Why hold bonds? (again...)

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babystep
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Re: Why hold bonds? (again...)

Post by babystep »

BFRAME wrote: Tue Jun 22, 2021 2:50 am
StormShadow wrote: Mon Jun 21, 2021 11:42 am
reln wrote: Mon Jun 21, 2021 11:26 am There is no point to holding bonds at any age.
Hmm...
Those who cannot remember the past are condemned to repeat it.
- George Santayana
I've been through three market crashes so far during my working years (in my 40's). Throughout that time, I've kept a fixed percent of my asset allocation in bonds and it has served me well. I plan to continue to do so.

Stay the course, folks.
But the point of savings (for me) is not about short-term success. It's about minimizing risk of not having enough money in retirement. Whether or not an allocation does well during specific market periods doesn't seem to justify whether or not it's a smart or appropriate strategy. There are tons of day traders that have gotten lucky and become rich, but it doesn't mean that they were justified in their choices. I feel like much of the focus on bond allocation is a vestige of an older generation, with the "it worked for me" approach used as a justification that it was the "correct" approach. There's so much focus in the boglehead world of just "staying the course". And this worked great during a 30 year bull bond market where 40% allocation to bonds fared almost as well as stocks. But perhaps this was just luck? Perhaps staying the course with a 60/40 or 70/30, or even 80/20, portfolio might just ensure you're broke when you retire. Staying the course only matters if you're headed in the right direction. And I still have yet to see how/why bonds are helping me point in the right direction.
Have you checked the wiki page for this? https://www.bogleheads.org/wiki/Three-f ... allocation

AA is personal and you can decide to be 100/0 based on your personal risk tolerance.
You must decide for yourself what percentage of stocks to hold, based in part on your personal risk tolerance. There are no shortcuts and and it needs to be done no matter what investment approach you are using.
If you do 100/0 just understand the risk and think about the glide path so that you can decide to reduce the risk as you get closer to withdrawals.
Topic Author
BFRAME
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Re: Why hold bonds? (again...)

Post by BFRAME »

babystep wrote: Tue Jun 22, 2021 3:07 am Have you checked the wiki page for this? https://www.bogleheads.org/wiki/Three-f ... allocation

AA is personal and you can decide to be 100/0 based on your personal risk tolerance.
You must decide for yourself what percentage of stocks to hold, based in part on your personal risk tolerance. There are no shortcuts and and it needs to be done no matter what investment approach you are using.
If you do 100/0 just understand the risk and think about the glide path so that you can decide to reduce the risk as you get closer to withdrawals.
This goes to the heart of my question -- I don't actually believe you or I or anyone has fundamentally different long-term "risk tolerance" in the end. Your desire not to live in poverty in retirement is more or less the same as mine. Maybe you're fine living with a slightly lower standard of living, or want to have more upside potential. But I would posit that our tolerance for risk of ruin is nearly identical -- right around 0%.

For the last 30 years, your risk of ruin might not have varied much whether you were 60/40 or 100/0. But was this strategy or just luck? If bonds had returned <1%, then 10k/yr annual contribution for the last 30 years would have yielded $2.6 million for a 100/0 portfolio, and $1.5 million for a 60/40 portfolio. This is a meaningfully large difference. And if we fall into a period where both bonds and stocks under-perform historical returns for the next 10-20 years, the 60/40 portfolio might leave you with very little to live off of for 20+ years.

This isn't about personal risk -- it's about making sure your portfolio has the appropriate upside potential to ensure you will have enough when you retire. The last 30+ years have baked in this idea that the difference between 60/40 and 100/0 is just about personal risk tolerance to market down turns, in part because there was little difference in terms of return. But will this necessarily be the case going forward? I just feel this whole "personal risk tolerance" idea of selecting your stock/bond split is falling into the trap of assuming the future will be like the past.
UpperNwGuy
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Re: Why hold bonds? (again...)

Post by UpperNwGuy »

OP, it sounds like you want to get out of bonds, and you don't find any of the rationale for keeping bonds to be convincing. I'd say you should stop trying to sway the rest of us and start acting on your belief, perhaps by reallocating half of your bonds initially. If after a period of time you are happy with the results, you could reallocate more.
longinvest
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Re: Why hold bonds? (again...)

Post by longinvest »

BFRAME wrote: Tue Jun 22, 2021 5:59 am I don't actually believe you or I or anyone has fundamentally different long-term "risk tolerance" in the end. Your desire not to live in poverty in retirement is more or less the same as mine. Maybe you're fine living with a slightly lower standard of living, or want to have more upside potential. But I would posit that our tolerance for risk of ruin is nearly identical -- right around 0%.

For the last 30 years, your risk of ruin might not have varied much whether you were 60/40 or 100/0. But was this strategy or just luck? If bonds had returned <1%, then 10k/yr annual contribution for the last 30 years would have yielded $2.6 million for a 100/0 portfolio, and $1.5 million for a 60/40 portfolio. This is a meaningfully large difference. And if we fall into a period where both bonds and stocks under-perform historical returns for the next 10-20 years, the 60/40 portfolio might leave you with very little to live off of for 20+ years.
BFRAME, I suggest learning about the surprising mathematics of retirement investing. Even if stocks were to significantly outperform bonds as they often did in the past (there's no such guarantee written on stock certificates), a small reduction in spending would allow an investor to use a less volatile 60/40 portfolio all lifelong and still retire with dignity.

Our wiki's VPW Accumulation And Retirement Worksheet contains an Accumulation sheet (screenshot) which uses the type of calculation found in the "mathematics of retirement investing" thread to estimate an adequate retirement portfolio contribution amount during accumulation given the investor's chosen asset allocation and current financial situation (age, salary, portfolio balance, target financial independence age, and future pensions). The estimate has to be recalculated at least once a year and on every major personal circumstance change.

When using this sensible approach, a less volatile portfolio improves stability during accumulation. The impact of personal circumstance changes or major portfolio fluctuations on portfolio contributions is reduced when using a balanced portfolio. This is similar to the impact of using a less volatile portfolio during retirement with a sensible portfolio withdrawal method (like VPW) which adapts withdrawal amounts to portfolio returns.
BFRAME wrote: Tue Jun 22, 2021 5:59 am This isn't about personal risk -- it's about making sure your portfolio has the appropriate upside potential to ensure you will have enough when you retire. The last 30+ years have baked in this idea that the difference between 60/40 and 100/0 is just about personal risk tolerance to market down turns, in part because there was little difference in terms of return. But will this necessarily be the case going forward? I just feel this whole "personal risk tolerance" idea of selecting your stock/bond split is falling into the trap of assuming the future will be like the past.
Bonds, like stocks, are marketable securities; their price is set by sellers and buyers agreeing on a price to transact or, if you prefer, by the Law of supply and demand.

I have no pretension to know more than all stock and bond investors as a group. I'm willing to accept their average return. The (free float) Global Stock-and-Bond Portfolio has a balanced allocation which is currently very close to 60/40 stocks/bonds. I'll be happy to get average returns (not too far from those of the global stock-and-bond portfolio) every day, month, year, and decade of my life by holding an all-in-one globally-diversified 60/40 stocks/bonds index ETF, very similar to the LifeStrategy Moderate Growth Fund (VSMGX) but with a different home bias.

VPW''s accumulation worksheet helps me contribute sufficiently to my portfolio during accumulation, while holding a balanced portfolio. I anticipate to continue holding this same globally-diversified balanced index portfolio during retirement. VPW's retirement worksheet will help me withdraw an adequate amount from my portfolio (as illustrated in this thread) to combine with pensions (current or delayed). The VPW approach will help me spend most of my portfolio using return-adjusted withdrawals and will never expose me to a risk of premature portfolio depletion.
Last edited by longinvest on Tue Jun 22, 2021 6:58 am, edited 2 times in total.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
dcabler
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Re: Why hold bonds? (again...)

