jun 08, 2021 7:26 am hmmm...I thought the purpose of bonds is a function of why the investor is holding them...
Bonds and their role in a portfolio don’t seem to very understood by most investors or by many investment writers, unfortunately.

Many investors confuse cause and effect, for instance. Reducing portfolio volatility is an effect of holding bonds, but not the reason a rational investor should be holding them.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
UpperNwGuy
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Re: My favorite authors are turning their backs on Bonds

Post by UpperNwGuy »

jdb wrote: Mon Jun 07, 2021 10:03 pm
Nicolas wrote: Mon Jun 07, 2021 8:57 am
snackdog wrote: Mon Jun 07, 2021 8:42 am My favorite authors have never mentioned bonds or stocks as far as I know,
Mine have. Mark Twain mentioned them. Gold and Silver mining stocks figured prominently in Roughing It, one of my favorite books by one of my favorite authors.
Anthony Trollope, one of my favorite authors, dealt with investments in The Way We Live Now. But they were fraudulent railroad stocks. Investors in 19th century London better off with gilts, government issued bonds denominated in sterling. None of my favorite authors knew about MPT. Good luck.
British novels of the 19th and 20th century are full of characters who lived off of "an income" that appeared to be bond dividends.
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Re: My favorite authors are turning their backs on Bonds

Post by UpperNwGuy »

dogagility wrote: Tue Jun 08, 2021 4:52 am
BolderBoy wrote: Mon Jun 07, 2021 10:09 am
Devil's Advocate wrote: Mon Jun 07, 2021 8:59 amBut once again, bonds are for preserving wealth, not for growing it.
This is the key point when one cuts through all the anti-bond noise.
And (if this generalization was true) the reason a person with a long timeline prior to portfolio withdrawal (i.e. the accumulator) should not be investing in bonds.

Perhaps bonds are for psychological comfort only (for the accumulator; not the retiree) which should be seen as a headwind for portfolio growth.
Don't underestimate the importance of psychological comfort.
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Re: My favorite authors are turning their backs on Bonds

Post by BalancedJCB19 »

I remember hearing how bad it was to hold bonds in your portfolio for over a decade now. I need something to protect me from myself even if the growth is not there. 60/40 for me has worked well for me for over 20 years and after looking at my returns I have no reason to think I was wrong. I'm all in with the Vanguard Balanced Index Fund. My Rate of return as of 05/31/2021 is 13.2%. I'll take it!!

Ignore the noise. Stemikger was right!
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Re: My favorite authors are turning their backs on Bonds

Post by Chadnudj »

I'm planning on staying at 80-20 (thanks to the Vanguard LifeStrategy Growth Fund) forever, essentially.

Yes, there may be some tax drag that way. I don't really care -- it's easy, auto-rebalances, and will get me to my goals. I feel like bonds may not be in vogue now, but they will be at some point in the not too distant future, and until then offer some ballast/chances for rebalancing in my portfolio (or, more accurately, in LifeStrategy Growth's fund).
Da5id
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Re: My favorite authors are turning their backs on Bonds

Post by Da5id »

BalancedJCB19 wrote: Tue Jun 08, 2021 7:37 am I remember hearing how bad it was to hold bonds in your portfolio for over a decade now.
Yep. "Interest rates have nowhere to go but up, bonds are doomed", "replace your useless bonds with junk/high yield corp/dividend stocks", etc have been around for quite some time. Bonds (and stocks for that matter) don't look to be in a great place right now by some metrics. However that doesn't mean there are good/useful alternatives, or that tea leaf reading can prospectively identify those alternatives. So stay the course and accept what comes.
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Re: My favorite authors are turning their backs on Bonds

Post by Random Walker »

dharrythomas wrote: Mon Jun 07, 2021 6:27 pm 10 year Treasury bonds are yielding 1.569%. That is what you can expect. Inflation target is 3%. The Treasury Secretary just said that the economy would be healthier with higher interest rates. She’s right, there should be some incentive for saving and lending. But there is a great deal of pain between current rates and 6% mortgage. If interest rates do go up, the myth of stable bond prices is revealed.

