Bonds: So Much More Dangerous Than You Think

[KMyer]

Here's an interesting article about the dangers of investing in bonds at the present time:

Bonds: So Much More Dangerous Than You Think

The article concludes with the following question?

At a conference two years ago, Wharton finance professor Jeremy Siegel laid out the history of stocks and bonds to a roomful of journalists: "You have never lost money in stocks over any 20-year period, but you have wiped out half your portfolio in bonds. So which is the riskier asset?"

The question answers itself.

What do you think?

 

[Original Wally]

K Myer - yes. IF you sell. If you hold to maturity, no. Let's make that distinction.

 

[Packman]

I'm in the middle of a book titled - "Bonds - The Unbeaten Path to Secure Retirement Growth". The author recommends an All Bond Portfolio and arugues the exact opposite of Siegel, that bonds cannot lose money, but with the typical individual investor's poor timing, stocks are a losing proposition. The assumption is to buy individual bonds, and not bond funds or ETF's. I certainly see the point, but still cannot bring myself to buy bonds with a 2% coupon. I just have to wait for interest rates to increase.

 

[Original Wally]

YIKES. 100% Bonds! Wow. No thanks. I do agree that at this time it is best to have a small percentage in bonds. Yields are just too low. When yields return to a "normal" level (whatever THAT is....) then a more normal allocation to bonds is warranted. IMHO.

 

[foxfirev5]

K Myer - yes. IF you sell. If you hold to maturity, no. Let's make that distinction.

I believe those losses take inflation into consideration. From the 50's into the early '80's bonds steadily lost value in real terms.

 

[ERhoosier]

Siegel raises some excellent points. Long bonds can be BIG losers in a rising inflation environment. Hold to maturity & you lose big in real dollar (inflation-adjusted) terms.

 

[Original Wally]

Heartily agree about losing in terms of inrflation adjusted dollars. That is specifically why I personally would not put much into bonds now. If Treasurys ever got into double digits again, hell yes.

 

[clifp]

K Myer - yes. IF you sell. If you hold to maturity, no. Let's make that distinction.

No even if you hold to maturity you will lose money especially after inflation and taxes are taken into account. 10 year year Treasury are yielding 2.0% Single A corporate 10 year are 2.66. If you are in the 25% tax bracket (ignoring state income tax.),that reduces the yields to 1.5% and and 2.0% respectively both well below the last 3 year inflation rate of 2.3% much less the historical rate of near 3% of inflation.

That bond guy is crazy.

 

[haha]

K Myer - yes. IF you sell. If you hold to maturity, no. Let's make that distinction.

It's a false distinction when applied in this way. But Ol' Jeremy is also flogging untruth about his darling stocks.

Look at this chart of inflation adjusted returns on S&P 500. Clearly there were 20 year periods that showed a loss- page down a bit and look at 1965-1985.

Ha

S&P 500: Total and Inflation-Adjusted Historical Returns

 

[Original Wally]

It's a false distinction when applied in this way.

Ha

No it isn't. Loss due to earning less than inflation is not the same as loss due to selling at a price less than paid. They are significantly different.

Buy and hold to maturity can be a valid stategy. At this point, with the low yields, it is silly to invest into long bonds. Building a bond ladder if rates start to resume is not as silly.

 

[haha]

No it isn't. Loss due to earning less than inflation is not the same as loss due to selling at a price less than paid. They are significantly different.

Buy and hold to maturity can be a valid stategy. At this point, with the low yields, it is silly to invest into long bonds. Building a bond ladder if rates start to resume is not as silly.

Especially since you apparently pay your rent and buy your groceries with nominal dollars. I do agree that in the rare circumstance where an individual has a nominal bill coming due at a particular time, he can if he wishes fund it with a bond that will pay that nominal amount, if he is also that very rare investor who pays no income tax.


Ha

 

[NW-Bound]

... Look at this chart of inflation adjusted returns on S&P 500. Clearly there were 20 year periods that showed a loss- page down a bit and look at 1965-1985.