Post by dcabler »

BFRAME wrote: Tue Jun 22, 2021 5:59 am
babystep wrote: Tue Jun 22, 2021 3:07 am Have you checked the wiki page for this? https://www.bogleheads.org/wiki/Three-f ... allocation

AA is personal and you can decide to be 100/0 based on your personal risk tolerance.
You must decide for yourself what percentage of stocks to hold, based in part on your personal risk tolerance. There are no shortcuts and and it needs to be done no matter what investment approach you are using.
If you do 100/0 just understand the risk and think about the glide path so that you can decide to reduce the risk as you get closer to withdrawals.
This goes to the heart of my question -- I don't actually believe you or I or anyone has fundamentally different long-term "risk tolerance" in the end. Your desire not to live in poverty in retirement is more or less the same as mine. Maybe you're fine living with a slightly lower standard of living, or want to have more upside potential. But I would posit that our tolerance for risk of ruin is nearly identical -- right around 0%.

For the last 30 years, your risk of ruin might not have varied much whether you were 60/40 or 100/0. But was this strategy or just luck? If bonds had returned <1%, then 10k/yr annual contribution for the last 30 years would have yielded $2.6 million for a 100/0 portfolio, and $1.5 million for a 60/40 portfolio. This is a meaningfully large difference. And if we fall into a period where both bonds and stocks under-perform historical returns for the next 10-20 years, the 60/40 portfolio might leave you with very little to live off of for 20+ years.

This isn't about personal risk -- it's about making sure your portfolio has the appropriate upside potential to ensure you will have enough when you retire. The last 30+ years have baked in this idea that the difference between 60/40 and 100/0 is just about personal risk tolerance to market down turns, in part because there was little difference in terms of return. But will this necessarily be the case going forward? I just feel this whole "personal risk tolerance" idea of selecting your stock/bond split is falling into the trap of assuming the future will be like the past.
I think that you'll find many of us here on the forum haven't just looked at the world of the last 30 years when making our AA decisions. Agree that making sure you have sufficient margin once retirement starts is high on many of our lists, however. AA is but one tool to achieve that, along with career choice, savings habits, spending habits, and the like.

Cheers.
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BFRAME
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Re: Why hold bonds? (again...)

Post by BFRAME »

UpperNwGuy wrote: Tue Jun 22, 2021 6:22 am OP, it sounds like you want to get out of bonds, and you don't find any of the rationale for keeping bonds to be convincing. I'd say you should stop trying to sway the rest of us and start acting on your belief, perhaps by reallocating half of your bonds initially. If after a period of time you are happy with the results, you could reallocate more.
It's not that I want to get out of bonds --- it's that I'm unclear why I have them, apart from that's what people have always done, so I'm hoping someone can provide a compelling reason. If we remove the psychological elements, basically it's unclear to me if bonds actually help reduce your risk of ruin in retirement. The few academic papers I've found on this suggest not -- there's moderate/negligible benefit of holding bonds. Of course this is using the past to predict the future, and I imagine there's a more principled way to determine how much bond allocation (if any) increases the expected return of the portfolio, particularly when you have imprecise knowledge of the future. In other words, I'm hoping for a data-driven answer, not a psychological answer about risk tolerance.
Da5id
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Re: Why hold bonds? (again...)

Post by Da5id »

BFRAME wrote: Tue Jun 22, 2021 2:32 am
Da5id wrote: Mon Jun 21, 2021 8:51 pm It is funny how many "why bonds" and "0% bonds" threads there are after a 10 year period with a 14% CAGR in the US stock market. I wonder how many such threads there were in 2009 after a 10 year US stock market CAGR of 1.71%, negative adjusted for inflation.

That said, you don't need much by way of bonds in your savings dedicated to retirement if that is in the distant future. Though the caveat up thread that "retirement savings" can be needed sooner than you think and that you are rather more likely to lose your job at the same time as the economy is tanking...
But it's also been a 30 year bull bond market....
Recency bias tends to be shorter term.
Da5id
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Re: Why hold bonds? (again...)

Post by Da5id »

BFRAME wrote: Tue Jun 22, 2021 7:40 am
UpperNwGuy wrote: Tue Jun 22, 2021 6:22 am OP, it sounds like you want to get out of bonds, and you don't find any of the rationale for keeping bonds to be convincing. I'd say you should stop trying to sway the rest of us and start acting on your belief, perhaps by reallocating half of your bonds initially. If after a period of time you are happy with the results, you could reallocate more.
If we remove the psychological elements, basically it's unclear to me if bonds actually help reduce your risk of ruin in retirement.
Your original post wasn't about "in retirement" but 10+ years out, are you changing the question or am I misreading?

Based on the data in the EarlyRetirementNow SWR series, you historically did marginally better in retirement in a few situations with 75% stocks/25% bonds than with 100% stocks (e.g. 30-40 years, ~4% SWR).

Image

And of course the past doesn't really provide guarantees for the future.

I didn't own much by way of bonds when I was far from retirement. Now I'm 50% bonds in early retirement, but that is largely a function of lack of need to take risk to achieve my goals.
Volando
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Re: Why hold bonds? (again...)

Post by Volando »

BFRAME wrote: Tue Jun 22, 2021 2:27 am
And if you look at the few studies that have compared withdrawal strategies, generally 90-100% stocks even in the withdrawal phase is optimal, particularly when you couple it with adaptive withdrawal rules. This same result also surely holds for when you're 50, but of course it depends on how much money you have by then. A 60% dip in your portfolio when you need to withdraw funds will hurt a lot less if you have 2 million than if you have 500,000. And the best way to get to 2 million by 50 seems to be (1) save as much as possible, and (2) don't let bonds drag you down.
I may be wrong in my understanding of your posts but in this and a few other posts you seem to imply that 100% stocks will have a greater likelihood of getting you a larger sum of money that will prevent you from living in poverty during retirement and bonds will just hold you back. I suppose this could work out depending on the time frame you’re looking at. If life and the markets cooperate and behave at least as good as certain time frames that might work out really well. Unfortunately, we don’t know what the future holds and being at 100% stocks allows for a larger variability in outcomes. The stock market could have a very nice run during your investing time frame, or it could not. In the event that stocks don’t perform at least you have a different asset class that behaves differently and has less risk to hold you over during market downturns so that you don’t have to sell from the stock side at a low and you have money to weather the storm. If you’re 100% stocks there’s no rule that the market and life won’t continue to pummel you and make it more difficult to hold on which could leave you worse off than having bonds at that point. There’s also no rule that it will only drop 50% and not drop again or that you will know when the bottom is. You could have subsequent drops that make being 100% stocks even more challenging.

You should also look at historical returns of bonds versus stocks because there are periods where bonds outperform stocks. I don’t know enough to argue about whether that will be different from now on. However, again, nobody knows the future and I don’t think you can completely rule out that bonds will outperform stocks over a significant period of time if the market has a prolonged slump.

I’m not saying you shouldn’t have more stocks than bonds at a younger age. I’m just saying that relying on 100% stocks to accomplish your goals may not work out in your favor.

Note: you did mention other asset classes besides stocks and bonds but I don’t know much about them so my response was focused on stocks/bonds.
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ClevrChico
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Re: Why hold bonds? (again...)

Post by ClevrChico »

BFRAME wrote: Tue Jun 22, 2021 2:40 am
So do you hold your bonds in taxable accounts and just bit the bullet on tax inefficiency? Otherwise how do you plan to access them when needed?

