Asset Allocation question: Bonds

You're right. I got it exactly backwards. D'oh! You buy long bonds when rates are dropping. Very short-term bonds (if bonds at all) when rates are rising.

I hate it when I do that.

Thanks, Bob

No, not "duh." Be exact with your citations or be ignored. It's a moderated newsgroup with admirable goals, so a professional patina might not be such a bad goal, ya know.

I thought you might be paraphrasing some commentator. I refused to yet again do homework another poster should have done before posting.

It says a 100% stock portfolio has not been as safe as a mix of stocks and bonds when drawing down. A lot of finer points might be inferred from this. However, I think it prudent to just let it stand in some opposition, in my opinion, to Jim's statement. People annoyed by this might also want to consider Robert Shiller's (Yale prof much quoted in the media) recent proposal that, given a choice between all TIPs or all stocks, he'd go all TIPs.

Also, my sense is there is some monday morning quarterbacking going on here: The average return of stocks over long periods has been x, so it will continue to be x, and since x is so high, it was a smart move to invest in stocks back then, and will be in the future. This implication is a disservice to newbies.

Sorry, when I said Trinity Study, I thought you would figure Trinity Study. So for future reference, I meant the Trinity Study.

Wow, touched a nerve...

I guess Sarge wasn't the only one to get coal in the ole stocking...

I think the only point that should be inferred is that bonds reduce volatility.

I'll ignore this since there's no cite... :) Just kidding, I believe you.

Admittedly many of us (but not me) are fond of quoting the 10% - 11% historical returns, but do you honestly think that bonds will outpace stocks over the next 60+ years (the OP's investment horizon)?

-Will

"Will Trice" wrote E

Or that's your poor defense for academic laziness. :-)

Asking for a citation is justified.

I cited it a few months ago here and thought you might remember. No big deal.

For the purposes of advising someone, I have no idea. I will only speak to what has happened in the past and perhaps the underpinnings of what drives stock price increases.

Talking about the future the way Jim did seems to imply possession of the proverbial crystal ball. Not to shoot him down. After all, maybe the problem is understanding the importance of phrasing here. "Stocks are your best bet for the long run," is more correctly phrased as "in the past, stocks have been the best bet for the long run."

I think that's a good idea. Vanguard is pretty much the leader in low MER index mutual funds.

If you want a low cost short term bond fund, you might as well just go with a high yield savings account.

Correct, adding bonds at around age 40 for someone retiring at age 60. Create a small position at age 40, then gradually increase this position as retirement grows closer. This is my opinion- there are other ways to do this.

I do not think income level suggests a person's risk tolerance. Conservative would be for someone which does not like seeing their principal change by 10% in one day, week, month or year. These are my interpretations, others will differ.

How much cash do you have relative to a years worth of income? I think conventional wisdom suggests a cash position of around 2-6 months of expenses. If you keep a larger cash position, I could probably come up with some logic to invest the rest of portfolio more aggressively (less bonds, more equities).

At a young age, you have time on your side to ride out a bear market. Even if the time is 10 years, you have the time to recover. Over long time periods stocks tend to reduce volatility on their own (bonds would be needed to ride out short term volatility). Long term IMO is more than 7 years.

In addition your idea of selling bond positions in bear markets to buy equities would be a form of rebalancing. That is a good idea, IMO.

can you translate this for me? (I'm making up return numbers here for this analogy)

I think what Elle is saying is a portfolio of 100% stocks will have average positive returns of say 10% over say 25 years but will have steep negative periods several times over which may co-incide with your ability to draw a retirement income (timing)

If you introduce and hold long term bond positions into your portfolio and find a right split between stocks-bonds then you can say your portfolio can come close to those average 12% returns however it comes close to that similar all stock returns not because of growth but because it softens the losses during negative periods. Is that what you are saying Elle?

Is this what the argument is? Some people are saying any bond holdings for long term investing never mind plans to withdrawal soon. I'm asking from the point of a 30 year old with a 30 year plan. Do bond holdings limit my growth potential or does an 100% stock/non-bond holdings funds portfolio limit my growth potential because of the steeper negative periods offset the higher positive returns in bull markets for stocks?

I'm working on an 80-20 stocks:bonds portfolio.

"The Henchman" wrote

I am a bit irritated that folks present data about past stock market behavior as though that behavior is guaranteed to continue into the future. When a celebrity commentator does it, it's the hallmark of a hack, AFAIC. Here at MIFP, it's arguably mostly bad writing, but writing that nonetheless seriously misleads. It's easily corrected. E.g. from another poster on January 10th, we have: "Over long time periods stocks tend to reduce volatility on their own..." Change the verb to "have tended". Otherwise, it reads like one can predict the future when it comes to stocks. On the contrary, it's all a collective hunch.

I do not consider this nitpicking. It goes to critical thinking skills when it comes to financial planning, skills essential to feeling comfortable about one's decisions. One should always be able to explain the reasoning for this or that decision, and that reasoning had best not be simply, "because so-and-so on Usenet, TV, or the radio said so."

Replace "will have" with "has had" above, etc., and we're fine.

