Bond Allocation

[Tiger]

Many experts recommend that an investor's bond portion of his portfolio equal his age. My take is that with the longer lifespan today at least 10 years should be added when calculating ones AA.

What is your opinion.

[Mwsinron]

I base it on my risk tolerance.

[terminator]

I'd say it depends on risk tolerance and what you have in the equity portion of your portfolio. Bond/Stock splits mean very little if you are comparing equity portfolios consisting of AAA blue chips paying 3% dividends on one hand and tech stocks and other non-dividend paying 'growth' companies on the other.

But to your actual question, I'd say subtracting 10 from the bond allocation probably makes more sense than adding 10 because the longer life just makes inflation that much more destructive.

[jIMOh]

Subtract retirement age from current age. Then compare the difference to 20: higher than 20 is 0, lower than 20. suggests that is % bonds needed at minimum.

Current age: 35
Retirement age 68

68-35=33, which is greater than 20, so 0% bonds

current age: 35
retirement age 50
50-35=5. This person should have 5% bonds this year, increasing 1% each year until retirement.

This implies a person is no more than 80% equity when they retire.

I have not found a good way to quantify what to do in retirement, my thought is increase bond allocation 1% each year of retirement, starting from a 70-20-10 allocation.

The whole point of increasing bond allocation each year is to "force sell" a small portion of gains. Large moves are risky, so 1% increments make sense.

[audreyh1]

Originally Posted by Mwsinron

I base it on my risk tolerance.

Ditto! And more specifically long-term portfolio survivability (which I balance with my desire to reduce risk).

Audrey

[MasterBlaster]

Originally Posted by Mwsinron

I base it on my risk tolerance.

I would base it on a variety of factors. Some have neat little formulas that say bond allocation = 100-age or 110 - age or 120 -age.

Others look at the quasi bond-equivalent effects of things like pensions and real estate holdings and adjust their portfolio accordingly. In other words if you have a big pension and lots of (non primary resident) real estate holdings then your bond allocation should be less than the little formula given above.

[RASAP]

current age: 35
retirement age 50
50-35=5. This person should have 5% bonds this year, increasing 1% each year until retirement.

I'm confused. Using a different set of parameters...

current age: 54
retirement age 55
55-54=1. This person should have 1% bonds this year, increasing 1% each year until retirement?

[ashtondav]

I feel comfortable with just 5% in bonds and 95% in dividend paying individual equities (about 20, representing most industrial sectors except tech), and equity income mutual funds and etfs (for european and asian dividend payers).

My dividend yield is currently 3.9% based on current value. In the last fifteen years i have only had 2 years of stagnant or declining dividend income - 2001 and 2002. Inflation busting increases in other years has more than compensated. I never touch the capital unless a share's dividend yield drops below the FTSE 100 (about 3%) when i sell and buy another high yielder.

The bonds are simply there to sell if dividend increases don't exceed inflation.

[jIMOh]

Originally Posted by RASAP

I'm confused. Using a different set of parameters...

current age: 54
retirement age 55
55-54=1. This person should have 1% bonds this year, increasing 1% each year until retirement?

I left out it is 20- the difference as % bonds (if difference is greater than 20, still zero). OOPS

age 35
retirement age 56

56-35=21. 21>20, 0% bonds

age 35
retirement age 51
51-35=16. 20-16=4. 4% bonds

age 51
retirement age 53
53-51=2. 20-2=18. 18% bonds.

[Tiger]

Originally Posted by jIMOh

I left out it is 20- the difference as % bonds (if difference is greater than 20, still zero).

How did you come up with this forumula?

Do you count cash separetly from bonds?

I am 68 - 65 = 3 + 20 = 23% bonds

I am 27% bonds and 16% cash & CDs. I count my REIT fund as part of equities.

[jIMOh]

Originally Posted by Tiger

How did you come up with this forumula?

Do you count cash separetly from bonds?

I am 68 - 65 = 3 + 20 = 23% bonds

I am 27% bonds and 16% cash & CDs. I count my REIT fund as part of equities.

I came up with this myself.

In your case it would be

68-65=3. 20-3=17 17% is minumum bond allocation.

Cach is seperate from bonds... and generally I do not consider cash as part of allocation. UNLESS you would be willing to reduce cash value in a rebalance if market drops. Meaning if you are 70-20-10, and market drops such that you are 50-30-20. Would you sell 10% of the cash position (mind you it has not increased, everything else just decreased).

