Firecalc and Bond holdings

[Ready]

I know that seeing 100% success rate in Firecalc gives a certain confidence level that we will not deplete our savings if we stick with the budgetary number we enter. I continue to question the current bond market though, and whether Firecalc may be misleading us into a level of confidence that may not be warranted.

Looking at bond rates over the past 86 years or so, it appears they have never been as low as they are now. For a good number of years, they have been above 8%. While we have no way of predicting where they will go over the next thirty or forty years, how concerned should we be that they are at historical lows now, with no reason to believe they will return to higher levels any time soon. Thinking about the sequence of returns, if the next five to ten years have below average returns, and 50% of my portfolio is in bonds, is Firecalc being overly optimistic?

Vanguard has a web page that shows the historical average of different asset allocations. They show 100% stocks returning 10%, while 50/50 returning 8.3%. Clearly with bonds being in the 1-3% range, this would not seem practical to expect.

Am I over analyzing this, or does the almost zero return rate on bonds cause Firecalc to be overly optimistic for a 30 year time period?

 

[brewer12345]

I think that what really matters is real returns from various asset classes rather than nominal. Remember that firecalc includes really nasty historical environments that may well be more stressfaul than what we have been through. I bet the 1966 retiree's bond returns were very negative despite nominal rates being higher than they are now.

 

[Ready]

So if bonds are in the 2-3% range, and inflation is about the same, the current real rate of return is about zero. Isn't that still well below the historical average?

 

[REWahoo]

Yes, but FIRECalc doesn't use averages, it runs your withdrawal plan through actual annual historical data, including "bad" bond periods like brewer mentioned.

Take the time to read this introduction to FIRECalc, paying close attention to the "How about describing FIRECalc step by step?"section: FIRECalc: Why another retirement calculator?

 

[brewer12345]

So if bonds are in the 2-3% range, and inflation is about the same, the current real rate of return is about zero. Isn't that still well below the historical average?

Remember, we don't really care about the historical average when stress testing portfolio survival. We care about the worst scenarios in history. If you look back, that was the unlucky bugger who retired in 1966 into the face of a prolonged period of negative real returns.

 

[Ready]

I think maybe I'm asking the wrong question. I'm focusing more on how the sequence of returns, specifically as it relates to bond performance, may affect someone who is retiring today and trying to make their portfolio last for 40+ years.

From what I can find on the internet, the long term (1926-current) real return after inflation on bonds has been 2.6%. I don't doubt that perhaps 5 or 10 years from now we may return to those figures, but if during the first 10 years of a 40 year cycle bonds return closer to 0% after inflation, how might that affect someone looking to retire today? Vanguard states that a 60/40 allocation should yield 8.7%, but that is based on the long term nominal bond rate being 5.5% (or real rate of about 2.5%).

Perhaps my question is not specifically about Firecalc, but just in general, trying to forecast the likely long term average return of a 60/40 portfolio with retirement beginning soon and bonds being at such historical lows. What is the more conservative approach to estimating the yield on such a portfolio given current bond rates? Ultimately I'm trying to decide if keeping 40% in bonds with rates being so low is a good idea right now, which is really the genesis of my original question.

Thanks for all your feedback so far. Sorry if I'm not asking the questions clearly. I'm still new to this forum.

 

[brewer12345]

Frankly, we have never been in an interest rate environmnet like this, so it is really hard to guess what a 60/40 portfolio or bonds in isolation will do going forward. I personally do not like the risk associated with bonds here, so I have chosen to diversify a bit. I have some traditional bond fund holdings (agg index, tips fund, etc.), but at least half of my fixed income exposure is made up of CDs, I bonds, savings accounts, and cash - all things which will not be exposed to market value losses if rates start to spike. I have also put some of what would otherwise be bond exposure into merger arbitrage funds. Finally, I have elected ot to aggressively pay off my mortgage and have gone with a 30 year fixed rate loan for the first time in my life.

Of course, we should expect that a spike in rates would not just affect bonds - equities will likely go through gyrations as well. Real tough to guess how that will all play out.