Why Hold Bonds?

[LOL!]

I wonder if there is a difference among 100/0, 80/20, 75/25, 60/40 portfolios when one considers lump-sum at the beginning of the time period (i.e. retired, no new income) versus adding new money continuously (i.e. still working, accumulation phase).

Anybody seen any studies? Also, perhaps the accumulation phase should start out with relatively small contributions and have ever large contributions each year -- much like real life (at least my life).

 

[cute fuzzy bunny]

Wasnt it Peter Lynch that said "Gentlemen who prefer bonds don't know what they're missing."? I think in some investment rag in the late 90's he simplified it to "Bonds are for wimps".

That having been said, in every decade stocks have outperformed bonds except for the 1930's.

The problem you get is income stream and volatility. If you have no other potential income streams that can fill in for your spending needs in times of high volatility, you could get in trouble with an all stock portfolio.

Lowering your spending needs and making as much of your spending optional as possible does mitigate this problem substantially. This is one of the often unforeseen aspects of carrying debt in ER. Carry debt and your ability to withstand volatility decreases. Carry a lot of debt and live an expensive lifestyle and you might find that you need a little ballast to improve your ability to take volatility.

A little income also helps reduce the volatility problem. See Bob Clyatts fine book for the details.

Cash is a lousy option for buffering because cash often pays lousy. Just a couple of years ago it was nice to find a 3% CD when inflation was running the same or worse.

Of course, high net worth individuals dont need to swing for the fences and can afford some fairly severe volatility. Treading water is satisfactory to get from here to the end of their lives. Sometimes that creates a bit of confusion when lower net worth people see the higher net worth folks get real excited about an investment that has a comparitively weak return.

Since we've got no debt and a small income stream, we dont have a lot of bonds and they're all in the target retirement funds. Which means that in ten years or so when my wife finally decides to quit working we'll have a bit more of them at about the right time. We keep about a years expenses in cash spread over the best money market and cd options available.

But unless you're over 60, have a huge pile of money, or are exceptionally risk averse...having more than 20-30% of your holdings in bonds may result in leaving some money on the table.

 

[FinanceDude]

I'm more into heavy dividend paying stocks than bonds.........because I like the potential for return in a stock which over the long haul is generally greater than bonds.........

When you're as good an investor as Peter Lynch, you can say "bonds are for wimps"............however I would love to see a debate between Mr Bond (Bill Gross) and "Mr. Equity Peter Lynch.............

 

[cute fuzzy bunny]

Personally I think lynch was more lucky than good and had some good opportunities coupled with a good inflow of cash as a result of his luck. Once magellan grew past a certain point his luck seemed to run out and he got out before it became apparent.

 

[FinanceDude]

Personally I think lynch was more lucky than good and had some good opportunities coupled with a good inflow of cash as a result of his luck. Once magellan grew past a certain point his luck seemed to run out and he got out before it became apparent.

Which is why he is SMART..........he knew he couldn't beat the S&P forever............

Wonder if he still has the AMC Concord 4X4 wagon he used to drive...........

 

[Nords]

however I would love to see a debate between Mr Bond (Bill Gross) and "Mr. Equity Peter Lynch.............

Gross isn't fit to wipe the mud off Lynch's boots. And any debate would have to include Mr. Gross' "interpreter"... the one who used to clarify Greenspan's Congressional testimony.

First question: "Mr. Gross, any updates to your DOW 5000 prediction?"

 

[brewer12345]

You guys have an awfully limited view. Who said you can't make attractive capital gains on bonds just like you can on stocks?

 

[FinanceDude]

You guys have an awfully limited view. Who said you can't make attractive capital gains on bonds just like you can on stocks?

You can............particularly in the high yield arena at times. Anyone who bought some of GM's issues after they dumped is sitting on some nice gains...........

 

[haha]

You can............particularly in the high yield arena at times. Anyone who bought some of GM's issues after they dumped is sitting on some nice gains...........

Including former mega-poster John Galt.

Ha

 

[Running_Man]

The reason for holding bonds is very apparent at market bottoms. In the midst of the upturn right now they look foolish. I do have a friend who took early retirement at 45 with 100% equities under that assumption. Because of the Nasdaq fiasco he lost 66% of his 2.5 million portfolio value in his technology laden holdings. He is now back working and still 100% stocks. My former boss in 2000 invested 50% ownership interest of his money in the stock of a consulting firm booming from Y2K business. Value went to zero by end of '01. He is also 100% stocks to this day, and while he did not go back to work his wife has. If you have these type of temperment then you can and will hold 100% because you inherently believe you will do better over the long run no matter how poorly you are doing.