Falling interest rates have provided a tailwind for portfolios, not only both debt and equity but also real estate, for my investing lifetime. Our first mortgage was in 1988 for 9% (rates had been higher) our second house was in 1999 for 7%. Our kids are under 4% with a 30 year loan.

Equities are priced for low returns at these P/E ratios, bonds are even worse even if rates don’t go up. My parents were buying bonds in the early 1980s, and they made good money.

People who lived through the 1970’s and 1980’s find nothing to like about bonds at these yields.
I agree with all the above. Could it be time for many hardcore TSM/TBM folks to reconsider international equity allocation, spreading equity risks across factors and styles, even alternatives?

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aristotelian
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

vineviz wrote: Tue Jun 08, 2021 7:32 am
Greg in Idaho wrote: Tue Jun 08, 2021 7:26 am hmmm...I thought the purpose of bonds is a function of why the investor is holding them...
Bonds and their role in a portfolio don’t seem to very understood by most investors or by many investment writers, unfortunately.

Many investors confuse cause and effect, for instance. Reducing portfolio volatility is an effect of holding bonds, but not the reason a rational investor should be holding them.
I am still not following this. Why can't an investor hold bonds for the purpose of achieving a desired effect? At this point it seems you are making a semantic distinction. Are you arguing against holding bonds or simply against how investors typically describe their reasons for holding bonds?
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Re: My favorite authors are turning their backs on Bonds

Post by alex_686 »

UpperNwGuy wrote: Tue Jun 08, 2021 7:32 am British novels of the 19th and 20th century are full of characters who lived off of "an income" that appeared to be bond dividends.
More likely rents, annuities, or equities. Yes, equities. Equities worked very much like bonds back then. You bought and sold stocks at around par value. The majority of returns were delivered by dividends.
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Random Walker
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Re: My favorite authors are turning their backs on Bonds

Post by Random Walker »

valleyrock wrote: Tue Jun 08, 2021 7:15 am Back during the great recession (2008-2009), stocks plunged and Treasury bonds rose a fair amount. That seems to illustrate the non-correlating asset mix in a nutshell, showing the (relative) safety of bonds, especially in a crisis. We can't predict the next crisis, but I suppose it's safe to say there will be one.
I believe overall high quality bonds and stocks uncorrelated, but there is a strong tendency for the correlation to turn strongly negative just when would want it to the most. As in the example above, when stocks tank, there’s a flight to quality and liquidity and bonds tend to perform well.

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Re: My favorite authors are turning their backs on Bonds

Post by Da5id »

alex_686 wrote: Tue Jun 08, 2021 8:37 am
UpperNwGuy wrote: Tue Jun 08, 2021 7:32 am British novels of the 19th and 20th century are full of characters who lived off of "an income" that appeared to be bond dividends.
More likely rents, annuities, or equities. Yes, equities. Equities worked very much like bonds back then. You bought and sold stocks at around par value. The majority of returns were delivered by dividends.
Timely advice: sell your stodgy bonds and buy South Seas Stock. Huge returns, endorsed by the crown, can't fail :)
alex_686
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Re: My favorite authors are turning their backs on Bonds

Post by alex_686 »

Seasonal wrote: Mon Jun 07, 2021 10:40 am Modern Portfolio Theory was started by Harry Markowitz in 1952. The core concept of a trade-off between risk and expected return is timeless. Otherwise, it's not really current, especially the idea that volatility equals risk (and mean-variance optimizing).
Actually, the core concept was to simplify the allocation problem so you could get actionable results off of a IBM mainframe.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am In the past there were a number of posts about portfolio optimization. People building spreadsheets and models. I haven't seen any discussions recently.

The problem is the the correlations between asset classes change over time and the markets tend to move together when things head South. Optimizers are good for telling you what you should have done in the past, not as accurate at telling you where to go now.
At the time Nisiprius said "MPT devotees simply substitute "chasing correlations" for "chasing performance."" and called MPT "garbage in, garbage out". Nedsaid agreed.

