The Bond Buyer's Dilemma - B Malkiel

[tightasadrum]

I am 100% equities.

What do you expect inflation to be over the next ten years? It is currently running at 3.5%. The 10-year Treasury is currently yielding 2%. So if nothing changes, each year you hold that Treasury you will lose about 1.5% of your purchasing power.

If you expect inflation to be zero over the next ten years, you will make a real return of 2% a year. The only way you can expect your rate of return to be better than that is if you expect there to be long term deflation. Long term deflation is a tough thing to have when the government can print money to correct it.

If inflation picks up, the people holding long-term bonds are going to have losses that are similiar to the losses people holding stocks had in the recent decline, ie 30-40% losses. Taking that risk for an upside of 2%/year seems foolish.

At least when you gamble by buying stocks today, there is a reasonable chance that you won't lose purchasing power by buying them. I don't see much chance of that with bonds at current prices.

If I was 25 years younger, I would be 100% equities too. Or, if I had enough cash to carry me through to my end, then put the rest in long-term growth for DD. Every situation is different. You might look back and see this as the greatest bargain in investing you ever saw and marvel at your investment wisdom. I hope so.

 

[Hamlet]

Yes, the current environment would be an unpleasant one to face if I was very near retirement.

The Fed has set things up so that the low-risk choices are likely to have negative real returns. So a retiree gets to choose between the slow erosion of their buying power in cash/CD's/bonds, or the roller coaster that stocks provide.

If I was 25 years younger, I would be 100% equities too. Or, if I had enough cash to carry me through to my end, then put the rest in long-term growth for DD. Every situation is different. You might look back and see this as the greatest bargain in investing you ever saw and marvel at your investment wisdom. I hope so.

 

[jebmke]

Yes, the current environment would be an unpleasant one to face if I was very near retirement.

The Fed has set things up so that the low-risk choices are likely to have negative real returns. So a retiree gets to choose between the slow erosion of their buying power in cash/CD's/bonds, or the roller coaster that stocks provide.

Yes, that is the dilemma. Could be a long slog before things turn around. Probably still have another 15-20% of housing value to shed before anything happens upside. I made a high stakes move to small cap in the 80s that paid off so I don't need to take the risk now.

Otherwise, I'd be more inclined to take more of a risk in equity at this stage. My big fear is Europe. They can figure it out eventually but my experience from living over there is that they take their time working out solutions that everyone can live with. If the sand runs out on the clock before they come up with a solution then we are cooked. Austerity will not cut it. It will take them a while to figure that out but they will get there eventually.

If I were just starting out, I'd be almost all-in. This feels a lot like the late 70s (minus the inflation, plus the over-valued housing).

 

[Mulligan]

Yes, that is the dilemma. Could be a long slog before things turn around. Probably still have another 15-20% of housing value to shed before anything happens upside. I made a high stakes move to small cap in the 80s that paid off so I don't need to take the risk now.

Otherwise, I'd be more inclined to take more of a risk in equity at this stage. My big fear is Europe. They can figure it out eventually but my experience from living over there is that they take their time working out solutions that everyone can live with. If the sand runs out on the clock before they come up with a solution then we are cooked. Austerity will not cut it. It will take them a while to figure that out but they will get there eventually.

If I were just starting out, I'd be almost all-in. This feels a lot like the late 70s (minus the inflation, plus the over-valued housing).

If it was the late 70's again, I sure would know what to do now. I was reading on Bogleheads this week if you would have put a little over 13k in the 30 year bond back then it would have been worth a million dollars when you cashed it a couple of years ago. Woulda, coulda, shoulda....but didnt

 

[clifp]

We all realize your [-]gamble[/-] suggestion might pay off, but show us your data to support less risk with dividend stocks vs treasuries...I can't find anything to support your hypothesis in the long run. In the end, all you're suggesting is increasing the equity position in your asset allocation, that's not a substitute for the purpose of bonds. I assume you're 100% equities?

Try making a FIRECalc run at 100% treasuries vs 100% Equities see which has the higher success rate. Even with only 3% withdraw rate 100% treasuries have a 87.4% success rate vs 100% success rate of a 100% equity.