My brother-in law retired around the same time to Scottsdale and held a 50-50 portfolio and is still retired and wealthier than ever. My father in law has held 70 percent fixed income throughout his retirement and over 20 years tripled his money and now lives in the Hyatt Classic residence with CEO's. Noone I know that enjoys a fixed income percentage of at least 40% has ever wished they held more stocks nor has any of the individuals that held 100% wish they had not, only that they had moved to the better performing stocks. Therefore I think for the most part emotional makeup of the individual is controlling the investment mix and not rational thought.

The major problem for bonds right now is the relatively low interest rates available, certainly I would not want to be in 30 year bonds right now due to the capital risk to the portfolio. But when interest rates are 14% for 30 year treasuries as in the 80's bonds were a very good long-term investment or when you see a major rise in coupon yield and can buy bonds substantially below par then they are a great investment.

 

[brewer12345]

Including former mega-poster John Galt.

Ha

Actaully, I am pretty sure Merica's Most Unwanted man was buying them at par and a bit under, so he is probably still sitting on a big, fat loss.

 

[lswswein]

If you are looking for a Bond Allocation, Short Term is the way to go.

http://www.dfaus.com/strategies/fixed/
Dimensional approaches fixed income primarily as a strategy to maximize overall portfolio benefit. Shorter-term, higher-quality debt instruments tend to have less risk. Dimensional engineers lower-risk bond strategies so investors can temper their total portfolio volatility or take more risk in equities, where expected returns are greater.

In fact, long bonds have volatilities approximately five times that of the one-year Treasury bill.

 

[brewer12345]

In fact, long bonds have volatilities approximately five times that of the one-year Treasury bill.

Irrelevant. I don't care what any asset class looks like in isolation. What does it add or take away from the total portfolio?

 

[lswswein]

Irrelevant. I don't care what any asset class looks like in isolation. What does it add or take away from the total portfolio?

I agree the DFA link also discusses how Long Bonds have higher Correlation to Equity compared to Short Bonds

 

[Nords]

I do have a friend who took early retirement at 45 with 100% equities under that assumption. Because of the Nasdaq fiasco he lost 66% of his 2.5 million portfolio value in his technology laden holdings. He is now back working and still 100% stocks. My former boss in 2000 invested 50% ownership interest of his money in the stock of a consulting firm booming from Y2K business. Value went to zero by end of '01. He is also 100% stocks to this day, and while he did not go back to work his wife has.

I think the investors in these situations confused "tech" and "single stock" with the concept of a diversified equity portfolio. These guys weren't just focused, they were stupid woefully undercompensated for the risks they assumed.

Lack of diversification doesn't mean that 100% stocks is bad and some bonds must be good. The case between a stock/bond split is usually an investor's tolerance for volatility and the ability to sleep at night.

I know that bonds can be profitable, espeically with cap gains, but I also think that it's a lot more difficult for the average retail investor to succeed against the bond market's liquidity, spread, and the experts. There seem to be a lot more neglected opportunities in the stock market, and if I was going to put money into bonds then I'd do it with TreasuryDirect or an index fund.

 

[yakers]

Gross isn't fit to wipe the mud off Lynch's boots. And any debate would have to include Mr. Gross' "interpreter"... the one who used to clarify Greenspan's Congressional testimony.

IMHO Gross is a better investor than Lynch although in significantly different fields. But you have to look at what he does, not what he says. And as a public speaker, yeah, OK, you got that right.

 

[brewer12345]

IMHO Gross is a better investor than Lynch although in significantly different fields. But you have to look at what he does, not what he says. And as a public speaker, yeah, OK, you got that right.

Ignore what Gross says. He likes to "talk his book" as they say in the trade.

 

[magellan_nh]

Ignore what Gross says. He likes to "talk his book" as they say in the trade.

I read gross on the PIMCO website every month and I've often wondered if that was the case. Either way, at least his musings can sometimes be entertaining.

FYI - My only PIMCO holding is PCRIX (commodities)...

Jim

 

[bbuzzard]

The case between a stock/bond split is usually an investor's tolerance for volatility and the ability to sleep at night.

