The Bond Buyer's Dilemma - B Malkiel

[jebmke]

Quote:

Originally Posted by Spanky I assume that your equity level is either low or you have other resources to fund your expenses.

Equity level is 40%. Yes, the other resources are in bonds of low duration.

But in any case, I think it is risky to build a retirement plan that depends on equity returns without a backup plan that is sustainable during a protracted period of poor results. The back up plan may range from cutting back lifestyle, going back to work or telling the heirs that there is nothing coming.

I don't try to forecast the outcomes -- I have no idea what will happen. But a long period of continued under performance of equity or even another severe drop with no recovery for years is a possible outcome.

When someone starts thinking of stocks and bonds as being in the same risk class, I cringe. I am reminded of a saying that a colleague of mine used to have "one thing I like about investing in stocks is that the most you can lose is all your money."

[Hamlet]

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.

Quote:

Originally Posted by Midpack 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?

[nun]

Quote:

Originally Posted by DFW_M5 Well if your treasuries (especially longer term ones) see a big uptick in rates the downside will also be great. In this environment, I feel there is a valid case for spreading your bets across different types of dividend paying investments (stocks, bonds, preferreds, CEF) vs staying only in traditional safe havens treasuries that pay close to nothing. Of course if you don't want to monitor closely, such approach may not be to your liking, especially if you are a buy and hold indexer.

Psst, Wellesley (YTD 7.53% return) or Wellington, and a pile of cash

[eytonxav]

Quote:

Originally Posted by nun Psst, Wellesley (YTD 7.53% return) or Wellington, and a pile of cash

Psst, thats my largest individual fund holding (admiral shares of course) aside from my cash position

[haha]

Quote:

Originally Posted by jebmke But in any case, I think it is risky to build a retirement plan that depends on equity returns without a backup plan that is sustainable during a protracted period of poor results.

I am not an advocate for 100% stocks, and even less for cap weighted indexes. I do tend to be pretty heavy in equities most times.

But clearly bonds of any even medium duration are a certain loss if bought and held.

Look back at 2008-2009 and see how many high class companies not only continued their dividends unreduced, but how many kept raising the dividend every year or so. Just don't try this if you are folowing a liquidation for expenses strategies, which I really do not recommend anyway. If you can live on your dividends, it may be that all you need is solid businesses that pay rising dividends, and some emergency money kept in very low duration instruments.

Read JM Keynes remarks on investing during the Great Depression in England and America, in Keynes, Economic Articles and Correspondence, Vol. XII.

Ha

[tightasadrum]

Quote:

Originally Posted by Hamlet 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.

Quote:

Originally Posted by tightasadrum 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]

Quote:

Originally Posted by 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.

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]

Quote:

Originally Posted by jebmke 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]

Quote:

Originally Posted by Midpack 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]

Quote:

Originally Posted by 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.

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]

Quote:

Originally Posted by Mulligan 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]

Quote:

Originally Posted by tightasadrum 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.

Quote:

Originally Posted by jayc 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]

Quote:

Originally Posted by jayc 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