As to insurance, this is exactly what bothers me. If you really think it through, it's just not enough insurance. It's like owning a $500,000 home and insuring it for $20,000. Sure, it can help for a little while, but it in no way addresses the long-term risk of ruin. To really have sufficient insurance you need either a ton of money saved to begin with (so that a 10-20% bond allocation is substantial), in which case you don't have much to worry about anyway; or you need to have a lot of you assets in bonds to guard against short-term ruin (i.e., losing a job), but at the increased risk of long-term ruin.
You could own bonds in taxable. That's a whole discussion on its own, but some people here would believe that's preferable:

https://www.whitecoatinvestor.com/asset ... n-taxable/

Or, you could sell bonds/cash in retirement accounts, replace with equities, and then do the opposite in your taxable account, maintaining your asset allocation.

My emergency fund requirements were a lot less when my net worth was pretty low. (No kids, no house, my parents' guest room was always an option.)
Paul78
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Re: Why hold bonds? (again...)

Post by Paul78 »

As someone who really started investing in 2011 (ie never had a major "crash" as last years crash lasted what 2 months). I am currently 80% stocks 20% g-fund. I hold bonds (well g-fund in my case) primarily to have some money on had to buy into the market during hug dips. Last year I took that 50% of the bond money and bought in near the market dip. Sure I probably would have done better just going 100% stocks from the start but this still gives me some feel of control and at least brings some positives (ie chance to buy) with market dips.

With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
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Re: Why hold bonds? (again...)

Post by KlangFool »

BFRAME wrote: Tue Jun 22, 2021 5:59 am
For the last 30 years, your risk of ruin might not have varied much whether you were 60/40 or 100/0.
BFRAME,

1) There were many recessions across the last 30 years. I was unemployed for more than 1 year a few times.

2) Have you ever been unemployed in a recession?

3) If your portfolio size equal to 1 year of expense and you have 6 months of emergency fund. If the stock drops 50% and you are unemployed,

A) If you are 100% stock, you could only last 1 year

B) If you are 60/40, you could last more than 1 year

C) If the recession lasted 1 year and 1 month, the 60/40 folks survive. The 100/0 folks would be homeless and starving.

<<your risk of ruin might not have varied much>>

4) But in a recession, that might be the difference between being homeless and starving versus survive until recovery.

5) You could sell/withdraw stock in your Roth IRA. Then, you exchange the bond to the stock in your tax-deferred account. Effectively, you are selling the bond.

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Re: Why hold bonds? (again...)

Post by KlangFool »

Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
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topper1296
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Re: Why hold bonds? (again...)

Post by topper1296 »

I'm 47 and have ~20% in bonds because it helps me sleep better at night during periods of market volatility and this is completely separate from my emergency fund.
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Re: Why hold bonds? (again...)

Post by HootingSloth »

BFRAME wrote: Tue Jun 22, 2021 5:59 am If bonds had returned <1%, then 10k/yr annual contribution for the last 30 years would have yielded $2.6 million for a 100/0 portfolio, and $1.5 million for a 60/40 portfolio. This is a meaningfully large difference. And if we fall into a period where both bonds and stocks under-perform historical returns for the next 10-20 years, the 60/40 portfolio might leave you with very little to live off of for 20+ years.

This isn't about personal risk -- it's about making sure your portfolio has the appropriate upside potential to ensure you will have enough when you retire. The last 30+ years have baked in this idea that the difference between 60/40 and 100/0 is just about personal risk tolerance to market down turns, in part because there was little difference in terms of return. But will this necessarily be the case going forward? I just feel this whole "personal risk tolerance" idea of selecting your stock/bond split is falling into the trap of assuming the future will be like the past.
BFRAME, the standard advice is to set your asset allocation based on need, ability, and willingness to take risk. If someone's savings rate is at a level where an allocation with a significant chunk of bonds makes it difficult for them to achieve their financial goals, then their need to take risk is high. It is appropriate, then, for such a person to hold a riskier portfolio, perhaps 100/0 (although they should probably at least have an emergency fund). Someone with a higher savings rate relative to their end goal would not have as high a need to take risk, and so may be able to hold bonds if they prefer.

For many, $1.5M would be a pretty healthy amount to have in retirement (much, much more than most end up with), especially if they have Social Security and a paid off house. Others will have a higher goal, but also a savings rate much higher than $10k per year. Someone that only wants to save $10k per year but wants to end up with $2.6M would need to take on more risk. Everyone's situation will be different.
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BFRAME
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Re: Why hold bonds? (again...)

Post by BFRAME »

longinvest wrote: Tue Jun 22, 2021 6:42 am I have no pretension to know more than all stock and bond investors as a group. I'm willing to accept their average return. The (free float) Global Stock-and-Bond Portfolio has a balanced allocation which is currently very close to 60/40 stocks/bonds. I'll be happy to get average returns (not too far from those of the global stock-and-bond portfolio) every day, month, year, and decade of my life by holding an all-in-one globally-diversified 60/40 stocks/bonds index ETF, very similar to the LifeStrategy Moderate Growth Fund (VSMGX) but with a different home bias.
I completely understand this approach, particularly from a set-it-and-forget-it perspective of not second guessing or trying to find an "optimal" allocation. But what I really don't get is why I would ever think my objectives match the "average" objective of the overall stock market. For example, institutions and large pension funds invest in bonds and various real assets, not because of higher expected returns, but because of stable interests and dividend payments, which are critical for providing stable income. They might only need a 2% return for their purposes, and be totally happy with trading returns for stability. That is, the "market cap" of stocks to bonds (or to alternatives) is not about what the market thinks maximizes returns over X years, but rather about the relative ratio of different investment objectives (stable income, limited volatility, maximum expected value, and so on). This again goes to the heart of my question -- if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
Paul78
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Re: Why hold bonds? (again...)

Post by Paul78 »

KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
I believe there is a difference between cashing out related to fear of the market crashing further and cashing out related to actually needing the money. Yes if I was in a situation where my livelihood depending on cashing out I would. It would not be a great feeling to realize the lose but obviously it is better than living on the streets. My point is if my value "on paper" drops 80% over the next year I won't make any changes (other than buying more stock) provide I am still employed.
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anon_investor
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Re: Why hold bonds? (again...)

Post by anon_investor »

KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
Not everyone will be suddenly unemployed in a recession, I think it depends on the industry/job type they have. Obviously some industries are more volatile than others.
dbr
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Re: Why hold bonds? (again...)

Post by dbr »

BFRAME wrote: Tue Jun 22, 2021 8:40 am if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
It depends on what YOU are focused on -- "focused" meaning what do you want and how well you can tolerate possible outcomes where you don't get what you want.

I would suggest you abandon the quest for "should" and instead consider what you are trying to do and how one does that in investing. Note there are no guarantees the world will cooperate with our wants so understanding how that works is part of the game.
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Re: Why hold bonds? (again...)

Post by KlangFool »

anon_investor wrote: Tue Jun 22, 2021 8:48 am
KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
Not everyone will be suddenly unemployed in a recession, I think it depends on the industry/job type they have. Obviously some industries are more volatile than others.
anon_investor,

This is personal finance. It is personal. We are not a statistic. We cannot be 4.5% unemployed. We are either employed or unemployed. If we are not prepared for unemployment, we may not financially survive the coming recession.

KlangFool
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Re: Why hold bonds? (again...)

Post by KlangFool »

Paul78 wrote: Tue Jun 22, 2021 8:48 am
KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
I believe there is a difference between cashing out related to fear of the market crashing further and cashing out related to actually needing the money. Yes if I was in a situation where my livelihood depending on cashing out I would. It would not be a great feeling to realize the lose but obviously it is better than living on the streets. My point is if my value "on paper" drops 80% over the next year I won't make any changes (other than buying more stock) provide I am still employed.
Paul78,

If we cannot predict our own future and unemployment in a recession is always possible, then, we do not have the ABILITY to take the RISK. Our WILLINGNESS to take the RISK does not matter.