The efficient frontier is near 75-80% equities historically, in this environmentI am not sure why the bond portfolio would be any higher.

 

[jayc]

Random thoughts. I live off of the taxable CD ladder and do my trading in the IRA accounts. Theory is keep the net worth growing by increasing the tax deferred accounts on the back end. I do not buy and hold the dividend stocks. When my goal is reached, (Div + options +- stock price), then I bail and do not go back into the market. Each 30K is one mule. In this up/down market I send the mule out once each year to earn 7-8%. At the end of the year all mules should be in their stalls waiting to go out for the next year. So far 6 of 7 mules are in the stall and the average for all 7 is a little above my goal.

I do not buy into the theory that stocks are a hedge against inflation. It is only an investment if you take your profits and I consider a loss to be just a bad place to park your stash vs doing nothing.

 

[tightasadrum]

Random thoughts. I live off of the taxable CD ladder and do my trading in the IRA accounts. Theory is keep the net worth growing by increasing the tax deferred accounts on the back end. I do not buy and hold the dividend stocks. When my goal is reached, (Div + options +- stock price), then I bail and do not go back into the market. Each 30K is one mule. In this up/down market I send the mule out once each year to earn 7-8%. At the end of the year all mules should be in their stalls waiting to go out for the next year. So far 6 of 7 mules are in the stall and the average for all 7 is a little above my goal.

I do not buy into the theory that stocks are a hedge against inflation. It is only an investment if you take your profits and I consider a loss to be just a bad place to park your stash vs doing nothing.

Are you buying options with all of your mules? Do you use fundamental analysis or technical analysis to guide your buy decisions, or both? How many hours per week do you spend herding your mules?

 

[Chuckanut]

If it was the late 70's again, I sure would know what to do now. I was reading on Bogleheads this week if you would have put a little over 13k in the 30 year bond back then it would have been worth a million dollars when you cashed it a couple of years ago. Woulda, coulda, shoulda....but didnt

A few years ago I read an article about he legendary John Templeton. I remembed thinking "if my dad had just put a thousand dollars in the Templeton fund in my name when I was 6, I would be a multi-millionair today, without ever having to save a dime of my salary."

Of course, back then that was asking a lot from dear old dad!

 

[Chuckanut]

I have to come down on the side of stocks whether its for gains or dividends, though I certainly would not have 100% invested in them.

My fear is inflation. The Fed is holding interest rates so very low I am already losing purchasing power on the money I keep to meet expenses if the market is doing poorly. Given the profligate spending at the Federal level, the only way to 'fix' the problem may be to inflate the currency and pay back lenders with very cheap dollars. I hope I am wrong.

FireCalc is as good a tool as I have seen to balance the various factors together - inflation, stock risk, interest rate risk - and come out with a scenario that gives me a fighting chance. Of course, I will continue to monitor things as long as I have the capacity to do so. After that - 50% total market index, 50% total bond index, and go to autopilot!!

 

[jayc]

Are you buying options with all of your mules? Do you use fundamental analysis or technical analysis to guide your buy decisions, or both? How many hours per week do you spend herding your mules?

Sell covered options. Only bought/sold options once, HPQ. Good return but time and risk not worth it to me.

Buy utilities (not always) with low PE and earning to cover dividend. Usually buy right after x-div date or when a really bad day in the market. So it would be both.

Example below with AEE. Still working on strategy. In this case the stock was above strike price and they captured my dividend because x-div date was 12/5/11. (Those others guys on wall st are pretty sharp about that) Also in hindsight the stock went so far above strike price that I would have been better off to not sell options and just unload the stock when I reached my goal. But that is the chance you take with the process.

I have also considered buying the options back to close my position on the big dips but have yet to try that. My initial plan was to repeat the process again and try to get another 6.8% in 6 months but the huge market drops in the last few months changed my mind.

Spend about 2 hours week. None when all mules are out working. Some past/present mules: duk,t,ppl,fe,mo,brkb,aep,cinf*,afg*
* I have had contracts at these places and feel comfortable with their business model.

