How high would interest rates have to go before you'd switch your (retirement) AA?

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Phyneas
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How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Phyneas »

Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
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toddthebod
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by toddthebod »

Phyneas wrote: Sat Jun 25, 2022 10:15 pm Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Marseille07 »

If the yields hit 10%~15% then 50/50 would do just fine.

The problem is you'll have lost a lot of money to get there. And no, there's no easy solution; what I personally do is to hold equities and reduce bonds when the yields are still low.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Beensabu »

Phyneas wrote: Sat Jun 25, 2022 10:15 pm In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?
If someone only has a 3% withdrawal rate after reaching FRA, why wouldn't they just build a TIPS ladder with the whole portfolio?
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Corvidae »

Maybe 3% real seems enticing now, but equities are likely to drop a lot more if that happens. There would be less to switch, and valuations likely would be more attractive, too. I'd be happy to be wrong about that prediction.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by jebmke »

My first mortgage was 14% so let’s use that as a baseline. At the time, I was investing in a portfolio that was probably 80% equity, 20% bonds in my taxable account (401K not available then).
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by nisiprius »

1) What matters isn't the absolute return in bonds themselves, it is the difference between the returns of bonds and stocks. If that doesn't change, asset allocation should not change. In particular, bonds should not be abandoned just because real returns are negative.

2) In theory, interest rate rises should affect both stocks and bonds in the same direction--possibly for the same reason. Under the dividend discount theory of stock values, a rising interest rate would mean that future dividends are worth less today, and the present value of that dividend stream--and thus the value of the stock--should fall, just as it does with bonds. Whether that is the actual explanation of the recent fall in both stocks and bonds, I wouldn't know.

3) I don't ever remember thinking I ought to change my asset allocation due to interest rate changes, and I don't remember target-date funds or the Vanguard LifeStrategy funds ever claiming to have adaptation to interest rates changes as part of their declared strategy.
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Svensk Anga
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Svensk Anga »

I’d consider it if real yields got to 2.5 - 3%. The US long term average is 2 to 2.5%, so bonds would be on sale if they got to 3.

The poster above who would jump on 15% tomorrow would be in trouble if inflation settled in at 20% the day after. You would want to lock in a real yield to reduce risk so buy TIPS.

In hindsight this would have worked great in 1999. Stocks were in a bubble and the new TIPS were at 3% plus. The retiree could have sailed through the lost decade comfortably. I’m afraid that TIPS yields were high then just because they were new and the market did not know how to price them. We may not see such relative bargains again.

There are times when TIPS go on sale, briefly. Late 2008 and early 2020 come to mind. These would have been good times to shift from nominals to TIPS, but not a good time to shift out of beaten down stocks.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by KlangFool »

toddthebod wrote: Sat Jun 25, 2022 10:21 pm
Phyneas wrote: Sat Jun 25, 2022 10:15 pm Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
And, if the inflation is 20+% or more, why would that be a good idea?

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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by mega317 »

Phyneas wrote: Sat Jun 25, 2022 10:15 pm lower returns than stocks over certain periods of time
You came close to answering your own question in the first sentence. Which time periods in the future will bonds have lower returns than stocks? That’s not knowable; it could be the very same time period one locks in the hypothetical 5% or 10% or 15% bonds.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by toddthebod »

KlangFool wrote: Sun Jun 26, 2022 8:03 am
toddthebod wrote: Sat Jun 25, 2022 10:21 pm
Phyneas wrote: Sat Jun 25, 2022 10:15 pm Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
And, if the inflation is 20+% or more, why would that be a good idea?

KlangFool
Inflation won't be 20% forever, but the 15% would be locked in for 30 years. The stock market averaged 10%/year returns in the thirty years after 1981, when you could have bought a 30 year bond with 15% coupon payments.