A 2009 Bogleheads thread on MPT has Valuethinker saying "they tend to weight your portfolio to what last did well" and Adrian Nenu called it "basically worthless". Rodc said "worthless might be an over-statement, but the value, if any, is very limited".
[/quote]

So, would one argue that Newton's Second Law of Motion, F = MA, is mostly bunk? I mean, it can only solve for problems with perfectly perfectly spherical elastic cows. Einstein proved that it was wrong. Take a look at engineering books and you will find tons of things that disprove it, like heat friction.

Yet, F= MA is still a core concept, lurking just below most physics and engineering. It is a simplification, but a very useful simplification to underpins the theory.

MPT is in the same boat. Using volatility as a risk measure is a simplification with know issues. On the plus side you can get actionable results with little data. It can be applied to almost any asset class. You only need college level statistics to use it correctly.

There are "better" theories and models out there. "Better" in that they address that returns are not normally distributed. However, these are extensions of MPT. More complex models.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates.
You should try reading old journals. People really did not know about diversification. Yeah, the word was thrown around alot, but nobody knew what it meant. It was even vaguer a word than beauty. Markowitz actually presented a intellectual framework where we could articulate the concept.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am This is what MPT says the optimal portfolio was, as of Q2 2019:


I think the above chart is a mischaracterization of MPT. I would like to know who produced that chart.

A known issues is that it is unstable. Small changes in inputs can result in large changes in allocations and corner solutions. It is theory verse practice. Investing is like medicine - it is a applied art. (I really do like the idea that medicine is the applied art of biology). A doctor can master theory and still be practice poorly. A doctor who has mastered both theory and practice can still fail. Such is life.

I have a hard time that a responsible practitioner would put that chart together using just MPT.
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alex_686
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Re: My favorite authors are turning their backs on Bonds

Post by alex_686 »

Da5id wrote: Tue Jun 08, 2021 8:52 am Timely advice: sell your stodgy bonds and buy South Seas Stock. Huge returns, endorsed by the crown, can't fail :)
For a bit more context, most equities where banks, insurance companies or railroads. Large steady businesses. Bought because they paid a steady dividend of 2% to 4%. There were runs and panics if people thought they couldn't pay their dividends. They took the South Seas Stock Bubble lesson to well to heart.

Depending on where you set the bar, the idea of principal appreciation was a legitimate valid form of long term return - and not just speculation - didn't happen until the 1950s to the 1970s. In part due to MPT.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: My favorite authors are turning their backs on Bonds

Post by Scooter57 »

alex_686 wrote: Tue Jun 08, 2021 8:37 am
UpperNwGuy wrote: Tue Jun 08, 2021 7:32 am British novels of the 19th and 20th century are full of characters who lived off of "an income" that appeared to be bond dividends.
More likely rents, annuities, or equities. Yes, equities. Equities worked very much like bonds back then. You bought and sold stocks at around par value. The majority of returns were delivered by dividends.
Rents were the primary source of income for the landed gentry in England up until the 1870s when imports from the US and Australia were priced cheaply enough to send agriculture in England into a depression. However, those who had inherited family money without the land that went with it, who were usually younger sons and daughters generally put their money into the Consols which were Government bonds paying 4-5% throughout the 19th century.

Stocks were considered a form of gambling and since they weren't regulated often were scams of the type depicted in Trollope's The Way We Live Now. Banks also were prone to failure. Jane Austen's brother Henry was a partner in a bank that failed during her lifetime, taking with it the money of those who had trusted in him. Including, I believe, some of hers (though she had pitifully little.)
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

alex_686 wrote: Tue Jun 08, 2021 9:17 am

I think the above chart is a mischaracterization of MPT. I would like to know who produced that chart.

A known issues is that it is unstable. Small changes in inputs can result in large changes in allocations and corner solutions. It is theory verse practice. Investing is like medicine - it is a applied art. (I really do like the idea that medicine is the applied art of biology). A doctor can master theory and still be practice poorly. A doctor who has mastered both theory and practice can still fail. Such is life.

I have a hard time that a responsible practitioner would put that chart together using just MPT.
The problem starts with feeding the analysis a list of the assets you want to consider. A practitioner working from that list of assets is going to end up with garbage. I think in general having too large a number of assets necessarily produces a mess. Also it should be a significant problem occurs when the correlations among many of the assets is high because the analysis is not very stable and many of the possible choices aren't meaningful in practice.