Just because we FEEL that we can take the RISK does not override the NEED to pay the bills.

KlangFool
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goingup
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Re: Why hold bonds? (again...)

Post by goingup »

dbr wrote: Tue Jun 22, 2021 8:49 am
BFRAME wrote: Tue Jun 22, 2021 8:40 am if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
It depends on what YOU are focused on -- "focused" meaning what do you want and how well you can tolerate possible outcomes where you don't get what you want.

I would suggest you abandon the quest for "should" and instead consider what you are trying to do and how one does that in investing. Note there are no guarantees the world will cooperate with our wants so understanding how that works is part of the game.
Wise words.

Morgan Housel likes to say we are all playing our own game. OP, you have to decide what you think your portfolio should look like. Mine will never hold gold, commodities, or other alternatives. Stocks/bonds got us to "enough". Yes, bonds are disappointing right now, but we need them to preserve wealth. I might feel differently if I was 30,40, or even 50 and playing a different game than the one I'm playing. :wink:
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Re: Why hold bonds? (again...)

Post by HootingSloth »

goingup wrote: Tue Jun 22, 2021 9:09 am
dbr wrote: Tue Jun 22, 2021 8:49 am
BFRAME wrote: Tue Jun 22, 2021 8:40 am if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
It depends on what YOU are focused on -- "focused" meaning what do you want and how well you can tolerate possible outcomes where you don't get what you want.

I would suggest you abandon the quest for "should" and instead consider what you are trying to do and how one does that in investing. Note there are no guarantees the world will cooperate with our wants so understanding how that works is part of the game.
Wise words.

Morgan Housel likes to say we are all playing our own game. OP, you have to decide what you think your portfolio should look like. Mine will never hold gold, commodities, or other alternatives. Stocks/bonds got us to "enough". Yes, bonds are disappointing right now, but we need them to preserve wealth. I might feel differently if I was 30,40, or even 50 and playing a different game than the one I'm playing. :wink:
I think this is a pretty common phenomenon. It seems like for many people, when they start seeing that "enough" is within their reach--regardless of age or distance to retirement--they will think about putting more into bonds. If you don't have a concept of how much is enough, or if you are very concerned that you will not be able to get there, choosing to invest in bonds will seem mysterious. Some people, who have a strong preference for "more" at all levels of wealth, will hold very high stock allocations even late in life. Others, with high savings rates and a belief that a smaller amount of money is enough, might start holding a significant amount in bonds much earlier in life. The idea is to figure out what kind of investor you are and act accordingly, which should help you to stay the course with your individual plan.
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Re: Why hold bonds? (again...)

Post by etfan »

Johnathon Livingston wrote: Mon Jun 21, 2021 6:32 pm I have a portion in a target date fund and a portion in all stocks. When I am 8-10 years out I will exchange the all stock portfolio for a vanguard target date fund and let it derisk on the remaining glide path. I will choose a target date that is actually 5 years later than my retirement. The result is I have a significant portfolio that is on an “appropriate glide path” and then my other portfolio that is aggressive.
Why is your TDF 5 years later than retirement? You're already able to control your bond allocation by owning stocks separately.
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Re: Why hold bonds? (again...)

Post by aristotelian »

There is some evidence that a bond allocation early in retirement reduces sequence of returns risk and increases chances of long term success. Also equity heavy portfolio increases chances of success in proportion to your withdrawal rate. At a certain point the volatility-averse investor could have the same chance of success if they are willing to save longer and have a lower withdrawal rate. If you are assuming a 4% or higher withdrawal rate, you are right, an equity heavy portfolio has been generally more successful over the long term.
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Re: Why hold bonds? (again...)

Post by nigel_ht »

KlangFool wrote: Tue Jun 22, 2021 8:57 am
Paul78 wrote: Tue Jun 22, 2021 8:48 am
KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
I believe there is a difference between cashing out related to fear of the market crashing further and cashing out related to actually needing the money. Yes if I was in a situation where my livelihood depending on cashing out I would. It would not be a great feeling to realize the lose but obviously it is better than living on the streets. My point is if my value "on paper" drops 80% over the next year I won't make any changes (other than buying more stock) provide I am still employed.
Paul78,

If we cannot predict our own future and unemployment in a recession is always possible, then, we do not have the ABILITY to take the RISK. Our WILLINGNESS to take the RISK does not matter.

Just because we FEEL that we can take the RISK does not override the NEED to pay the bills.

KlangFool
With a large portfolio AA makes little difference. 50% crash means you still have a lot of money.
With a small portfolio AA makes little difference. You don't have enough assets to survive a 1+ year of no income regardless of AA.

Only with moderate portfolios does this make a difference. And the difference is still measured in months rather than years.

My opinion is planning to downsize more rapidly will do more to safeguard against 1+ years of unemployment in this middle ground than changing your AA mix to a conservative 60/40 in early to mid accumulation.

Not owning a home is probably what I would recommend to my kids. That allows you to more rapidly downsize locally to a less expensive apartment or to more rapidly relocate for job opportunities. Given that shelter often is the largest component to living expenses this likely gives your the longest run time for funds remaining in the worst case scenario vs being suddenly unemployed and underwater on your mortgage in a GFC scenario.

If they can get a place and have roommates to help pay the mortgage that's a slightly different scenario.
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Re: Why hold bonds? (again...)

Post by RubyTuesday »

BFRAME wrote: Tue Jun 22, 2021 2:40 am
So do you hold your bonds in taxable accounts and just bit the bullet on tax inefficiency? Otherwise how do you plan to access them when needed?
Assuming you have stocks in taxable and bonds in tax deferred, it’s still easy to access bond cash when market is down…

You sell stocks in taxable (presumably for a loss), sell bonds in tax deferred, and rebuy stocks in tax deferred.
“Doing nothing is better than being busy doing nothing.” – Lao Tzu
Johnathon Livingston
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Re: Why hold bonds? (again...)

Post by Johnathon Livingston »

etfan wrote: Tue Jun 22, 2021 9:24 am
Johnathon Livingston wrote: Mon Jun 21, 2021 6:32 pm I have a portion in a target date fund and a portion in all stocks. When I am 8-10 years out I will exchange the all stock portfolio for a vanguard target date fund and let it derisk on the remaining glide path. I will choose a target date that is actually 5 years later than my retirement. The result is I have a significant portfolio that is on an “appropriate glide path” and then my other portfolio that is aggressive.
Why is your TDF 5 years later than retirement? You're already able to control your bond allocation by owning stocks separately.
The TDF I currently hold is on target. TDF that I will eventually fold my all stock portfolio into will be 5 years off target. The reason is I want an overall more aggressive retirement portfolio than the more moderate allocation that the TDFs provide when used on target. I could simply add bonds to my all stock portfolio and do it myself but at this time I’d rather turn it over to Vanguard. That’s my way of controlling behavioral risk as I get older. I recognize that I want to be forever young and will probably be better off turning over control to someone else on my allocations. Otherwise I’ll be that old guy playing with fire in the stock market. I’d rather be drawing down my retirement and doing all the things I have planned.

The reason I have this barbell approach is that I started investing in 2000, so I had a really bad decade that I feel like I need to make up for. So, I have my TDF that I started post 2008 that will run its course and this other all stock portfolio that is making up for my lost decade and makes my total portfolio more aggressive. I believe higher allocations to equities are necessary for a lot of people in this low interest rate era and unless you have a whole lotta money.
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Re: Why hold bonds? (again...)