So I would move all my existing investments into individually held 30 year bonds, and, assuming interest rates didn't stay that high forever, I would invest new savings and coupon payments in equities as the rates fell. With 15% coupon payments, I would be back to 60/40 in about 8 years.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by bikechuck »

Beensabu wrote: Sun Jun 26, 2022 12:09 am
Phyneas wrote: Sat Jun 25, 2022 10:15 pm In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?
If someone only has a 3% withdrawal rate after reaching FRA, why wouldn't they just build a TIPS ladder with the whole portfolio?
If the Tips ladder was built with pre tax money would that complicate RMD's? How could that be managed?
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by MathWizard »

I shifted my AA a bit more towards stocks, due to high inflation.
Interest rates should move along with inflation, though so it would be related, so between 7 and 9% inflation was enough .

I believe that stocks have more inflation protection than bonds,
though more volatility.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by KlangFool »

toddthebod wrote: Sun Jun 26, 2022 9:36 am
KlangFool wrote: Sun Jun 26, 2022 8:03 am
toddthebod wrote: Sat Jun 25, 2022 10:21 pm
Phyneas wrote: Sat Jun 25, 2022 10:15 pm Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
And, if the inflation is 20+% or more, why would that be a good idea?

KlangFool
Inflation won't be 20% forever, but the 15% would be locked in for 30 years. The stock market averaged 10%/year returns in the thirty years after 1981, when you could have bought a 30 year bond with 15% coupon payments.

So I would move all my existing investments into individually held 30 year bonds, and, assuming interest rates didn't stay that high forever, I would invest new savings and coupon payments in equities as the rates fell. With 15% coupon payments, I would be back to 60/40 in about 8 years.
toddthebod,

I assume that you understand that inflation does not need to be 20% forever in order to destroy your portfolio and your retirement plan. It does not take 30 years.

Let's assume that the inflation is 20%. Your portfolio would be reduced by 5% in real term every year without any withdrawal.

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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by toddthebod »

KlangFool wrote: Sun Jun 26, 2022 10:44 am
toddthebod wrote: Sun Jun 26, 2022 9:36 am
KlangFool wrote: Sun Jun 26, 2022 8:03 am
toddthebod wrote: Sat Jun 25, 2022 10:21 pm
Phyneas wrote: Sat Jun 25, 2022 10:15 pm Bonds carry their own risks (e.g. credit risk, inflation risk (zero/negative real returns), lower returns than stocks over certain periods of time, and I believe, in general, et cetera), but once interest rates go high enough, presuming you trust the issuer (US government for instance), at what interest rate do they become so attractive to a retiree that they can, or should, consider changing their AA?

For instance, my AA calls for a 3% WR in retirement, and I use a 50/50 portfolio because it matches my risk tolerance and goals. But let's say that interest rates go up to 5%, or 10%, or 15%, something that I did not (though no doubt should have) considered. What does the math/history say (if anything) about this? In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?

Variables would include TIPS vs nominals, what durations, and how long their retirement is, and maybe the retirement studies (Trinity/Bengen/Pfau/Kitces) have already accounted for this, but I'd be interested to know this forum's thoughts.
If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
And, if the inflation is 20+% or more, why would that be a good idea?

KlangFool
Inflation won't be 20% forever, but the 15% would be locked in for 30 years. The stock market averaged 10%/year returns in the thirty years after 1981, when you could have bought a 30 year bond with 15% coupon payments.

So I would move all my existing investments into individually held 30 year bonds, and, assuming interest rates didn't stay that high forever, I would invest new savings and coupon payments in equities as the rates fell. With 15% coupon payments, I would be back to 60/40 in about 8 years.
toddthebod,

I assume that you understand that inflation does not need to be 20% forever in order to destroy your portfolio and your retirement plan. It does not take 30 years.

Let's assume that the inflation is 20%. Your portfolio would be reduced by 5% in real term every year without any withdrawal.

KlangFool
Inflation peaked in 1980 at a bit over 13%, interest rates soon after hit 15%. Within 3 years inflation was back to 3%, but those 30 year Treasury bonds continued to pay 15% for 27 more years. Even better, as interest rates fell, the market value of those bonds soared, resulting in long-term treasuries as a whole out-returning the US stock market over 30 years.

