Is the next downturn coming soon...?

[RetireeRobert]

Yes, a downturn is coming soon. Fed will get its hands off the stuck interest rates and will let them (maybe nudge them) to rise.

 

[Lsbcal]

Something to crow about: I reduced AA from 70% stocks to 60% stocks at the start of the month.

Something to cry about: That 60% allocation is going down with the market.

Tea leaves: Probably not the bottom but does not look like an oncoming recession to me. I might even rebalance back up to 60% if this goes down further.

 

[Love This Community]

When most of the people on this forum believe that stocks will go up in the long run, why do they have bonds in the portfolio. Wouldn’t it make sense to have cash for emergency purposes and invest everything else in stocks for the long ride?

 

[RetireeRobert]

Fed has a meeting tomorrow (Tuesday). So today stocks dropped 614 points!

Maybe the downturn is here.

 

[target2019]

"Today we have less. Some days there'll be more."
Said the butcher of meats, a little past four.

 

[Markola]

When most of the people on this forum believe that stocks will go up in the long run, why do they have bonds in the portfolio. Wouldn’t it make sense to have cash for emergency purposes and invest everything else in stocks for the long ride?

Personal finance is personal. If you live through a few periods where your portfolio balance drops 30-50%, evaporating all those little spending plans you fantasized about, and while the financial press hits the panic button daily to sell breathless articles about all the reasons stock prices are never coming back, well, unless you are an emotion-free Dr. Spock, you may come to appreciate owning some bonds. In those times, the Fed has cut interest rates and bond prices are rising, making it comforting to own some bonds.

And you also experience long periods, like the first decade of this century, when stock prices are flat, and you don’t know when they will pick up, because nobody knows. Meanwhile, you see bond prices are booming. It was circa 2009 in such a time when I got the idea, “Oh, this is why people own bonds”, and I started a slow migration into owning some by changing to an 80/20 allocation. At that time, some “smart people” in the financial press were explaining how stock prices might fall ANOTHER 50%. I couldn’t take any more and reallocated to some bonds for the first time.

How much in bonds? Well, again, every person is different and it usually boils down to an emotional decision based on how many years of expenses in bonds let one sleep well at night. It’s also different emotionally having a smallish portfolio on paper in one’s 20s-40s when you’re focused on career than a fat one later that you are depending on so that you don’t have to work so hard for The Man or The Woman.

I’ve invested through several recessions since the 90s and, at present in my mid-50s and spending from it in early retirement, we have a 50 stock/50 bond globally-diversified Vanguard index fund portfolio. Emotionally, after experimentation, I like that allocation, because I feel as ready for anything as I can be. Fortunately, the long-term returns between 50/50 and 70/30 allocations are not very different, so that’s a bit of a free lunch.

 

[Love This Community]

Markola….thanks a lot for your wisdom. I truly appreciate it. I guess being the bull market for a decade clouds how much of a drop one can handle emotionally over a long period of time.

Though I am eligible for 2 small pensions which I consider as bonds, it might be wise to have some bonds in after tax account since my funds are not accessible till FRA and I am planning/hoping to retire early.

 

[Lsbcal]

Personal finance is personal. If you live through a few periods where your portfolio balance drops 30-50%, evaporating all those little spending plans you fantasized about, and while the financial press hits the panic button daily to sell breathless articles about all the reasons stock prices are never coming back, well, unless you are an emotion-free Dr. Spock, you may come to appreciate owning some bonds. In those times, the Fed has cut interest rates and bond prices are rising, making it comforting to own some bonds.

...

Well said.

My personal opinion (shared by many pretty good investors) is that we are in a different rate climate after 40 years of rate declines. So one should not expect the boost to the portfolio like in the past 40 years from bonds should we get an extended market decline (recession induced). Still bonds might hold up better then stocks in a recession although the 1970's saw bonds and stocks doing poorly. So I hold bonds but shorter duration and some inflation protected too with decent real rates.

 

[audreyh1]

When most of the people on this forum believe that stocks will go up in the long run, why do they have bonds in the portfolio. Wouldn’t it make sense to have cash for emergency purposes and invest everything else in stocks for the long ride?

Because some people here live off their portfolios and prefer lower annual volatility. How much bigger it is at the end isn’t as important providing you have enough already.

 

[2177V]

When most of the people on this forum believe that stocks will go up in the long run, why do they have bonds in the portfolio. Wouldn’t it make sense to have cash for emergency purposes and invest everything else in stocks for the long ride?

I agree with the mindset of maximizing equities when you are young. To understand why bonds are useful, I need to demonstrate this by some calculations:

Example: $1M 60/40 portfolio is $600K equities/$400K bonds. Equities earn an average of 10% per year while corp bonds makes 7%. This means bonds under perform the equities by 3% which is 3% x $400K = $12K per year. Over 10 years this is $120K of under performance which is enough to buy a C8 Corvette (BTW I am a car guy).

If you have $400K cash instead of corp bonds, this is 10% x $400K or $40K per year or $400K of under performance over 10 years. Thus it pays to maximize your equities and buy some corp bonds to avoid a large under performance cost.

IMO...To do a AA intelligently, here is a chart of bear markets:

I personally like to use 48 months because what happened in the 1930's should not apply now because of federal regulations on the banking industry and the FED intervention. If you have a $1M portfolio and your expenses is $50K per year then you need $200K of liquidity which translate to a 80%/20% portfolio.