5/23/11 Buy 800 @ 29.61
6/30/11 Div 308.00
7/1/11 Sell option @30 224.00 expired
9/30/11 Div 308.00
9/7/11 Sell option @30 784.00 called 12/3/11
12/3/11 stock gain 312.00
1624/23688 = 6.8% approx 6 months.

 

[Hamlet]

Doesn't this strategy give you all of the downside risk of stocks while capping your upside?

Granted, you get higher current income, but in a serious downturn you lose almost as much as you would have just owning the stocks normally, and if the market moves strongly to the upside you miss out on it.

Sell covered options. Only bought/sold options once, HPQ. Good return but time and risk not worth it to me.

Buy utilities (not always) with low PE and earning to cover dividend. Usually buy right after x-div date or when a really bad day in the market. So it would be both.

Example below with AEE. Still working on strategy. In this case the stock was above strike price and they captured my dividend because x-div date was 12/5/11. (Those others guys on wall st are pretty sharp about that) Also in hindsight the stock went so far above strike price that I would have been better off to not sell options and just unload the stock when I reached my goal. But that is the chance you take with the process.

I have also considered buying the options back to close my position on the big dips but have yet to try that. My initial plan was to repeat the process again and try to get another 6.8% in 6 months but the huge market drops in the last few months changed my mind.

Spend about 2 hours week. None when all mules are out working. Some past/present mules: duk,t,ppl,fe,mo,brkb,aep,cinf*,afg*
* I have had contracts at these places and feel comfortable with their business model.

5/23/11 Buy 800 @ 29.61
6/30/11 Div 308.00
7/1/11 Sell option @30 224.00 expired
9/30/11 Div 308.00
9/7/11 Sell option @30 784.00 called 12/3/11
12/3/11 stock gain 312.00
1624/23688 = 6.8% approx 6 months.

 

[frank]

can anyone tell me if you owned wesselelly admiral for 10 years, price was 50. a share in 2002 and price now is 55.13, what would be your percentage of growth be and how much would you have gained in dividends ? I guess what I am asking is what your profit would have been over 10 years.

 

[REWahoo]

Frank, here are the total annual returns for Wellesley Admiral going back 10 years including dividends. The share price does not reflect the funds quarterly dividend.

YTD 2011 +7.8%
2010 +10.7%
2009 +16.0%
2008 -9.8%
2007 +5.6%
2006 +11.3%
2005 +5.0%
2004 +7.6%
2003 +9.7%
2002 +4.6%

 

[MichaelB]

Yahoo finance will give you the daily pricing and dividend history as well, and you can download this into a spreadsheet. VWIAX Historical Prices | VANGUARD WELLESLEY INCOME FD AD Stock - Yahoo! Finance

 

[tightasadrum]

Sell covered options. Only bought/sold options once, HPQ. Good return but time and risk not worth it to me.

Buy utilities (not always) with low PE and earning to cover dividend. Usually buy right after x-div date or when a really bad day in the market. So it would be both.

Example below with AEE. Still working on strategy. In this case the stock was above strike price and they captured my dividend because x-div date was 12/5/11. (Those others guys on wall st are pretty sharp about that) Also in hindsight the stock went so far above strike price that I would have been better off to not sell options and just unload the stock when I reached my goal. But that is the chance you take with the process.

I have also considered buying the options back to close my position on the big dips but have yet to try that. My initial plan was to repeat the process again and try to get another 6.8% in 6 months but the huge market drops in the last few months changed my mind.

Spend about 2 hours week. None when all mules are out working. Some past/present mules: duk,t,ppl,fe,mo,brkb,aep,cinf*,afg*
* I have had contracts at these places and feel comfortable with their business model.

5/23/11 Buy 800 @ 29.61
6/30/11 Div 308.00
7/1/11 Sell option @30 224.00 expired
9/30/11 Div 308.00
9/7/11 Sell option @30 784.00 called 12/3/11
12/3/11 stock gain 312.00
1624/23688 = 6.8% approx 6 months.