Little aside: IIRC the Trinity Study's bond data was from individual, long-term maturity, investment grade corporate bonds, not bond mutual funds. Not sure if this would make too much difference here. I am persuaded that most people will be most comfortable with intermediate term investment grade bonds (individual ones or perhaps in a low expense ratio mutual fund), if past performance continues.

That's certainly the idea, but I defer to how the Trinity Study authors, among others, put it.

The way to put this, to be clear and accurate, is "In the past, /have/ bond holdings limited growth in a 30-year time horizon?... " And so forth.

I think it's important to remember asset allocation is not an exact science. This is most importantly because asset allocation assumes the future will repeat the past. Of course this has turned out not to be always so.

What does make a good deal of mathematical and logical sense to me is to diversify.

I would use the free online tools linked at

among others, continue to read, study, and ask questions here, then make a decision on allocation for today. Subsequently be open to adjusting this allocation as your sense of the future changes, if it changes. For your situation, you might find the variation in the output of these tools, along with the nuances of their approaches, helpful. Just don't attempt to chase short-term returns. That's a proven failing strategy, AFAIC. Hopefully you know this already.

zxcvbob,

You are (eventually) right that bond prices rise and fall with an inverse relationship to interest rates. But I disagree that the ability to hold bonds to maturity in an increasing interest rate market is a substantial bonus over bond funds.

The reason that bond prices fall as interest rates rise is becuase the old bond's coupon payment is inferior to that of new, comparable bonds. Sure you could hold to maturity and recapture your principal, but you recieved a lower than market coupon payment the whole time.

Often it is as equally advantageous to sell the old bond at a discount and purchase a new one with a higher interest rate. The loss of principal is recouped by the increase in interest payments.

Market equilibrium for comparable bond products contradicts your arguement.

If we are talking about drawing down, then bonds have a significant impact on the draw down strategy. I do not remember drawing down being a primary discussion point, as OP is ~30 years from the first year of draw down.

I do not think 12% return is a reasonable expectation for any portfolio. 100% stocks might approach this, adding bonds would probably reduce how often a portfolio reaches 12% returns.

I think bonds limit growth potential... to a certain extent. I think if we are in a bear market that an 80-20 mix would beat a 100-0 mix.

These are my opinions... past performance is no guarantee of future performance.

bonds reduce volatility and help preserve principal bonds also help provide an income stream

it is probably likely a 60-40 mix is less volatile than an 80-20 mix. The 80-20 mix is probably less volatile than a 100-0 mix. There is no one size fits all (if you are comfortable with 80-20, then go for it).

100% stocks does not mean 100% S&P 500... definitely diversify regardless of 80-20 or 100-0.

Large Caps-domestic Small Caps-domestic Large caps-foreign Small caps foreign Maybe a mid cap, growth or sector fund as well Maybe a bond fund or two Maybe a Value fund as well.

I wouldn't expect nor wish for those returns. A 12% wish might mean a 20% decrease. I simply made up those return numbers to state an anology. Personally I'm aiming to give myself a shot at 8.5 or 9% but would be just as happy with 7.5% or 8%. Just trying to give myself a shot at that.

I'm trying to determine my mix of Value versus Growth so I have do some research on that first. My 80% stock allocation is presenting itself as the following: Is it too diverse to accommodate bond holdings?

15% Large cap Canada 10% Medium Cap Canadian 10% Canadian financial (including insurance companies etc.)

5% LC USA

10% MC USA 10% SC USA

10% European

5% Japan 5% Far East without Japan

Canadian financials pay very large dividends so that is why I am devoting

10% to this sector. Is this to much to allocate to one sector? This sector is about 20% of Canada's top Index the TSX. It's a growth and income and reinvestment allocation. Plus the Canadian small cap is way too wild west for me to consider at this time. Too many stocks under $5.00 a share for a newbie.

American stocks will be expensive esp. the large cap that's why only 5%. Once I have some capital I can readjust down the road.

All earnings will be reinvested.

Elle schrieb: >

I asked Jose the same question the misc.invest.mutual-funds forum. He is also NOT in favor of using bonds.

I wrote:>>

Thats intersesting you said that because I read a book here in Germany about MPT and EMT and in the diversafivation Bonds were NOT recommended in the conservative area of the Portfolio.

Even money market funds can be used but NOT bonds. I think this had to do with cost reasons, but I really do not understand why?

"Turtle" wrote

He also thinks a small selection of microcap stocks has the same risk as a microcap mutual fund with a much larger selection of microcap stocks.

Different people have different risk tolerances, or are less read on the effect of bonds on a portfolio.

I recommend letting Jose speak for himself, anyway, and not dragging in comments from other fora here, especially unmoderated ones, where every crackpot posts, driving away the sane to rebut them, and the tenor is very different as a result.

One cannot tell whether this is a book on investing via Germany or what all. I'd say 95% of the comments here are directed to those based in the U.S. Advice to those outside the U.S. should necessarily differ in a number of ways.

At the end of the road, and simply put, high grade bonds do one very important thing in particular: Reduce risk.

They do other things as well, but that's the important one for people in retirement.

Folks should remember that the inverted bond yield curve we now have is unusual. Ordinarily, money market rates are much lower than those of bonds with a five-year maturity or so.

9 funds/sectors is well diversified. an 80-20 mix with an expectation of a 7.5% return sounds reasonable to me.