I remember the same thing happened when my 401k had access to Financial Engines. The default model was to consider a portfolio selected from every fund available in the 401k even though one already knew that one would never invest in many of them. You could get a more sensible analysis by restricting the list to a few likely candidates.
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Re: My favorite authors are turning their backs on Bonds

Post by mikejuss »

Scooter57 wrote: Tue Jun 08, 2021 9:28 am
alex_686 wrote: Tue Jun 08, 2021 8:37 am
UpperNwGuy wrote: Tue Jun 08, 2021 7:32 am British novels of the 19th and 20th century are full of characters who lived off of "an income" that appeared to be bond dividends.
More likely rents, annuities, or equities. Yes, equities. Equities worked very much like bonds back then. You bought and sold stocks at around par value. The majority of returns were delivered by dividends.
Rents were the primary source of income for the landed gentry in England up until the 1870s when imports from the US and Australia were priced cheaply enough to send agriculture in England into a depression. However, those who had inherited family money without the land that went with it, who were usually younger sons and daughters generally put their money into the Consols which were Government bonds paying 4-5% throughout the 19th century.

Stocks were considered a form of gambling and since they weren't regulated often were scams of the type depicted in Trollope's The Way We Live Now. Banks also were prone to failure. Jane Austen's brother Henry was a partner in a bank that failed during her lifetime, taking with it the money of those who had trusted in him. Including, I believe, some of hers (though she had pitifully little.)
Fascinating context. Thank you. Perhaps we ought to start a separate thread on the intersection of finance and literature.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Tue Jun 08, 2021 8:34 am
vineviz wrote: Tue Jun 08, 2021 7:32 am
Greg in Idaho wrote: Tue Jun 08, 2021 7:26 am hmmm...I thought the purpose of bonds is a function of why the investor is holding them...
Bonds and their role in a portfolio don’t seem to very understood by most investors or by many investment writers, unfortunately.

Many investors confuse cause and effect, for instance. Reducing portfolio volatility is an effect of holding bonds, but not the reason a rational investor should be holding them.
I am still not following this. Why can't an investor hold bonds for the purpose of achieving a desired effect? At this point it seems you are making a semantic distinction. Are you arguing against holding bonds or simply against how investors typically describe their reasons for holding bonds?
There are definitely rational reasons to hold bonds. I own some myself, both individual bonds and bond funds.

I'm arguing that - broadly speaking - "reducing portfolio volatility" is not a rational reason to hold bonds. I know this is commonly cited as a reason, but it's not a good reason IMHO.

The key feature of bonds compared to most other asset classes, like stocks, is that they produce a predictable stream of cash flows.

Change "predictable" to "fixed" and "cash flows" to "income" and you'll get the name of the asset class: fixed income. It's this feature of having predictable cash flows that makes bonds useful to investors, not the knock-on effect of price volatility which is generally associated with them.
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Re: My favorite authors are turning their backs on Bonds

Post by WS1 »

nisiprius wrote: Mon Jun 07, 2021 8:21 am
dbr wrote: Mon Jun 07, 2021 8:03 am...The idea that bonds are held in order to get income makes no sense and never did...
Exactly.

A bond is a legal contract that (often) guarantees the payment of specific numbers of dollars on specific days. We can summarize that phrase in the word "fixed," in the phrase "fixed income."

"Bond" is from the same root as "binding," in a phrase like "binding contract." What makes a bond a "bond" is not the "income" part, but the "fixed" part.

Too many people with products or strategies to sell will say "Bonds provide an income stream. My pet asset class (real estate, dividend stocks, covered calls, whatever) provides an income stream. Therefore my pet asset class is a bond substitute." No.
Wait, are you two saying that the point of making your capital available for rent was never to earn a profit?
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

vineviz wrote: Tue Jun 08, 2021 10:14 am
There are definitely rational reasons to hold bonds. I own some myself, both individual bonds and bond funds.

I'm arguing that - broadly speaking - "reducing portfolio volatility" is not a rational reason to hold bonds. I know this is commonly cited as a reason, but it's not a good reason IMHO.

The key feature of bonds compared to most other asset classes, like stocks, is that they produce a predictable stream of cash flows.