You seem to believe that equities will reliably return better than 15% year after year in such an environment. What do you base that on?
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Marseille07 »

MathWizard wrote: Sun Jun 26, 2022 10:42 am I shifted my AA a bit more towards stocks, due to high inflation.
Interest rates should move along with inflation, though so it would be related, so between 7 and 9% inflation was enough .

I believe that stocks have more inflation protection than bonds,
though more volatility.
I'm not sure if stocks have any inflation protection. Inflation introduces the Fed hikes and the markets don't like hikes.

This is not to say stocks are bad here, but the reason for holding would not be inflation protection.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by KlangFool »

toddthebod wrote: Sun Jun 26, 2022 10:59 am
KlangFool wrote: Sun Jun 26, 2022 10:44 am
toddthebod wrote: Sun Jun 26, 2022 9:36 am
KlangFool wrote: Sun Jun 26, 2022 8:03 am
toddthebod wrote: Sat Jun 25, 2022 10:21 pm

If nominal treasuries were paying 15% tomorrow, I would liquidate my equity holdings and invest 100% in individual bonds paying those rates.
And, if the inflation is 20+% or more, why would that be a good idea?

KlangFool
Inflation won't be 20% forever, but the 15% would be locked in for 30 years. The stock market averaged 10%/year returns in the thirty years after 1981, when you could have bought a 30 year bond with 15% coupon payments.

So I would move all my existing investments into individually held 30 year bonds, and, assuming interest rates didn't stay that high forever, I would invest new savings and coupon payments in equities as the rates fell. With 15% coupon payments, I would be back to 60/40 in about 8 years.
toddthebod,

I assume that you understand that inflation does not need to be 20% forever in order to destroy your portfolio and your retirement plan. It does not take 30 years.

Let's assume that the inflation is 20%. Your portfolio would be reduced by 5% in real term every year without any withdrawal.

KlangFool
Inflation peaked in 1980 at a bit over 13%, interest rates soon after hit 15%. Within 3 years inflation was back to 3%, but those 30 year Treasury bonds continued to pay 15% for 27 more years. Even better, as interest rates fell, the market value of those bonds soared, resulting in long-term treasuries as a whole out-returning the US stock market over 30 years.

You seem to believe that equities will reliably return better than 15% year after year in such an environment. What do you base that on?
toddthebod,

1) I do not claim that stock would reliably return better than 15% year after year.

2) However, I do not think it is safe to assume that the inflation cannot stay above 15% for a very long time. That is the assumption you would be making by putting 100% of your money into 30 years 15% bond.

"Inflation peaked in 1980 at a bit over 13%, interest rates soon after hit 15%. Within 3 years inflation was back to 3%, "

3) It is not safe to assume that this would repeat itself this time.

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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by KlangFool »

OP,

In summary, I would not adjust my AA based on interest rate. Especially, not 100% into anything. It is not safe to put all your eggs in one basket.

My AA is 60/40.

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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by JackoC »

nisiprius wrote: Sun Jun 26, 2022 6:21 am 1) What matters isn't the absolute return in bonds themselves, it is the difference between the returns of bonds and stocks. If that doesn't change, asset allocation should not change. In particular, bonds should not be abandoned just because real returns are negative.

2) In theory, interest rate rises should affect both stocks and bonds in the same direction--possibly for the same reason. Under the dividend discount theory of stock values, a rising interest rate would mean that future dividends are worth less today, and the present value of that dividend stream--and thus the value of the stock--should fall, just as it does with bonds. Whether that is the actual explanation of the recent fall in both stocks and bonds, I wouldn't know.