Ha

S&P 500: Total and Inflation-Adjusted Historical Returns

Yes, 1965-1985 was a crummy period, and an investor in stocks barely made a bit of money after inflation. If we look at 2010 till now, it looks like the same story. So far that is.

Yet, many investors here, myself included, did OK so far. In a range-bound market like what we have been in, trading in/out of the market, or rebalancing as many people say they are doing, turned out very well.

In a long bull market like what we had encountered in the past, rebalancing would not work out as well, and I am sure people would be kicking themselves for doing it.

 

[Donzo]

All of my bonds are in bond funds - VG, mostly intermediate and some high yield. When you buy can be an issue....but not for most with the ER mindset (here). I buy bonds when my equity AA is higher than it should be ie hopefully selling high (at least higher, I tend to RE- A early). So I'm taking money earned/grown from Equities and purchasing fixed.
Now if you had loads of money on the sidelines and decided to jump in with both feet into bonds (or stocks) you may get burned (short term - LT who knows for sure?). But taking money off the table and reinvesting seems less likely to end poorly. Unless stocks/bonds dive in lock step - but, that NEVER happens...........right?

 

[haha]

Yes, 1965-1985 was a crummy period, and an investor in stocks barely made a bit of money after inflation. If we look at 2010 till now, it looks like the same story. So far that is.

Yet, many investors here, myself included, did OK so far. In a range-bound market like what we have been in, trading in/out of the market, or rebalancing as many people say they are doing, turned out very well.

In a long bull market like what we had encountered in the past, rebalancing would not work out as well, and I am sure people would be kicking themselves for doing it.

I have no issue with stocks, only with Jeremy lying about no 20 year period when we have had an S&P loss.

There were alternatives that did well in this period- notably cash. There is a false idea around that stocks and bonds are on opposite ends of a teeter totter, when one goes up, the other goes down. Pretty rare, except in times of out of control inflation

Ha

 

[Gatordoc50]

I don't believe that holding bond funds is prudent. Yields of 2 to 2.5% on short and intermediate term bonds? Certainly the total return will not be better than this and most likely will be closer to zero. When interest rates rise 3 or 4 percent, I can see then buying funds. Really, this is a perfect time for individual bond ladders especially if, like me, you stick to no or very low risk bonds. It depends on how one is using their bonds. For income or to soften their equity risk.

 

[meierlde]

Siegel raises some excellent points. Long bonds can be BIG losers in a rising inflation environment. Hold to maturity & you lose big in real dollar (inflation-adjusted) terms.

Lets take an extreme example Before and during the Napoleanic War the UK issued consols which were perpetual bonds which paid interest every 3 months. If you had invested in one in 1776 (at which time it paid 3%) you wound have over the last 230 years lost your shirt on it due to inflation. The last ones were issued in 1923 or so. If you use the gold price in 1717 of 4.25 pounds per ounce and take todays gold price of 1044.89 the ratio says you have .406% of the original value of the bond, not a great return over that length of time.

 

[traineeinvestor]

YIKES. 100% Bonds! Wow. No thanks.

+1

100% of anything is a bad idea (IMHO). I have no idea what the future will hold, especially over a very long retirement period, and would prefer to be diversified accross at least two asset classes. Not only does this provide some diversification but also opportunities to rebalance from time to time.

That said, if I had to come down one way or the other, I would take stocks over bonds in today's market.

 

[samclem]

Look at this chart of inflation adjusted returns on S&P 500. Clearly there were 20 year periods that showed a loss- page down a bit and look at 1965-1985.

Ha

S&P 500: Total and Inflation-Adjusted Historical Returns

Okay, here is the chart. I don't see any 20 year periods that show an inflation-adjusted loss when dividends are reinvested (the orange line).

1965-1985: $7-$8 grew to over $9
For the graphology impaired: Where's the 20 year window with a real loss? Of course, we're dealing with a thin line on a chart, but on the face of it I can't see that Siegel is "lying".

 

[haha]

Okay, here is the chart. I don't see any 20 year periods that show an inflation-adjusted loss when dividends are reinvested (the orange line).