Post by KlangFool »

nigel_ht wrote: Tue Jun 22, 2021 9:36 am
KlangFool wrote: Tue Jun 22, 2021 8:57 am
Paul78 wrote: Tue Jun 22, 2021 8:48 am
KlangFool wrote: Tue Jun 22, 2021 8:25 am
Paul78 wrote: Tue Jun 22, 2021 8:18 am
With regards to getting scared and cashing out of market when it crashes. Honestly that is not my personality. When I have failing investments (or relationships or anything) my problem is staying until the bitter end. So it is far more likely I would watch the market go to 0 then sell after taking a huge loss. I mean the loses are just "on paper" until either you cash out or it goes to zero.
Paul78,

If you are unemployed and run out of your emergency fund, you would have to cash out your portfolio in order to pay your bills. That has nothing to do with your personality.

KlangFool
I believe there is a difference between cashing out related to fear of the market crashing further and cashing out related to actually needing the money. Yes if I was in a situation where my livelihood depending on cashing out I would. It would not be a great feeling to realize the lose but obviously it is better than living on the streets. My point is if my value "on paper" drops 80% over the next year I won't make any changes (other than buying more stock) provide I am still employed.
Paul78,

If we cannot predict our own future and unemployment in a recession is always possible, then, we do not have the ABILITY to take the RISK. Our WILLINGNESS to take the RISK does not matter.

Just because we FEEL that we can take the RISK does not override the NEED to pay the bills.

KlangFool
With a large portfolio AA makes little difference. 50% crash means you still have a lot of money.
With a small portfolio AA makes little difference. You don't have enough assets to survive a 1+ year of no income regardless of AA.
nigel_ht,

1) With a large portfolio, you do not have the TIME to wait for recovery. You had lost a lot of money and you are in danger of involuntary early retirement. With 70/30, you lost less money and you could retire.

<<You don't have enough assets to survive a 1+ year of no income regardless of AA.>>

2) With a small portfolio, every bit of difference is one more day to find new employment before you are homeless and starving. This is personal finance. We do not know how long we could be unemployed in a recession. More money means that we have a better fighting chance.

3) So, what is the point of 100% stock?

KlangFool
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JoeQ
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Re: Why hold bonds? (again...)

Post by JoeQ »

alex_686 wrote: Mon Jun 21, 2021 11:25 am
BFRAME wrote: Mon Jun 21, 2021 10:44 am 2. To reduce "risk" (i.e., volatility or something similar)
I can make 2 solid arguments for those in the long term accumulation phase.

First, consider rebalancing. Increasing you allocation to equities increases you expected returns. However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
This is true. But doesn't the same apply to bond returns?
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alex_686
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Re: Why hold bonds? (again...)

Post by alex_686 »

JoeQ wrote: Tue Jun 22, 2021 10:19 am
alex_686 wrote: Mon Jun 21, 2021 11:25 am
BFRAME wrote: Mon Jun 21, 2021 10:44 am 2. To reduce "risk" (i.e., volatility or something similar)
I can make 2 solid arguments for those in the long term accumulation phase.

First, consider rebalancing. Increasing you allocation to equities increases you expected returns. However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
This is true. But doesn't the same apply to bond returns?
No. What you want to focus on is the total return and volatility of your entire portfolio. You should not care about the characteristics of a individual asset, rather the impact of adding that asset to your portfolio.

So adding a low volatility asset to your portfolio can reduce your volatility.

Importantly, adding a high-volatility low-correlation asset to your portfolio can also reduce your portfolio's volatility.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
JoeQ
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Re: Why hold bonds? (again...)

Post by JoeQ »

alex_686 wrote: Tue Jun 22, 2021 10:28 am
JoeQ wrote: Tue Jun 22, 2021 10:19 am
alex_686 wrote: Mon Jun 21, 2021 11:25 am
BFRAME wrote: Mon Jun 21, 2021 10:44 am 2. To reduce "risk" (i.e., volatility or something similar)
I can make 2 solid arguments for those in the long term accumulation phase.

First, consider rebalancing. Increasing you allocation to equities increases you expected returns. However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
This is true. But doesn't the same apply to bond returns?
No. What you want to focus on is the total return and volatility of your entire portfolio. You should not care about the characteristics of a individual asset, rather the impact of adding that asset to your portfolio.

So adding a low volatility asset to your portfolio can reduce your volatility.

Importantly, adding a high-volatility low-correlation asset to your portfolio can also reduce your portfolio's volatility.
I tried to do a backtest that proves your point, but this shows that CAGR decreases as bond% increases. What am I doing wrong?

PV Link
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dbr
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Re: Why hold bonds? (again...)

Post by dbr »

JoeQ wrote: Tue Jun 22, 2021 10:49 am
alex_686 wrote: Tue Jun 22, 2021 10:28 am
JoeQ wrote: Tue Jun 22, 2021 10:19 am
alex_686 wrote: Mon Jun 21, 2021 11:25 am
BFRAME wrote: Mon Jun 21, 2021 10:44 am 2. To reduce "risk" (i.e., volatility or something similar)
I can make 2 solid arguments for those in the long term accumulation phase.

First, consider rebalancing. Increasing you allocation to equities increases you expected returns. However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
This is true. But doesn't the same apply to bond returns?
No. What you want to focus on is the total return and volatility of your entire portfolio. You should not care about the characteristics of a individual asset, rather the impact of adding that asset to your portfolio.

So adding a low volatility asset to your portfolio can reduce your volatility.

Importantly, adding a high-volatility low-correlation asset to your portfolio can also reduce your portfolio's volatility.
I tried to do a backtest that proves your point, but this shows that CAGR decreases as bond% increases. What am I doing wrong?

PV Link
Bonds return less than stocks so adding bonds reduces return. Bonds are less volatile than stocks so adding bonds reduces volatility.

Combing two assets that have the same arithmetic average return does not change the arithmetic return but can reduce the volatility to the degree that the correlation is less than one.

By return I mean the expected return or the mean of the distribution of possible returns. This can be estimated by taking the arithmetic average of a set of periodic returns. The compound average return is a different animal and can be increased by reducing the volatility for the same average return.

By unqualified average I mean the arithmetic average of a set of data. By CAGR we mean the following formula: https://www.investopedia.com/terms/c/cagr.asp

This is also one hundred times one less than the exponential of the arithmetic average of the logs of a set of gain factors where a gain factor for a period is one plus one one-hundreth of the return in that period. This is also an example of the general concept of an average as being the inverse transformation of the (arithmetic) average of a transformation of a set of data elements.
Last edited by dbr on Tue Jun 22, 2021 11:04 am, edited 1 time in total.
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eye.surgeon
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Re: Why hold bonds? (again...)

Post by eye.surgeon »

reln wrote: Mon Jun 21, 2021 11:26 am
There is no point to holding bonds at any age.
You're on the wrong forum.
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UpperNwGuy
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Re: Why hold bonds? (again...)

Post by UpperNwGuy »

BFRAME wrote: Tue Jun 22, 2021 7:40 am
UpperNwGuy wrote: Tue Jun 22, 2021 6:22 am OP, it sounds like you want to get out of bonds, and you don't find any of the rationale for keeping bonds to be convincing. I'd say you should stop trying to sway the rest of us and start acting on your belief, perhaps by reallocating half of your bonds initially. If after a period of time you are happy with the results, you could reallocate more.
It's not that I want to get out of bonds --- it's that I'm unclear why I have them, apart from that's what people have always done, so I'm hoping someone can provide a compelling reason. If we remove the psychological elements, basically it's unclear to me if bonds actually help reduce your risk of ruin in retirement. The few academic papers I've found on this suggest not -- there's moderate/negligible benefit of holding bonds. Of course this is using the past to predict the future, and I imagine there's a more principled way to determine how much bond allocation (if any) increases the expected return of the portfolio, particularly when you have imprecise knowledge of the future. In other words, I'm hoping for a data-driven answer, not a psychological answer about risk tolerance.
You most definitely do want to get out of bonds — because you're asking the forum to "bring me a rock." You're not going to get what you want by making a vague demand for a "compelling reason" and "a data-driven answer" while rejecting all the usual reasons that investors hold bonds.