3) I don't ever remember thinking I ought to change my asset allocation due to interest rate changes, and I don't remember target-date funds or the Vanguard LifeStrategy funds ever claiming to have adaptation to interest rates changes as part of their declared strategy.
I somewhat agree with that. I definitely found posts in favor of the topic idea on 'why not be all stocks with bond yields this low?' (common thread type for awhile till recently) to be at odds with my thinking. If not explicitly rejecting your idea in 1/2, they seemed to implicitly assume stock expected return is a quasi-constant, at least in the 'long run'. I don't think there's any central mean 'long run' stock return. What the US stock market did from 1872-2022 or something is basically irrelevant taken by itself without considering starting valuations and yields IMO. The expected return is, rather, best estimated by valuation and macroeconomics (GDP trend>EPS trend etc) at the starting point. Or, if there's going to be a simple default assumption, it would be expected equity risk premium as the quasi-constant based on history, not the absolute expected return. It seemed few people on those threads argued for more stocks even if they only earned the historical premium for taking the extra risk of stocks, which risk might also be assumed same as historical (we don't know obviously but I don't know a definitive argument that it is more or less).

But, I don't entirely reject the idea of preferring more or less risk depending on the level of return once being realistic about how return likely actually varies (ie unlikely there's a free lunch where stock expected return is the supposed 'normal' when bond yields are way below normal, again I don't believe there is any 'normal', short run or long). The literature of 'utility functions' would suggest this is possible, but more simply that's my gut feel for myself. If the riskless return were high enough and ignoring irrelevant rearview mirror considerations (assume I was deploying a new windfall lump sum), there could be a gteed riskless real rate where I'd forget about stocks assuming the historical ERP. But it's not close to that even in the recent fairly dramatic shift from 10 yr TIPS yield from -1% or so to 0.57%, it would have to be much higher*.

*the 10 yr TIPS at 0.57% would still return minus for me after tax in taxable (large % of assets) assuming inflation equal to the 10 yr TIPS breakeven of 2.56%, worse if inflation averaged higher. Taxable TIPS return is still subject to inflation risk, just not as much as nominal bond after tax real return. But in a hypothetical case/world where I get 3% gteed *after tax real return* I might forget about stocks.
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Phyneas
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Phyneas »

nisiprius wrote: Sun Jun 26, 2022 6:21 am 1) What matters isn't the absolute return in bonds themselves, it is the difference between the returns of bonds and stocks. If that doesn't change, asset allocation should not change. In particular, bonds should not be abandoned just because real returns are negative.

2) In theory, interest rate rises should affect both stocks and bonds in the same direction--possibly for the same reason. Under the dividend discount theory of stock values, a rising interest rate would mean that future dividends are worth less today, and the present value of that dividend stream--and thus the value of the stock--should fall, just as it does with bonds. Whether that is the actual explanation of the recent fall in both stocks and bonds, I wouldn't know.

3) I don't ever remember thinking I ought to change my asset allocation due to interest rate changes, and I don't remember target-date funds or the Vanguard LifeStrategy funds ever claiming to have adaptation to interest rates changes as part of their declared strategy.
Those are good arguments, especially (1) and (2). I went back and compared the time periods shown here to how bonds performed during the same spans, and a 60/40 portfolio, or anything with 'more stocks' still did better than all-bonds or 'more bonds' did during those same spans. That isn't to say that the pattern will continue, maybe bonds do better than stocks in a high/rising rate environment for some anomalous reason, but in order for it to really work, an investor would need a perfect starting point on the bond side, which is unlikely, so unless bond yields go up to high double digits, and it is timed perfectly, one is not likely to get ahead much by tilting their AA more heavily towards bonds. Maybe some retirees are willing to lock in their WR and take a lower return, but it would be risky, especially if they lived longer than they expect and could run out of money, or re-up their bonds at unattractive yields several years later and when stocks are at their highs so switching back would be expensive for them.
Last edited by Phyneas on Sun Jun 26, 2022 1:31 pm, edited 1 time in total.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by tvubpwcisla »

Interest rate fluctuations are not part of my investment plan. I would not make AA changes based on interest rates.