Change "predictable" to "fixed" and "cash flows" to "income" and you'll get the name of the asset class: fixed income. It's this feature of having predictable cash flows that makes bonds useful to investors, not the knock-on effect of price volatility which is generally associated with them.
I want a portion of my portfolio in stable (non volatile) assets because I do not want all my money at risk in the stock market. I want to preserve some level of wealth and hopefully earn a bit of income in the process. Am I irrational?

Yes, bonds are literally fixed income securities. Can they have no other purposes for the investor? Sorry to belabor this but I am still not understanding your point in this distinction.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Tue Jun 08, 2021 11:13 am I want a portion of my portfolio in stable (non volatile) assets because I do not want all my money at risk in the stock market. I want to preserve some level of wealth and hopefully earn a bit of income in the process. Am I irrational?
Why do you want to "preserve some level of wealth and hopefully earn a bit of income in the process"? What will you do with that wealth and/or income?
"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: My favorite authors are turning their backs on Bonds

Post by aristotelian »

vineviz wrote: Tue Jun 08, 2021 11:27 am
aristotelian wrote: Tue Jun 08, 2021 11:13 am I want a portion of my portfolio in stable (non volatile) assets because I do not want all my money at risk in the stock market. I want to preserve some level of wealth and hopefully earn a bit of income in the process. Am I irrational?
Why do you want to "preserve some level of wealth and hopefully earn a bit of income in the process"? What will you do with that wealth and/or income?
Is this a trick question? Lol.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Tue Jun 08, 2021 11:48 am
vineviz wrote: Tue Jun 08, 2021 11:27 am
aristotelian wrote: Tue Jun 08, 2021 11:13 am I want a portion of my portfolio in stable (non volatile) assets because I do not want all my money at risk in the stock market. I want to preserve some level of wealth and hopefully earn a bit of income in the process. Am I irrational?
Why do you want to "preserve some level of wealth and hopefully earn a bit of income in the process"? What will you do with that wealth and/or income?
Is this a trick question? Lol.
Not at all.

People don't typically accumulate wealth simply to have wealth: they accumulate wealth so that they can USE that wealth for something. That something is usually future consumption of one sort or another.
"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: My favorite authors are turning their backs on Bonds

Post by AlwaysLearningMore »

vineviz wrote: Mon Jun 07, 2021 1:13 pm
SteadyOne wrote: Mon Jun 07, 2021 12:14 pm Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
+1 At the end of the day, a bond is a loan.
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Re: My favorite authors are turning their backs on Bonds

Post by luckyducky99 »

If someone knows that they will get stressed out if their portfolio goes down "a lot" (subjective and vague)
vineviz wrote: Tue Jun 08, 2021 11:59 am
aristotelian wrote: Tue Jun 08, 2021 11:48 am
vineviz wrote: Tue Jun 08, 2021 11:27 am
aristotelian wrote: Tue Jun 08, 2021 11:13 am I want a portion of my portfolio in stable (non volatile) assets because I do not want all my money at risk in the stock market. I want to preserve some level of wealth and hopefully earn a bit of income in the process. Am I irrational?
Why do you want to "preserve some level of wealth and hopefully earn a bit of income in the process"? What will you do with that wealth and/or income?
Is this a trick question? Lol.
Not at all.

People don't typically accumulate wealth simply to have wealth: they accumulate wealth so that they can USE that wealth for something. That something is usually future consumption of one sort or another.
If someone knows that they'll get stressed out if the current value of their portfolio declines by "a lot" (whatever "a lot" is to them), then even if their investment horizon is long and that view is economically myopic, then can't it make sense to avoid that stress by holding bonds to dampen volatility -- especially if they can still meet their future consumption goals?

So I would take it a step further and say that the point of consumption is to have a happy life that you can enjoy. Sacrificing future consumption for peace of mind now is a tradeoff, and it might not be 100% economically rational in the sense that it fails to maximize lifetime consumption, but it still might be right for someone without the temperament to own a volatile portfolio.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

luckyducky99 wrote: Tue Jun 08, 2021 1:22 pm If someone knows that they'll get stressed out if the current value of their portfolio declines by "a lot" (whatever "a lot" is to them), then even if their investment horizon is long and that view is economically myopic, then can't it make sense to avoid that stress by holding bonds to dampen volatility -- especially if they can still meet their future consumption goals?
This is a good example of an irrational reason to own bonds.