You want "a more principled way to determine how much bond allocation (if any) increases the expected return of the portfolio." Did someone tell you that bonds increase the expected return?
alex_686
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Re: Why hold bonds? (again...)

Post by alex_686 »

JoeQ wrote: Tue Jun 22, 2021 10:49 am I tried to do a backtest that proves your point, but this shows that CAGR decreases as bond% increases. What am I doing wrong?
I have a low opinion of back testing - in particular when run over long periods of time.

It ignores risk. Over the long term equities will dominate. As long as you have the ability and willingness to never withdraw from your portfolio than you should certainly go with equities. On the other hand, why are you investing if you will never need the money?

It is highly sensitive to the starting period. If the first few years are abnormal or have quirks it can impact the rest of the run.

Investing is one of those disciplines that adding data give you worse. i.e., results that have less power and are of lower statistical significance. Statistics assume stable regimes. If the system changes across a data set you are going to get garbage data. In this case, you are assuming that market returns, volatility, and correlations are stable across the period being tested. They are not. I am not even referring to the levels, but the relationship between the values. For example, when correlations are high and the market is trend following you will get worse results, not better.

I would read up on the theory and the math. Limit test runs to no more than 10 years. Long term treasuries give clearer results.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Volando
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Re: Why hold bonds? (again...)

Post by Volando »

alex_686 wrote: Mon Jun 21, 2021 11:25 am However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
Thanks for pointing that out. I hadn't heard of that particular term yet so it got me interested in learning more. Came across this article which I think lays it out nicely: https://portfoliocharts.com/2015/08/24/ ... lity-trap/. Thought the comparison between a total U.S. stock market and the permanent portfolio was interesting. 1% difference in CAGR between a total stock market portfolio and the permanent portfolio which is 25% total stock market, 25% long term bonds, 25% cash, 25% gold while having substantially lower volatility and much shorter duration in longest drawdown. The red in the TSM chart illustrates how certain time frames can have rough stock performance. If life throws its worst at you during that time, I can only imagine that it will be a rough ride to recovery if you're able to hold on for that long.

Not advocating for any particular portfolio. Just thought there were some interesting comparisons.
dbr
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Re: Why hold bonds? (again...)

Post by dbr »

Volando wrote: Tue Jun 22, 2021 12:12 pm
alex_686 wrote: Mon Jun 21, 2021 11:25 am However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
Thanks for pointing that out. I hadn't heard of that particular term yet so it got me interested in learning more. Came across this article which I think lays it out nicely: https://portfoliocharts.com/2015/08/24/ ... lity-trap/. Thought the comparison between a total U.S. stock market and the permanent portfolio was interesting. 1% difference in CAGR between a total stock market portfolio and the permanent portfolio which is 25% total stock market, 25% long term bonds, 25% cash, 25% gold while having substantially lower volatility and much shorter duration in longest drawdown. The red in the TSM chart illustrates how certain time frames can have rough stock performance. If life throws its worst at you during that time, I can only imagine that it will be a rough ride to recovery if you're able to hold on for that long.

Not advocating for any particular portfolio. Just thought there were some interesting comparisons here that demonstrate the effects of volatility.
See my post above. The math referred to is "hard" as it has to consider the statistical properties of a data set which is a combination of data sets each having their own statistical properties. The issue is to derive the mean and standard deviation of the combination from the means and standard deviations of the components and the correlations of the returns of the different assets. CAGR is a different issue because it is the return associated with the geometric or compound average of a sequence of gain factors (1+R/100). It is not the geometric mean of the returns themselves. The issue is often confused because the arithmetic mean of a sequence of returns is used to estimate the mean of the return distribution as if each year's returns were a random sample from a stable (stationary) distribution. Note correlations can be quite variable in time. Applying the usual methods of statistics to investment returns is conceptually helpful but dicey in practice. Applying time series methods is also dicey in practice. Even so volatility drag is real if you do the math to see it. Your comparison to two different portfolios requires the full blown analysis of everything that is going on.
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Re: Why hold bonds? (again...)

Post by SnowBog »

RubyTuesday wrote: Tue Jun 22, 2021 9:41 am
BFRAME wrote: Tue Jun 22, 2021 2:40 am
So do you hold your bonds in taxable accounts and just bit the bullet on tax inefficiency? Otherwise how do you plan to access them when needed?
Assuming you have stocks in taxable and bonds in tax deferred, it’s still easy to access bond cash when market is down…

You sell stocks in taxable (presumably for a loss), sell bonds in tax deferred, and rebuy stocks in tax deferred.
This seems counterintuitive... It took me many, many times hearing about it and thinking through the mechanics. But it's why many people say "money is fungible". And why people recommend setting an AA based on need, willingness, and ability to take risk (with 0 regard to where particular parts of your investments may or may not be).

Many "data driven" studies recommend having an allocation of "safe assets". I forget the exact AA, but I think it's around 70/30 where the Modern Portfolio Theory found a similar risk-adjusted return as 100/0.

I think you mentioned upthread bond alternatives such as dividend stocks, EM funds, etc. Those are not "safe assets".
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Re: Why hold bonds? (again...)

Post by hudson »

BFRAME,

I hold fixed income because I don’t like stocks or real estate.
nigel_ht
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Re: Why hold bonds? (again...)

Post by nigel_ht »

KlangFool wrote: Tue Jun 22, 2021 10:18 am
3) So, what is the point of 100% stock?

KlangFool
What is the point of running when the skies get dark? To reach the relative safety of the house before it rains.

The period where you have too much to lose and not enough for FI is the most dangerous time…

You can choose a more conservative AA regardless of circumstances or if the sky’s look pretty clear put out every sail to get to safe harbor before any storms hit.

Both entails risk. Is moderate risk over a longer period really better than more risk over a shorter period?
JoeQ
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Re: Why hold bonds? (again...)

Post by JoeQ »

alex_686 wrote: Tue Jun 22, 2021 11:16 am
JoeQ wrote: Tue Jun 22, 2021 10:49 am I tried to do a backtest that proves your point, but this shows that CAGR decreases as bond% increases. What am I doing wrong?
I have a low opinion of back testing - in particular when run over long periods of time.

It ignores risk. Over the long term equities will dominate. As long as you have the ability and willingness to never withdraw from your portfolio than you should certainly go with equities. On the other hand, why are you investing if you will never need the money?

It is highly sensitive to the starting period. If the first few years are abnormal or have quirks it can impact the rest of the run.

Investing is one of those disciplines that adding data give you worse. i.e., results that have less power and are of lower statistical significance. Statistics assume stable regimes. If the system changes across a data set you are going to get garbage data. In this case, you are assuming that market returns, volatility, and correlations are stable across the period being tested. They are not. I am not even referring to the levels, but the relationship between the values. For example, when correlations are high and the market is trend following you will get worse results, not better.

I would read up on the theory and the math. Limit test runs to no more than 10 years. Long term treasuries give clearer results.

I don't disagree with anything in your post. However, regarding the bolded part, the OP was asking about bond allocation during accumulation phase.

Other than that, I think everything about the volatility drag is really interesting. And the formula for approximating CAGR really helps to visualize how volatility affects portfolio returns.

(1 + Arithmetic mean)^2 - StdDev^2 = (1 + CAGR)^2
75% Total US Stock | 25% Total International Stock
JoeQ
Posts: 66
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Re: Why hold bonds? (again...)