I think this sums things up for me. I very seriously doubt that I will even hold more than 30% bonds. OTOH, I have been wrong before.

I definitely do see than if one is retired with only cash in the bank (no pension) and your withdrawals must stay at some nominal level, say 4%, to preserve a basic living standard, one would be more interested in bonds. Fortunately, this is not the case for myself. That was the whole point of my original post. If you can tolerate the volatility, you do not need as much in bonds.

 

[Gone4Good]

That was the whole point of my original post. If you can tolerate the volatility, you do not need as much in bonds.

People are notorious for over estimating their tolerance for volatility - especially after double digit equity gains. Having a bi-weekly pay check also makes a big difference.

As far as the premise that more equity is always better if you can stomach the volatility - I'm not convinced. FIRECalc shows that a 4% withdrawal from an all equity portfolio survives 92.5% of historic 30 year periods. The same withdrawal from a 70/30 portfolio survived 95.3%. Higher survivability and lower volatility all at the expense of possibly missing a huge payday, which won't likely be realized until the last 10 years of your life, seems like a good deal to me.

 

[rmark]

"Long-term past performance of the total market tells us much about long-term future performance of the total market."

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=476981

Magellean fund was originally a private fund for Fidelity's Johnson family, with 2 failed funds folded into it when it went public. Peter Lynch invested mostly in mid-cap stocks, at least until the fund was too big, and he apparently didn't beat the market when properly measured against that benchmark, after costs and taxes.

 

[haha]

Nasty, nasty- you should not link that paper here. We are optimists, and in the long run, in America, the Optimists always win.

All together now, "In America, the Optimists Always Win!"

Ha

 

[figner]

I'm currently in the 100% stock allocation camp, though also in the process of refining my AA over the next year or so. I'm leaning towards a pretty minimal (maybe 10%) allocation to bonds, just enough to get some of the diversification benefits. Since I still have 10-13 years to go before withdrawals, I figure the worst case scenario just means I work a few more (ok, maybe several more) years. Once I ER, I'll probably consider moving somewhere in the 20-40% bonds range - hopefully I'll be in my 40's, so planning on a long portfolio survival time.

It sounds like at least some here would consider this foolhardy. Maybe I'll post my proposed AA for you kind folks to poke and prod.

 

[Hamlet]

I call bull.

From this link:
http://www.streetauthority.com/peter_lynch.asp

"Lynch secured his reputation as one of the most successful fund managers in history while in charge of the Fidelity Magellan fund between 1977 and 1990. During the 13 years until his retirement in 1990, Magellan was the top-ranked general-equity mutual fund. A $10,000 investment in Magellan in 1977 would have grown to $288,000 by 1990. During this period Lynch achieved and average annual return of 29%."

I'm pretty sure that even with being very tax inefficient, a return of 29% annually is higher than what MidCaps returned during that 13 year period.

I also take issue with saying that he invested mostly in MidCaps. He invested in almost ever equity class available. SmallCap, MidCap, LargeCap, International. Heck, early on one of his largest holdings was 30-year government bonds. That holding did quite well as interest rates plummeted.

"Long-term past performance of the total market tells us much about long-term future performance of the total market."

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=476981

Magellean fund was originally a private fund for Fidelity's Johnson family, with 2 failed funds folded into it when it went public. Peter Lynch invested mostly in mid-cap stocks, at least until the fund was too big, and he apparently didn't beat the market when properly measured against that benchmark, after costs and taxes.

 

[cute fuzzy bunny]

Thing is, you have ten million monkeys flipping coins and one of them will flip 'heads' an awful lot.

The monkey wasnt a genius, he was just a bit lucky.

Out of all the investors in the world, we have a handful that have kept flipping heads. As Lynch's tenure lengthened and his fund grew, his returns reduced. Which has a lot of explanations in terms of bloat and market conditions, but its also what you'd expect from a monkey with a coin...eventually the luck runs out. Towards the end Lynch was "thrash trading" the fund to try to keep up a positive return and burned out.

Bill Miller's another lucky monkey, I think.

By stepping in and running (or at least seriously influencing) some of the companies he's invested in, Buffet's been making his own two-headed coins for a while, so I dont think he counts. I suspect he's less a great investor and more a good business manager that can spot a good value...and has the money to do something about it.