Does anyone have interest rate changes a part of their investment plan?
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by CraigTester »

nisiprius wrote: Sun Jun 26, 2022 6:21 am 1) What matters isn't the absolute return in bonds themselves, it is the difference between the returns of bonds and stocks. If that doesn't change, asset allocation should not change. In particular, bonds should not be abandoned just because real returns are negative.
This of course is only true if you accept being "trapped" in a spectrum of only two choices.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by MathWizard »

Marseille07 wrote: Sun Jun 26, 2022 11:06 am
MathWizard wrote: Sun Jun 26, 2022 10:42 am I shifted my AA a bit more towards stocks, due to high inflation.
Interest rates should move along with inflation, though so it would be related, so between 7 and 9% inflation was enough .

I believe that stocks have more inflation protection than bonds,
though more volatility.
I'm not sure if stocks have any inflation protection. Inflation introduces the Fed hikes and the markets don't like hikes.

This is not to say stocks are bad here, but the reason for holding would not be inflation protection.
Inflation caused by labor shortages means more nominal dollars in worker's hands. But in the US , workers are also customers.
Inflation can actually be good for the bottom line if you have a business in which labor costs are not the major portion of the cost of your product.

I'm going to use exaggerated numbers for ease of exposition

Let's suppose s company has not debt, do a ride in interest rates had no effect. Inflation would still have an effect in terms of labor costs.

In a tight labor market,companies have to pay more in wages
Let's suppose that worker's wages doubled.

The cost of production is more than just labor cost. Let's suppose it is half the cost.

Then a doubling in wages causes the product to be 1.5x as expensive to make. The workers now have twice as many dollars, so they can pay double for the product,but it only cost 1.5x as much to produce, if there is no downward pressure on prices, companies could actually earn more profit.

This all ignores the effect of corporate debt, and the non-labor costs associated with machinery , or shifting market share between companies with varying levels of debt, and various percentage of worker cost in the final product cost.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Beensabu »

bikechuck wrote: Sun Jun 26, 2022 10:34 am
Beensabu wrote: Sun Jun 26, 2022 12:09 am
Phyneas wrote: Sat Jun 25, 2022 10:15 pm In other words, at what point is a retiree taking equity risk that they no longer need to because the bond yields available to them will cover more of their retirement spending?
If someone only has a 3% withdrawal rate after reaching FRA, why wouldn't they just build a TIPS ladder with the whole portfolio?
If the Tips ladder was built with pre tax money would that complicate RMD's? How could that be managed?
Couldn't you include the extra (beyond spending need) required for RMD when purchasing the bonds for the first few RMD years where that's going to be the case and then reinvest that extra at an appropriate duration immediately after distribution each year until your RMD is less than your spending need?

That may be overly naïve. I'm sure someone will say something if so.
"The only thing that makes life possible is permanent, intolerable uncertainty; not knowing what comes next." ~Ursula LeGuin
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Ocean77
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Ocean77 »

tvubpwcisla wrote: Sun Jun 26, 2022 1:30 pm Interest rate fluctuations are not part of my investment plan. I would not make AA changes based on interest rates.
Same here.

It seems like an odd idea to change your portfolio based on interest rates. Now, the interest rate change may bring about a drop in bond prices and trigger a rebalance into bonds. Or it may not. I.e. if bonds drop in lockstep with stocks (no longer an unusual concept after this year), then there may be no rebalance action no matter how high rates go.
30% US Stocks | 30% Int Stocks | 40% Bonds
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Marseille07 »

tvubpwcisla wrote: Sun Jun 26, 2022 1:30 pm Does anyone have interest rate changes a part of their investment plan?
If I held bonds, I'd use the Ten to change my bond allocation.
heyyou
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by heyyou »

On the OP's question:
Don't know and don't care since I'm using a variable % withdrawal plan that includes spending portfolio interest and dividends.