Post by JoeQ »

Volando wrote: Tue Jun 22, 2021 12:12 pm
alex_686 wrote: Mon Jun 21, 2021 11:25 am However, it also increases you volatility and thus "volatility drag". Look up the term. Basically, as you crank up the risk you reduce your long term returns. You don't care about your annual returns, rather your Compound Annual Growth Rate (CAGR). Simplified, your CAGR is your annual returns less the square root of your portfolio's volatility. The math behind this is hard. So adding low-return low-volatility bonds can actually increase your long term returns. A issue with the math is that it is dependent on the inputs - market returns, correlations, and other factors. There are fact cases that go either way. So it is a debatable point.
Thanks for pointing that out. I hadn't heard of that particular term yet so it got me interested in learning more. Came across this article which I think lays it out nicely: https://portfoliocharts.com/2015/08/24/ ... lity-trap/. Thought the comparison between a total U.S. stock market and the permanent portfolio was interesting. 1% difference in CAGR between a total stock market portfolio and the permanent portfolio which is 25% total stock market, 25% long term bonds, 25% cash, 25% gold while having substantially lower volatility and much shorter duration in longest drawdown. The red in the TSM chart illustrates how certain time frames can have rough stock performance. If life throws its worst at you during that time, I can only imagine that it will be a rough ride to recovery if you're able to hold on for that long.

Not advocating for any particular portfolio. Just thought there were some interesting comparisons.
That is a beautiful chart. However, I would like to see how the numbers work if you begin in 1975 instead of 1972.

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SafeBonds
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Re: Why hold bonds? (again...)

Post by SafeBonds »

"The purity of noncallable, long-term, default-free Treasury bonds provides the most powerful diversification to investor portfolios." -David Swensen.
dboeger1
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Re: Why hold bonds? (again...)

Post by dboeger1 »

Marseille07 wrote: Mon Jun 21, 2021 2:42 pm
esteen wrote: Mon Jun 21, 2021 1:59 pm Stocks could crash and provide an even lower (aka greater negative) return than bonds for 10+ years. Will it happen? Most likely not. Could it? Of course. There is no law that says we are doomed to repeat only the length/severity of prior market crashes and no more. Something is always unprecedented, until it happens.

That said I personally have confidence that for 12+ year timeframes, stocks will outperform bonds so I hold the portion of my portfolio with that time horizon 100% in stocks. I might be wrong!
Imo the goal of an accumulator is to load up as many shares as they can. A crash is actually better than a bull market for accumulators.
That really only makes sense to the extent that percentage ownership of public companies is a reasonable proxy for inherent economic value that can be liquidated to pay for one's expenses; in other words, if you expect the value of those shares to be greater or at least equal in the future. Unfortunately, this assumption is not guaranteed to play out, and it's possible that one's expenses and/or bonds may grow more than the value of their portfolio. A trivial example would be investing in companies that get nationalized in one's home country. In that case, it's quite possible that the government is systematically destroying the value of public shares while propping up the value of government bonds. Ignoring the greater economic implications of such extreme actions and assuming relatively fixed living expenses denominated in the local currency, bonds could be the better bet. In other words, bonds defend against a different set of risks that seem like remote possibilities when looking at 20th century America and other developed markets in hindsight, but are not impossible going forward, so I think there is some value for even the 100% stock crowd to invest at least a little in bonds as a hedge against unexpected disasters in public equity markets, if nothing else. In that case, one would be investing in them for reasons other than expected return, which is kind of what people including Bogleheads have been saying all along. They're not there to be the highest-performing asset class, but rather to mitigate certain types of risk.
Marseille07
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Re: Why hold bonds? (again...)

Post by Marseille07 »

dboeger1 wrote: Tue Jun 22, 2021 4:27 pm That really only makes sense to the extent that percentage ownership of public companies is a reasonable proxy for inherent economic value that can be liquidated to pay for one's expenses; in other words, if you expect the value of those shares to be greater or at least equal in the future. Unfortunately, this assumption is not guaranteed to play out, and it's possible that one's expenses and/or bonds may grow more than the value of their portfolio. A trivial example would be investing in companies that get nationalized in one's home country. In that case, it's quite possible that the government is systematically destroying the value of public shares while propping up the value of government bonds. Ignoring the greater economic implications of such extreme actions and assuming relatively fixed living expenses denominated in the local currency, bonds could be the better bet. In other words, bonds defend against a different set of risks that seem like remote possibilities when looking at 20th century America and other developed markets in hindsight, but are not impossible going forward, so I think there is some value for even the 100% stock crowd to invest at least a little in bonds as a hedge against unexpected disasters in public equity markets, if nothing else. In that case, one would be investing in them for reasons other than expected return, which is kind of what people including Bogleheads have been saying all along. They're not there to be the highest-performing asset class, but rather to mitigate certain types of risk.
While you have a point, what's preventing us from buying bonds on the day you retire? If the risks you're listing manifest while accumulation, I think the bottom line is simply that you keep working longer. You can certainly invest in bonds during accumulation, but it's unlikely that you reach your number "X" faster than 100/0.
longinvest
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Re: Why hold bonds? (again...)

Post by longinvest »

BFRAME wrote: Tue Jun 22, 2021 8:40 am
longinvest wrote: Tue Jun 22, 2021 6:42 am I have no pretension to know more than all stock and bond investors as a group. I'm willing to accept their average return. The (free float) Global Stock-and-Bond Portfolio has a balanced allocation which is currently very close to 60/40 stocks/bonds. I'll be happy to get average returns (not too far from those of the global stock-and-bond portfolio) every day, month, year, and decade of my life by holding an all-in-one globally-diversified 60/40 stocks/bonds index ETF, very similar to the LifeStrategy Moderate Growth Fund (VSMGX) but with a different home bias.
I completely understand this approach, particularly from a set-it-and-forget-it perspective of not second guessing or trying to find an "optimal" allocation. But what I really don't get is why I would ever think my objectives match the "average" objective of the overall stock market. For example, institutions and large pension funds invest in bonds and various real assets, not because of higher expected returns, but because of stable interests and dividend payments, which are critical for providing stable income. They might only need a 2% return for their purposes, and be totally happy with trading returns for stability. That is, the "market cap" of stocks to bonds (or to alternatives) is not about what the market thinks maximizes returns over X years, but rather about the relative ratio of different investment objectives (stable income, limited volatility, maximum expected value, and so on). This again goes to the heart of my question -- if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
BFRAME, I suggest to entirely read my previous post as well as the mathematics of retirement investing thread it links to, instead of considering a single paragraph out of context.

It is sensible for an accumulation plan to regularly adapt to the investor's evolving circumstances (age, salary, portfolio size, asset allocation, target financial independence age, and future pensions). When using such a sensible plan, a less volatile portfolio results into smaller fluctuations of the suggested portfolio contribution amount, and therefore, into a more stable amount of money available to spend (after taxes and portfolio contributions) during accumulation. A less volatile portfolio also provides more stability to face unanticipated events like a major change of personal circumstances. It has a cost*, as explained in the "mathematics of retirement investing" thread, but this cost is smaller than generally believed; it just requires spending a little less.

* We're talking about a probabilistic cost, here, not a known cost. A balanced portfolio could possibly outperform a stock-only portfolio, in our real lives, but the model's calculations assume that stocks will outperform a balanced portfolio.

Stocks, like bonds, are mostly owned by institutions and large pension funds which have their own reasons to buy more of one type of stocks than the other. Vanguard itself is an institution. As for the beneficiaries of pension funds, they're individuals. I see no reason to seek an alternate weighting. Capitalization-weighted indexing benefits from mathematical certainties (see William Sharpe's The Arithmetic of Active Management).

My goal is to retire with dignity. If I can't do that with average market returns and a sensible portfolio contribution plan, a lot of other people won't be able to retire with dignity either. A globally-diversified all-in-one balanced index fund (or ETF) with a moderate home bias greatly simplifies investing. It can help avoiding many behavioral pitfalls and I think that it's good enough for investors of all ages and all wealth levels. (There's more about it in the One-Fund Portfolio thread).
Last edited by longinvest on Tue Jun 22, 2021 6:34 pm, edited 6 times in total.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
SnowBog
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Re: Why hold bonds? (again...)