Now, we’re all irrational to some degree and sometimes we have to make decisions that accommodate that irrationality instead of suppressing it.

Frankly acknowledging our irrationality is crucial to limiting the damage it inflicts on our decision making IMHO.
"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: My favorite authors are turning their backs on Bonds

Post by NoRegret »

alex_686 wrote: Tue Jun 08, 2021 9:17 am
Seasonal wrote: Mon Jun 07, 2021 10:40 am Modern Portfolio Theory was started by Harry Markowitz in 1952. The core concept of a trade-off between risk and expected return is timeless. Otherwise, it's not really current, especially the idea that volatility equals risk (and mean-variance optimizing).
Actually, the core concept was to simplify the allocation problem so you could get actionable results off of a IBM mainframe.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am In the past there were a number of posts about portfolio optimization. People building spreadsheets and models. I haven't seen any discussions recently.

The problem is the the correlations between asset classes change over time and the markets tend to move together when things head South. Optimizers are good for telling you what you should have done in the past, not as accurate at telling you where to go now.
At the time Nisiprius said "MPT devotees simply substitute "chasing correlations" for "chasing performance."" and called MPT "garbage in, garbage out". Nedsaid agreed.

A 2009 Bogleheads thread on MPT has Valuethinker saying "they tend to weight your portfolio to what last did well" and Adrian Nenu called it "basically worthless". Rodc said "worthless might be an over-statement, but the value, if any, is very limited".

So, would one argue that Newton's Second Law of Motion, F = MA, is mostly bunk? I mean, it can only solve for problems with perfectly perfectly spherical elastic cows. Einstein proved that it was wrong. Take a look at engineering books and you will find tons of things that disprove it, like heat friction.

Yet, F= MA is still a core concept, lurking just below most physics and engineering. It is a simplification, but a very useful simplification to underpins the theory.

MPT is in the same boat. Using volatility as a risk measure is a simplification with know issues. On the plus side you can get actionable results with little data. It can be applied to almost any asset class. You only need college level statistics to use it correctly.

There are "better" theories and models out there. "Better" in that they address that returns are not normally distributed. However, these are extensions of MPT. More complex models.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates.
You should try reading old journals. People really did not know about diversification. Yeah, the word was thrown around alot, but nobody knew what it meant. It was even vaguer a word than beauty. Markowitz actually presented a intellectual framework where we could articulate the concept.
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am This is what MPT says the optimal portfolio was, as of Q2 2019:


I think the above chart is a mischaracterization of MPT. I would like to know who produced that chart.

A known issues is that it is unstable. Small changes in inputs can result in large changes in allocations and corner solutions. It is theory verse practice. Investing is like medicine - it is a applied art. (I really do like the idea that medicine is the applied art of biology). A doctor can master theory and still be practice poorly. A doctor who has mastered both theory and practice can still fail. Such is life.

I have a hard time that a responsible practitioner would put that chart together using just MPT.
There are different levels of persistence in various parameters. The most stable are asset class volatilities, followed by cross-asset correlations, while asset returns are the least stable.

An example of asset class volatility stability is that I have good confidence that going forward the volatility of gold will be > that of equities > that of quality bonds. Even if there are fluctuations within each asset, the difference between assets are so great and so intrinsic that this relationship should hold.

For cross-asset correlation, there're discussions of equity/bond correlation elsewhere, but in general if they change whether in response to inflation, there are regimes lasting decades. Another example is I have no issue assuming the correlation between gold and equities to be low (~0) going forward. But in general we should be aware that cross-asset correlations can change over time.

The same cannot be said for asset returns -- I think that's where the objections to Sharpe optimal MVO come from, and I would agree. Sometimes I would look at the results of risk parity, min var, and max diversification, but generally favor a hierarchical approach (informed by macro) and keep things simple.