I might buy some newly issued, uncallable individual bonds if rates go over 10% on them, like I missed in 1984. Current rates then were a few percent higher than the fixed 10% offered on those long bonds. The risk was the over-10 rate continuing for decades, but that didn't happen.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by JackoC »

MathWizard wrote: Sun Jun 26, 2022 3:30 pm
Marseille07 wrote: Sun Jun 26, 2022 11:06 am
MathWizard wrote: Sun Jun 26, 2022 10:42 am I shifted my AA a bit more towards stocks, due to high inflation.
Interest rates should move along with inflation, though so it would be related, so between 7 and 9% inflation was enough .

I believe that stocks have more inflation protection than bonds,
though more volatility.
I'm not sure if stocks have any inflation protection. Inflation introduces the Fed hikes and the markets don't like hikes.

This is not to say stocks are bad here, but the reason for holding would not be inflation protection.
Inflation caused by labor shortages means more nominal dollars in worker's hands. But in the US , workers are also customers.
Inflation can actually be good for the bottom line if you have a business in which labor costs are not the major portion of the cost of your product.

I'm going to use exaggerated numbers for ease of exposition

Let's suppose s company has not debt, do a ride in interest rates had no effect. Inflation would still have an effect in terms of labor costs.

In a tight labor market,companies have to pay more in wages
Let's suppose that worker's wages doubled.

The cost of production is more than just labor cost. Let's suppose it is half the cost.

Then a doubling in wages causes the product to be 1.5x as expensive to make. The workers now have twice as many dollars, so they can pay double for the product,but it only cost 1.5x as much to produce, if there is no downward pressure on prices, companies could actually earn more profit.

This all ignores the effect of corporate debt, and the non-labor costs associated with machinery , or shifting market share between companies with varying levels of debt, and various percentage of worker cost in the final product cost.
The main thing it ignores is real rates. Since the beginning of 2022 the market inflation expectation in 10 yrs, if read as the TIPS breakeven, has actually gone *down* slightly, from 2.6% to 2.56%. What has skyrocketed in the real yield, 10 yr TIPS going from -.97% on the first trading day to +0.57% 6/24. Even if every component of input cost and revenue moves in lockstep with inflation, and thus real future profit is unaffected, it's now discounted at a significantly higher rate to get the present value of future profits. So it's not a surprise for the S&P to move down sharply in such a situation; that's not the only thing going on but it's a significant negative thing. If real rates rose because of more positive expectation of real growth, that could be neutral or good, but doesn't seem to be case between beginning of year and now, if anything real growth expectations are fading also.

Which relates to what Marseille07 said 'the markets don't like hikes', an expectation of higher real Fed Funds rate over time equates to higher term real treasury yields now.

And it's questionable whether actually high inflation is neutral for stocks even assuming it doesn't result in higher real rates. High inflation tends to mean more uncertain inflation. More uncertain inflation makes it harder to run businesses efficiently. There's ample evidence (US in the 60's-80's, other countries) a serious inflation problem is not good for stocks, combining the effect of higher real rates to bring the inflation under control and the negative impact of high, uncertain inflation on economic efficiency in case the inflation isn't brought under control. A moderate increase in inflation is more likely to be neutral for stocks than a serious burst of inflation requiring strong countermeasures.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by iamblessed »

One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Dottie57 »

I am at about 50/50 so no switch.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by manuvns »

i will be swtching to bonds due to my age
Thanks!
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by manuvns »

iamblessed wrote: Mon Jun 27, 2022 12:00 pm One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
if treasury pay 10% the expected return on stocks will be 20% . the cheaper stocks are the more you should hold them , typically bonds are a place to park money
Thanks!
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by jdamo »

nisiprius wrote: Sun Jun 26, 2022 6:21 am 1) What matters isn't the absolute return in bonds themselves, it is the difference between the returns of bonds and stocks. If that doesn't change, asset allocation should not change. In particular, bonds should not be abandoned just because real returns are negative.