A more conservative investor could use my equation with 30 as "magic number" instead of 20 and have a good guideline. 80-20 the year of retirement is aggressive... the year I retire I plan to be 70-20-10...

the 10 years prior to retirement I will consider adding 1% cash to allocation, and I will liquidate this cash in down years to put back into market.

[MasterBlaster]

Jimoh:

Your bond allocation formula is a liitle on the short side based on a number of studies.

Adding more bonds to your portfolio will reduce the fluctuation (ie downside) risk without giving up much on the growth side.

Below is but one study that suggests that a 68 year old with a 25 year expected lifespan should be about 30 percent in bonds. That dovetails pretty well with the rule-of-thumb of 100-age.

[jIMOh]

Originally Posted by Masterblaster

Jimoh:

Your bond allocation formula is a liitle on the short side based on a number of studies.

Adding more bonds to your portfolio will reduce the fluctuation (ie downside) risk without giving up much on the growth side.

If comparing bond allocations in small increments (5% or 10%), I agree the impact on returns is minimal... but when comparing 90-10 to 70-30... you'll have a hard time convincing me at age 33 the 30% bond position will not eat into long term returns. Even .5% matters with 30 years of compounding... so I am willing to take the risk, even if a bond position suggests less volatility. Time negates volatility more than a bond position will.

[MasterBlaster]

Jimoh:

You are forgetting about the poitive effect that bonds have on a portfolio during market downturns. When the market goes south, interest rates usually fall and bond prices rise. So for a balanced portfolio that is periodically re-balanced to some optimal mix the lower average yield of bonds is not so much a factor.

I will see if I can find a risk versus reward chart showing the positive effects of bonds on a balanced portfolios.

- Bonds are a good thing

[jIMOh]

like I said, bonds have a role when steadiness of returns is as important as portfolio growth. IMO, I am in accumumlation stage.

I have about 150k set aside at age 34. I need the extra .5% return I would get from 100% equity. year over year, that .5% means quite a bit. I add the bond position once I know I have enough set aside to retire within 20 years.

I fully expect to retire by 58, so at 38 I would imagine getting more moderate in my risk profile.

there is more than one way to combat volatility. In my portfolio, time is the primary means to deal with variance of returns. When a person does not have time, bonds are a great substitute.

[MasterBlaster]

Originally Posted by jIMOh

so I am willing to take the risk, even if a bond position suggests less volatility. Time negates volatility more than a bond position will.

For someone who is approaching retirement or who is retired, you are literally betting-the-farm that stocks will not devolve over the term when you need them. You might be better off, and then again you just might have to go back to work.

[jIMOh]

You are taking a simplistic view in only looking at a static asset allocation.

The way I plan to do things is to use the "20-difference" rule.

so year 20 I will be 100% equity. Year 19 is 1% bond. I need to sell off some of my "winners" to create this position.

year 18- if market tanks, bonds might be 2% already, if not, I sell off another 1-2% of equities to create a 2% bond position.

year 17, selling off more winners to create 3% bond position.

The forced selling of winners is what will lock in gains. This also prevents me from selling in a down year.

I have an allocation I follow (75-25 domestic/international) and a 45 LC-15 MC-15 SC-15 ILC-10 ISC allocation. Rebalancing within this also helps lock in gains.

[Tiger]

Originally Posted by jIMOh

I came up with this myself.

In your case it would be

68-65=3. 20-3=17 17% is minimum bond allocation.

Cach is seperate from bonds... and generally I do not consider cash as part of allocation. UNLESS you would be willing to reduce cash value in a rebalance if market drops. Meaning if you are 70-20-10, and market drops such that you are 50-30-20. Would you sell 10% of the cash position (mind you it has not increased, everything else just decreased).

A more conservative investor could use my equation with 30 as "magic number" instead of 20 and have a good guideline. 80-20 the year of retirement is aggressive... the year I retire I plan to be 70-20-10...

the 10 years prior to retirement I will consider adding 1% cash to allocation, and I will liquidate this cash in down years to put back into market.

I have never seen an AA strategy that didn't consider cash as part of the portfolio be it money market, CDs or savings accounts so why do you not make it part of the portfolio?

For me cash represents my emergency fund which is a fixed figure plus moneys I am waiting to invest with so if the market drops I would be buying therefore reducing my cash position.

I also see where people here include their homes as part of their portfolio but from everything I have read and seen discussed homes, Social Security, pensions and pay shouldn't be included.

[FinanceDude]

I have had 10% in bonds since 1998, and have not regretted it at all.

Currently am 80 stock, 10 bond, 10 cash................