You mean, you mean ... You time the market?
I'm trying to figure out options trading. And I agree that the amount of time to do option trading may be more than I'm willing to invest. Thanks for a look at your method...Tight

 

[REWahoo]

I guess what I am asking is what your profit would have been over 10 years.

If my calculations are accurate, I come up with a profit of $8,955 on a $10,000 investment.

 

[jayc]

Doesn't this strategy give you all of the downside risk of stocks

I think this downside risk applies to anybody that owns stocks individually, MF, and/or ETF. Since it is a common denominator and a fact of life with the beast, that is a given for everyone. Capping your gains on the upside happens if the option is called. No problem because I met my goal.

If it expires then I have extra $ and my upside is back to the same as anybody else that owns that stock. I trade my limitless upside potential for a few months in return for capped gains and increased return.

I would not do this if interest rates were greater than my SWR and for me this is less risk than a bond fund.

 

[jebmke]

Try making a FIRECalc run at 100% treasuries vs 100% Equities see which has the higher success rate. Even with only 3% withdraw rate 100% treasuries have a 87.4% success rate vs 100% success rate of a 100% equity.

The efficient frontier is near 75-80% equities historically, in this environmentI am not sure why the bond portfolio would be any higher.

One of the problems I have with 80/20 in a retirement scenario is that a severe market drop (say 75%) requires you to liquidate 60% of your bond holdings to rebalance (if I did my math right). If you don't do that you aren't really 80/20.

I agree though, if you need a higher withdrawal rate like 3-4% you probably need a good weighting of equity unless you are old.

 

[clifp]

One of the problems I have with 80/20 in a retirement scenario is that a severe market drop (say 75%) requires you to liquidate 60% of your bond holdings to rebalance (if I did my math right). If you don't do that you aren't really 80/20.

I agree though, if you need a higher withdrawal rate like 3-4% you probably need a good weighting of equity unless you are old.

Well 75% is pretty much unprecedented in a year. Here are the starting balances for a 1 Million portfolio with 80% Total stock and Total Bond funds from 2008 (-37% loss) through 2011. It would have required you to sell 1/3 of the bond fund to rebalance in 2009.

2008 2009 2010 2011

800 571.4 707.7 814.7

200 142.9 176.9 203.7

So by and large an 80/20 AA is back to 2008 levels. Obviously a higher bond allocation would result in more money. Furthermore if you were withdrawing money at 4% plus adjusting for inflation, a 30 year retirement looks dicey. However, if you retired in 2003 or 2004 the 80/20 AA looks pretty good. Plus we have FireCalc to go back and look at the historical data.

 

[jebmke]

Well 75% is pretty much unprecedented in a year.

Don't disagree. I'm thinking more about the Japan scenario. Highly unlikely but not impossible. As I said, I don't take the risk because I don't need to. Upside potential doesn't help me much -- it will all go to charity when spouse and I buy the farm so no reason to make the bet.

 

[Hamlet]

I was talking with my dad last night, and he told me that he had shifted dramatically towards equities, for essentially the same reasons that I've espoused here. He's 57.

I have to admit I puckered up a little at the thought of him being mostly in equities. I had a hard time arguing against the same logic that I had been advocating here though

His thinking is actually more extreme than mine, since he feels that the official inflation stats understate inflation dramatically (let's skip that debate here though. We can just use the search function)

On the plus side, both he and my stepmother will have substantial pensions, so they'll be ok even if the market crashes again.

Yes, that is the dilemma. Could be a long slog before things turn around. Probably still have another 15-20% of housing value to shed before anything happens upside. I made a high stakes move to small cap in the 80s that paid off so I don't need to take the risk now.

Otherwise, I'd be more inclined to take more of a risk in equity at this stage. My big fear is Europe. They can figure it out eventually but my experience from living over there is that they take their time working out solutions that everyone can live with. If the sand runs out on the clock before they come up with a solution then we are cooked. Austerity will not cut it. It will take them a while to figure that out but they will get there eventually.

If I were just starting out, I'd be almost all-in. This feels a lot like the late 70s (minus the inflation, plus the over-valued housing).