2) In theory, interest rate rises should affect both stocks and bonds in the same direction--possibly for the same reason. Under the dividend discount theory of stock values, a rising interest rate would mean that future dividends are worth less today, and the present value of that dividend stream--and thus the value of the stock--should fall, just as it does with bonds. Whether that is the actual explanation of the recent fall in both stocks and bonds, I wouldn't know.

3) I don't ever remember thinking I ought to change my asset allocation due to interest rate changes, and I don't remember target-date funds or the Vanguard LifeStrategy funds ever claiming to have adaptation to interest rates changes as part of their declared strategy.
Nsiprius, why should bonds not be reduced, maybe significantly, if real returns are negative? The latest article from the BIS, Bank of International Settlements, (think tank and transfer funds between nation's central banks) says interest rates must rise above the inflation rate, which is currently 6-9% depending on method of measuring it. This could go on for years!
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Beensabu »

iamblessed wrote: Mon Jun 27, 2022 12:00 pm One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
I think that's because there's an assumption that for a 30-year treasury bond to have a 10% yield, there must be surrounding economic conditions that make that 10% yield seem unappetizing. But that disregards the probability of economic conditions changing in that next 30 years, to the point that the 10% yield would be seen as quite favorable somewhere further down the line. And then, of course, you could apply that to 5% yields, or 3%... At any point in time, people just think yields will go higher. That's a part of bond investing.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by toddthebod »

manuvns wrote: Mon Jun 27, 2022 3:29 pm
iamblessed wrote: Mon Jun 27, 2022 12:00 pm One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
if treasury pay 10% the expected return on stocks will be 20% . the cheaper stocks are the more you should hold them , typically bonds are a place to park money
At that precise moment in time, maybe. Are you telling me if you could go back in time to 1981 and purchase 30 year treasury bonds with 15% coupon payments, you wouldn't shift your asset allocation to load up? The market averaged just under 10%/year from 1981-2011.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by iamblessed »

manuvns wrote: Mon Jun 27, 2022 3:29 pm
iamblessed wrote: Mon Jun 27, 2022 12:00 pm One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
if treasury pay 10% the expected return on stocks will be 20% . the cheaper stocks are the more you should hold them , typically bonds are a place to park money
That might be true but given time that 20% will revert back to 10% like it always does.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by Tamalak »

If yields got higher than inverse P/E, I'd waver. The last time that happened was 2000 and it looks very good for bonds in retrospect.

Of course in 2000 P/E was so high because of enormous optimism for earnings growth. We know now that optimism was silly. But if it happened again, it would be in the same context of equally powerful optimism. Would it be unjustified again? And if it was, how would I know? So, I'd probably stick to my AA anyway.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by whodidntante »

People used to talk about cash allocations. Then rates dropped and we made fun of them for owning a non-productive asset. So they started calling cash allocations emergency funds instead. And we nodded and pretended to know what they were talking about.

My guess is that cash will become an asset class again. I don't know the exact definition of an asset class. Let's start with "something astute investors will not make fun of you for owning." That's probably what it is.
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Re: How high would interest rates have to go before you'd switch your (retirement) AA?

Post by manuvns »

toddthebod wrote: Mon Jun 27, 2022 5:17 pm
manuvns wrote: Mon Jun 27, 2022 3:29 pm
iamblessed wrote: Mon Jun 27, 2022 12:00 pm One thing I don't understand here is most bogleheads will invest in the stock market that has made about 10% since 1926 but will not lock in to a 30 year treasury bond paying 10%? To me the treasury would be much better.
if treasury pay 10% the expected return on stocks will be 20% . the cheaper stocks are the more you should hold them , typically bonds are a place to park money
At that precise moment in time, maybe. Are you telling me if you could go back in time to 1981 and purchase 30 year treasury bonds with 15% coupon payments, you wouldn't shift your asset allocation to load up? The market averaged just under 10%/year from 1981-2011.
and how much does treasury average in same time period ?1.88% ? i was talking about a hypothetical situation .
Thanks!
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