As long as you do the math and use objective data, you can make better decisions. Finally, bonds behave differently during a bear market:

As you can see, equities by the blue line drops significantly. No surprise there. But look at the difference between corp bonds (yellow line) and junk bonds (green line) and treasuries (orange line). Treasuries actually rises during a bear market because of the flight to safety.

Here is the problem: Treasures earns little during a bull market and do well during a bear market. Corp bonds and Junk bonds also decline during a bear market but less than equities and recovers faster than equities.

Bottomline: There is no free lunch and it is up to the investor on what type of safety net you want and what you need. I am only suggesting that you should estimate the cost of the safety net during a bull market and also determine if that safety net is good enough for your situation based on objective data and not make a subjective judgement. You should also make sure the objective data is current since I do not know how old these charts are and I am only using these charts and data to illustrate my main points which are: (1) Liquidity is important so be aware of the second chart. (2) Duration of your liquidity or your safety net is important so be aware of the first chart. (3) The cost of liquidity or the cost of being conservative is important so do some calculations to determine your under performance cost of your safety net.

 

[Love This Community]

Thanks Lsbcal and Audreyh1. Appreciate the additional dimensions. I guess I was focusing more on the destination / end rather than less volatile stock bond mix to smoothen the ride.
My take away: As Markola rightly said, the accumulation phase 20-40’s allows one to be a bit more risky but bonds provide peace of mind as the portfolio grows and one reaches a point of withdrawal phase where less volatility is desired.

 

[brett]

How long is a piece of string?

 

[Markola]

Well said.



My personal opinion (shared by many pretty good investors) is that we are in a different rate climate after 40 years of rate declines. So one should not expect the boost to the portfolio like in the past 40 years from bonds should we get an extended market decline (recession induced). Still bonds might hold up better then stocks in a recession although the 1970's saw bonds and stocks doing poorly. So I hold bonds but shorter duration and some inflation protected too with decent real rates.

I agree about 40 year bond rate declines. Heck, there’s a book out saying we’re at 3,000 year interest rate lows or something. I guess the way I mentally address it is three-fold:

1) We are also in an historically-low inflationary period, so bonds and other investments don’t have to work as hard to create real returns.

2) Should inflation spike for longer than an ephemeral period, I trust the Fed will raise rates to cool things down. My bond index fund will eventually reflect those higher rate bonds. The average bond duration in my Vanguard index fund is about 8 years, so the lower yielding ones will be cleaned out in due time, to be replaced by….whatever bond rates the markets and Fed provide over those subsequent 8 years.

3) Our bond portfolio is 1/3 international bond index, so that all of our eggs aren’t subject to domestic markets alone. I know that is controversial among many here, but a) I sleep better with less home country bias, and 2) It’s approximately the allocation that Vanguard gives its target date and Life Strategy funds, so critics would have to persuade me how they are smarter than Vanguard. So far, none have.

 

[Lsbcal]

Here are my 2 cents worth.

I agree about 40 year bond rate declines. Heck, there’s a book out saying we’re at 3,000 year interest rate lows or something. I guess the way I mentally address it is three-fold:

1) We are also in an historically-low inflationary period, so bonds and other investments don’t have to work as hard to create real returns.
As of August we have 12 month inflation running around 4.9%. Who knows if that will continue. The Fed says it will not.

2) Should inflation spike for longer than an ephemeral period, I trust the Fed will raise rates to cool things down. My bond index fund will eventually reflect those higher rate bonds. The average bond duration in my Vanguard index fund is about 8 years, so the lower yielding ones will be cleaned out in due time, to be replaced by….whatever bond rates the markets and Fed provide over those subsequent 8 years.
Probably such higher duration bonds will do OK over the long term. I don't have confidence over the next year or two. But that is me.

3) Our bond portfolio is 1/3 international bond index, so that all of our eggs aren’t subject to domestic markets alone. I know that is controversial among many here, but a) I sleep better with less home country bias, and 2) It’s approximately the allocation that Vanguard gives its target date and Life Strategy funds, so critics would have to persuade me how they are smarter than Vanguard. So far, none have.
I'm not trying to be smarter then VG but I'm just not comfortable with international bonds. It seems that whenever there is a flight to quality it tends to favor US Treasuries.

Just trying to manage my risk by having bonds not too subject to interest rate risks or inflation risk. Will take the risk on the stock side.

But really these are just somewhat fine points. Not saying my way is the right way to think.

 

[GenXguy]

Inflation has always been higher than the government figures for me, year after year. My homeowner's insurance went up 12% this year. Food prices and everything else seems to be going up even faster now, as the government figures show, but at a higher true inflation rate. Yes, it's likely to last for years and will get worse if certain things happen.

 

[Lsbcal]

This was the Fed's projection today for core inflation:

Including food and energy, officials expect inflation to run at 4.2% this year, up from 3.4% in June. The subsequent two years are expected to fall back to 2.2%, little changed from the June outlook.

Sounds pretty reasonable to me.

https://www.cnbc.com/2021/09/22/federal-reserve-holds-interest-rates-steady-says-tapering-of-bond-buying-coming-soon.html

 

[Markola]

^^^^^. Yeah, just noise for the financial press to have something to write about.

 

[NW-Bound]

4.2% inflation?

My wife will see that reflected in her SS deposit. As for me, I get to subtract 4.2% out from the portfolio to get at the real return. Bummer.