Post by SnowBog »

Marseille07 wrote: Tue Jun 22, 2021 4:48 pm
dboeger1 wrote: Tue Jun 22, 2021 4:27 pm That really only makes sense to the extent that percentage ownership of public companies is a reasonable proxy for inherent economic value that can be liquidated to pay for one's expenses; in other words, if you expect the value of those shares to be greater or at least equal in the future. Unfortunately, this assumption is not guaranteed to play out, and it's possible that one's expenses and/or bonds may grow more than the value of their portfolio. A trivial example would be investing in companies that get nationalized in one's home country. In that case, it's quite possible that the government is systematically destroying the value of public shares while propping up the value of government bonds. Ignoring the greater economic implications of such extreme actions and assuming relatively fixed living expenses denominated in the local currency, bonds could be the better bet. In other words, bonds defend against a different set of risks that seem like remote possibilities when looking at 20th century America and other developed markets in hindsight, but are not impossible going forward, so I think there is some value for even the 100% stock crowd to invest at least a little in bonds as a hedge against unexpected disasters in public equity markets, if nothing else. In that case, one would be investing in them for reasons other than expected return, which is kind of what people including Bogleheads have been saying all along. They're not there to be the highest-performing asset class, but rather to mitigate certain types of risk.
While you have a point, what's preventing us from buying bonds on the day you retire? If the risks you're listing manifest while accumulation, I think the bottom line is simply that you keep working longer.
That is an assumption... And while it may be true (or true enough) the majority of the time - it is not universal. And if one's plans are based on such an assumption - they may end up in a rude awakening...

A few examples:
  • You die unexpectedly, and leave behind a spouse/family (granted this can be partially mitigated with life insurance)
  • You become disabled, and are unable to continue working (this may be mitigated with disability insurance - although fewer people likely have adequate coverage should the need arise)
  • You become sick, and are temporarily unable to work (unpaid leave), as you have exhausted vacation/sick time and don't qualify for disability
  • A family member becomes sick and requires you to temporarily leave the workforce (and/or unpaid leave) to care for them
  • Your company/industry is eliminated - and you are unable to find similar employment at similar income/benefits (think of the potential impact of AI or changes in legislation - and how those could put a lot of people out of work)
  • Your job is eliminated - and you are unable to find employment at similar income/benefits (in many industries ageism is real, just search for threads of people getting laid off in their 50's)
  • You are laid off - and it takes you 6 - 12+ months to find a similar job/benefits (sure you could take something less if desperate, but ideally you aren't forced into doing so)
And these potentially would all be "worse" if the economy had crashed (higher unemployment, lower wages, higher costs of goods, etc.).

As such I make the conservative assumption that I will not be gainfully employed until the day I want to retire. Not because I believe that will happen to me, but because I know that could happen to me... Its also the same reason I use low growth and modest inflation assumptions during planning... "Hope for the best, plan for the worst..."

Additionally, once you get close enough that you can see the light at the end of the tunnel - the last thing you want to do is risk making the tunnel longer. This is where we are at currently... We are at (or nearly at) FI - and are on track to be able to retire in a few years (waiting for spouse to qualify for retiree medical coverage). Sure - if markets remain like they currently are - we could be 100/0 and maybe shave off a few months getting to our end state. But if markets turn south - we may be adding years to our timeline... So we'll happily "settle" for a more conservative AA (60/40 in our case) - knowing that doing so will still get us to our goal - on our timeline - under nearly all likely scenarios (and maybe a few unlikely ones as well).
Marseille07
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Re: Why hold bonds? (again...)

Post by Marseille07 »

SnowBog wrote: Tue Jun 22, 2021 5:38 pm As such I make the conservative assumption that I will not be gainfully employed until the day I want to retire. Not because I believe that will happen to me, but because I know that could happen to me... Its also the same reason I use low growth and modest inflation assumptions during planning... "Hope for the best, plan for the worst..."

Additionally, once you get close enough that you can see the light at the end of the tunnel - the last thing you want to do is risk making the tunnel longer. This is where we are at currently... We are at (or nearly at) FI - and are on track to be able to retire in a few years (waiting for spouse to qualify for retiree medical coverage). Sure - if markets remain like they currently are - we could be 100/0 and maybe shave off a few months getting to our end state. But if markets turn south - we may be adding years to our timeline... So we'll happily "settle" for a more conservative AA (60/40 in our case) - knowing that doing so will still get us to our goal - on our timeline - under nearly all likely scenarios (and maybe a few unlikely ones as well).
Well, first of all we all need enough fixed income to survive the downturns. It's simplified as 100/0 but it's never 100/0 for anyone, myself included.

With that out of the way, it is true that if you're really unlucky then you will run into a lost decade (like 2000~2009) where 100/0 trails 60/40 for a long long time. I think the question really comes down to how much risk you want to take, knowing that's a possibility.
djm2001
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Re: Why hold bonds? (again...)

Post by djm2001 »

BFRAME wrote: Tue Jun 22, 2021 8:40 am
longinvest wrote: Tue Jun 22, 2021 6:42 am I have no pretension to know more than all stock and bond investors as a group. I'm willing to accept their average return. The (free float) Global Stock-and-Bond Portfolio has a balanced allocation which is currently very close to 60/40 stocks/bonds. I'll be happy to get average returns (not too far from those of the global stock-and-bond portfolio) every day, month, year, and decade of my life by holding an all-in-one globally-diversified 60/40 stocks/bonds index ETF, very similar to the LifeStrategy Moderate Growth Fund (VSMGX) but with a different home bias.
I completely understand this approach, particularly from a set-it-and-forget-it perspective of not second guessing or trying to find an "optimal" allocation. But what I really don't get is why I would ever think my objectives match the "average" objective of the overall stock market. For example, institutions and large pension funds invest in bonds and various real assets, not because of higher expected returns, but because of stable interests and dividend payments, which are critical for providing stable income. They might only need a 2% return for their purposes, and be totally happy with trading returns for stability. That is, the "market cap" of stocks to bonds (or to alternatives) is not about what the market thinks maximizes returns over X years, but rather about the relative ratio of different investment objectives (stable income, limited volatility, maximum expected value, and so on). This again goes to the heart of my question -- if we were to weed out all of the people in the market that are not focused solely on having enough income in retirement, what would (should?) the effective market cap be?
You're right in theory. But we'd also have to weed out those who have different retirement horizons than us, and those with different employment characteristics than us. Not only is this difficult for us to measure, but we might not find enough remaining people to be confident about the resulting asset allocation. And if we start opening that can of worms, then we should not be happy with market caps within stocks and bonds either. We'd have to buy weightings of individual stocks and individual bonds that are specific to our particular situation.

Going back to your original question, I think the role of bonds is to make the return profile smoother so that annual withdrawals don't do as much damage during bad years ("sequence of return risk"). Ultimately, everyone who retires has a negative drag on their portfolio from their annual spending. This is the reason why volatility and sequence of risk is a consideration at all. If not for the forced withdrawals, we'd only be concerned with the final long-term value of the portfolio, and not the path it takes to get there. But because we have these forced withdrawals, we prefer smoother return profiles to more jagged ones, and so it makes sense to sacrifice some long-term return (by allocating some amount to bonds) to avoid volatility along the way.

edit: Since a picture is worth a thousand words, here's a graph of someone retiring in 2000 (a very bad year to retire w.r.t. sequence of returns outcome) and using a 4% withdrawal rate. The blue line is 100% US bonds, the red is 100% US stocks, and the yellow is a 60:40 mix. This bad case scenario illustrates the value of a reasonable bond allocation during the retirement phase.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
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