1965-1985: $7-$8 grew to over $9
For the graphology impaired: Where's the 20 year window with a real loss? Of course, we're dealing with a thin line on a chart, but on the face of it I can't see that Siegel is "lying".

I assumed that we were dealing with retirees, in which case dividends after being netted out against taxes and investment costs, would be spent.

I believe it would also be a very close call, after tax and investment expenses, even if remaining amounts were reinvested. During many of these years, capital gains taxes were high, and low cost tax managed vehicles did not exist. Also, most peoiple that had any money to invest held it taxable accounts in 1965, so the sheltering that is available today was not then.

Ha

 

[brewer12345]

No it isn't. Loss due to earning less than inflation is not the same as loss due to selling at a price less than paid. They are significantly different.

Bullcrap. There is no other way to put it except bluntly. If you live in an inflation-free world, well, mazletov! The rest of us do not. Bonds take a beating when inflation and rates rise and it doesn't matter if you sell or hold (except at least the seller caps his pain). Anything else is nothing but a temporarily comforting illusion. Don't go there or drag others with you.

 

[NW-Bound]

I assumed that we were dealing with retirees, in which case dividends after being netted out against taxes and investment costs, would be spent.

I believe it would also be a very close call, after tax and investment expenses, even if remaining amounts were reinvested. During many of these years, capital gains taxes were high, and low cost tax managed vehicles did not exist. Also, most peoiple that had any money to invest held it taxable accounts in 1965, so the sheltering that is available today was not then.

Ha

Good point about taxes. From 1962 to 1982, the gain after inflation was minuscule, and most likely was negative after taxes on dividends, even if one did not spend any and reinvested it all.

 

[samclem]

I assumed that we were dealing with retirees, in which case dividends after being netted out against taxes and investment costs, would be spent.

I believe it would also be a very close call, after tax and investment expenses, even if remaining amounts were reinvested. During many of these years, capital gains taxes were high, and low cost tax managed vehicles did not exist. Also, most peoiple that had any money to invest held it taxable accounts in 1965, so the sheltering that is available today was not then.

Seigel didn't say retirees, and he didn't say anything about tax rates. What tax rate would we assume: 50%? Some people do (and did), pay zero percent. And certainly dividends should be included, they are part of the total return. The quote from Siegel isn't "stock prices have never declined over a 20 year period."

Seigel's point is accurate: In the US there has not been a 20 year period when investors lost money with a broad investment in common stocks.

 

[Original Wally]

Bullcrap. There is no other way to put it except bluntly. If you live in an inflation-free world, well, mazletov! The rest of us do not. Bonds take a beating when inflation and rates rise and it doesn't matter if you sell or hold (except at least the seller caps his pain). Anything else is nothing but a temporarily comforting illusion. Don't go there or drag others with you.

First, you have absolutely no reason to be so rude. That is inexcusable. Second, you are flat wrong. If you truly cannot see the difference between growth at even 1% and the loss of principle then the bullcrap is in your world.

 

[audreyh1]

For some perspective on the dangers of bonds versus the dangers of stocks - stocks can drop even more in a given year:

from PRAGMATIC CAPITALISM Stock and Bond Drawdowns - Historical Perspective

There is really no place to hide. You just have to hope that most years at least some of your asset classes do well, and in years where most asset classes do poorly - well, you hope at least it doesn't last too long.

 

[imoldernu]

I think the correct term for this is Asset Price Inflation.

Today's article:
There's a Feeling of Instability Bubbling Up - WSJ.com

But it doesn't take much of a leap of imagination to see shadows of a very different decade: as in the early Noughties, the dominant dynamic in the markets today is a desperate search for yield that is fueling potential asset bubbles across global markets. Just as the U.S. Federal Reserve loosened monetary policy in the aftermath of the dotcom crash, central banks have been again flooding the world with easy money to try to pull the global economy out of its current malaise. And as in the past decade, there is evidence that all this liquidity is leading to asset-price inflation even as consumer-price inflation remains low, with concerns about bubbles in assets as varied as Swiss, Canadian and London real estate, emerging-market equities and the European corporate-credit market.

Think Tulips.