The Resolve paper on portfolio optimization has been cited here multiple times.
https://investresolve.com/file/pdf/Port ... epaper.pdf
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Re: My favorite authors are turning their backs on Bonds

Post by GP813 »

How good is sage advice if people abandon it at the first sign of turmoil? The 60/40 portfolios will probably end up being prudent for many investors in the long run.
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Re: My favorite authors are turning their backs on Bonds

Post by mikejuss »

vineviz wrote: Tue Jun 08, 2021 1:35 pm
luckyducky99 wrote: Tue Jun 08, 2021 1:22 pm If someone knows that they'll get stressed out if the current value of their portfolio declines by "a lot" (whatever "a lot" is to them), then even if their investment horizon is long and that view is economically myopic, then can't it make sense to avoid that stress by holding bonds to dampen volatility -- especially if they can still meet their future consumption goals?
This is a good example of an irrational reason to own bonds.

Now, we’re all irrational to some degree and sometimes we have to make decisions that accommodate that irrationality instead of suppressing it.

Frankly acknowledging our irrationality is crucial to limiting the damage it inflicts on our decision making IMHO.
Why irrational?
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Re: My favorite authors are turning their backs on Bonds

Post by alex_686 »

GP813 wrote: Wed Jun 09, 2021 3:15 pm How good is sage advice if people abandon it at the first sign of turmoil? The 60/40 portfolios will probably end up being prudent for many investors in the long run.
Why? There is nothing magical about 60/40. We know what the drivers were and the character of the 60/40 portfolio. Now the drivers and risks are different. If the facts change shouldn't your opinion change as well?
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: My favorite authors are turning their backs on Bonds

Post by Johnathon Livingston »

I think the era of the 60/40 has passed. Back in the 90s when I started investing, a financial advisor would put a 25 year old or a 55 year old in a 60/40. It was a beautiful thing—60% in the US stock market, 40% in US Bonds. The 60/40 offered good returns during a bull run and would pop back up during a bear market and get you back above water and appreciating again in no time. Simple, elegant, versatile.

Change with the times my friends.
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Re: My favorite authors are turning their backs on Bonds

Post by Da5id »

Johnathon Livingston wrote: Wed Jun 09, 2021 5:32 pm I think the era of the 60/40 has passed. Back in the 90s when I started investing, a financial advisor would put a 25 year old or a 55 year old in a 60/40. It was a beautiful thing—60% in the US stock market, 40% in US Bonds. The 60/40 offered good returns during a bull run and would pop back up during a bear market and get you back above water and appreciating again in no time. Simple, elegant, versatile.

Change with the times my friends.
This is now the era of crypto, WSB touted meme stocks, and ???

Mind you, I'm dubious that 60/40 was ever a great strategy for a 25 year old looking at working 40 years, at least for retirement portion of their savings. If they were saving for a down payment on a house or something of course that is different.
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Re: My favorite authors are turning their backs on Bonds

Post by staustin »

Financial repression is certainly very real and must be considered when determining an asset allocation.

We've changed the mix of our bonds but not the percentage allocation; overweight abs, corporate, high yield and emerging market. No interest in owning treasuries in the current environment or being pushed into alt investments.
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Re: My favorite authors are turning their backs on Bonds

Post by UpperNwGuy »

Johnathon Livingston wrote: Wed Jun 09, 2021 5:32 pm I think the era of the 60/40 has passed. Back in the 90s when I started investing, a financial advisor would put a 25 year old or a 55 year old in a 60/40. It was a beautiful thing—60% in the US stock market, 40% in US Bonds. The 60/40 offered good returns during a bull run and would pop back up during a bear market and get you back above water and appreciating again in no time. Simple, elegant, versatile.

Change with the times my friends.
What is your recommended portfolio for the post-60/40 era?
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Re: My favorite authors are turning their backs on Bonds

Post by UpperNwGuy »

staustin wrote: Wed Jun 09, 2021 5:46 pm Financial repression is certainly very real and must be considered when determining an asset allocation.

We've changed the mix of our bonds but not the percentage allocation; overweight abs, corporate, high yield and emerging market. No interest in owning treasuries in the current environment or being pushed into alt investments.
Glad to see a positive statement about corporate bonds. Normally they get no love in this forum.
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