Why does anyone invest in bonds long term?

[Fedup]

More confusing to the average investor. So it even confirms that it's not a good idea to be 100% in stocks. What about 40% stocks and 60% bonds? What's the chart going to be like?

 

[UnrealizedPotential]

I invest in bonds for two reasons. One reason is because I need the income bonds can provide. Second reason is because bonds reduce volatility.

 

[UnrealizedPotential]

there is a difference between losing 50% of your porfolio vs it fluctuating by 50%.

in fact odds are pretty good someone 100% in equities for a long time who falls 50% would still be a head of much more conservative portfolio's .

it really is a mental thing instead of a financial thing .

True. But the question I would ask is how many investors will stay the course and not panic and sell after a 50% market drop?

 

[Fedup]

Exactly. It's easier said then done.

 

[2017ish]

True. But the question I would ask is how many investors will stay the course and not panic and sell after a 50% market drop?

I know my answer for that in accumulation phase. But, will I have the same mindset in decumulation mode? Another reason why I am comfy with some non-equity as we near the transition....

 

[audreyh1]

I believe the portfolio survival charts show that 20% bonds supports a higher withdrawal rate than 100% stocks, and that 30 to 40% stocks supports a higher withdrawal rate than 100% bonds.

So yes, at least a small exposure to bonds helps long term portfolio survival.

Maybe someone has the graph handy.

 

[UnrealizedPotential]

I know my answer for that in accumulation phase. But, will I have the same mindset in decumulation mode? Another reason why I am comfy with some non-equity as we near the transition....

Yes, if you are not sure , that is a perfect reason to spread some risk around. I own about 70 % bonds and 30% stocks. It wasn't really that way by design. It was more of what I needed in bonds to get the income I needed. Anything I didn't need in bonds went in stocks. I would like to get my stock allocation up to 35%. I think I can slowly do that over time without any pain.

 

[GravitySucks]

While I was working, I never invested in bonds (long term or at all). I was fine with the large ups and downs of a pure equity portfolio and felt it would provide better returns. In preparation for retirement, I moved some money into bonds to avoid having to sell equities at a large loss during a market downturn. So yes, I now have bonds longer term.

+1

 

[RobLJ]

As a gedanken experiment on the function of bonds (and to underline previous responses on how bonds and income help smooth a portfolio and help sticking to an allocation, particularly in downdrafts),
yesterday the S&P went down 1.78%. I recently bought a zerocoupon Treasury bond fund that matures in 2025 (so, roughly an intermediate bond), as insurance against a market downturn. It went up .91% yesterday.
I plan to add to it further in strong market upswings, if they occur.

Like many who have posted, I had less than 10% in bonds while accumulating, until '06 when I changed allocation given the looming of my 50s in the near distance and my concern about housing/bank stability.

It is both a question of surviving severe market downturns, keeping to your allocation in a severe downturn, and making it easier to harvest income for yearly withdrawals (SWR).

Everyone's reality differs and also whether their nads are made of steel in >20% market slumps. While I was accumulating I didn't pay a lot of attention to market corrections, save in '08/09. When you're in the withdrawal stage, the pyschology can be different (or not).

(I would also add that while I generally agree with your suspicion of bonds longterm, the current valuation of the S&P also doesn't bode well for longterm--well, over the next 10 years--returns for the S&P. This is one reason why I am 1/3 of stock allocation in international stock, which had done badly vs. the S&P the last 5 years, but well this year, so far. So far.)

Very interesting replies, thanks all. I guess I'm being introduced to a new type of risk that decreasing volatility helps protect against: irrationality risk. I imagine I would be wise to acknowledge that I am not and will not forever be a perfectly rational entity. Also, the less slack in one's withdrawal rate, the more bonds might seem particularly attractive.

exnavynuke:

I'm not sure I agree with this assessment based on the numbers you provide. An additional 2.4% may not sound like much, but compounded over multiple decades is pretty huge in my book. A quick run in ******** (I think I'm running it right, though I don't usually run constant growth simulations) shows an average ending balance of 6.52mil vs 2.16 mil on 1 mil pot withdrawing 40k a year over 30 years. A difference of 4.3 million, around 300%, yes that's definitely huge in my book.

OldShooter: wow that pdf looks like a real trove thanks for sharing. Not actually sure if you were presenting that chart on page 64 as evidence for against my argument but I think it only goes to show my point. Yes the track for the mixed allocation portfolios dips less, but at the end of 10 years the S&P has caught up with and surpassed the mixed asset portfolios. Also one must note that this 10 year period starts right before the great recession. So we are looking at a sample here starting at the worst possible time for equities in recent memory, and the 100/0 portfolio still wins after 10 years. So long term, this confirms what I was thinking. Assuming JP Morgan puts out this analysis every year, then the 2019 version of this chart will have the 100/0 portfolio absolutely beating the pants off the mixed allocation portfolios.

Yikes that bar chart is scary though, boy I hope I don't turn out to be an average investor.

 

[RetiredAt55.5]

Bonds helpful for automatic 401K periodic withdrawals

I retired last year at 55 and counted on the Rule of 55 for funding my first couple of years of retirement. I had "parked" a fair amount of money in my 401K in a money market account and thought I would use that "bucket" of money, and leave the other stock positions within my 401K alone.

I was shocked when I went to set up periodic withdrawals that my 401K, and evidently many others, are very limited as to withdrawal options. I.e., unlike an IRA, I could not select which position to withdraw from -- my only option is that it will withdraw the money proportionately from all my positions within the 401K. Well, that really sucks as I could be drawing down the stock positions in my 401K in a down market. Further, being married, making any changes to the periodic withdrawals requires notarized paperwork and 30+ days lead time.

Plus, I couldn't roll the 401K into IRA accounts to facilitate more withdrawal flexibility, since I would then hit the early IRA withdrawal penalties (pre 59.5 rule).

So my solution was to move most of my stock positions out of my 401K into other retirement accounts, and most of my bond positions into the 401K. I also kept the bonds to mostly short term duration.

I feel more comfortable with the automatic withdrawals now given that bonds will be less volatile.

Funny thing is I worked for Vanguard and their 401K plan is this restricted.

 

[Ted_Shepherd]

Why hold bonds? Short answer: For me, the allocation to bonds is zero, as it has been for the 26 years of my retirement. My accounts with financial institutions hold about 5% in cash. Longer answer: Some of my assets don't show up at my brokerage, bank, or other financial institutions, yet throw off spendable income or, what's equivalent, reduce my cost of living. I have monthly income from social security and a meager corporate pension. I own outright two homes, one in the West and in the East. The fair rental value of owner-occupied houses counts as part of Gross National Product. (Reference: https://www.bea.gov/faq/?faq_id=488). I consider that value as income on fixed assets since ownership gives my the usefulness of residence without fixed monthly mortgage payments. Adding up the pension, social security, and rental values gives me an annual sum of, say, X. (I'm vague to protect privacy and maybe ward off baseless charges of bragging.) With long-term treasures paying about 2%, the total holding in bonds I would need to generate X per year is 50 times x. That comes to millions of dollars. Further, I don't need bonds because my small pension and social security benefits are enough to support a modest standard of living with no mortgage. YMMV

 

[mathjak107]

I believe the portfolio survival charts show that 20% bonds supports a higher withdrawal rate than 100% stocks, and that 30 to 40% stocks supports a higher withdrawal rate than 100% bonds.

So yes, at least a small exposure to bonds helps long term portfolio survival.

Maybe someone has the graph handy.

here is the chart .

longer retirement time frames did better at higher draws with 100% stock .

 

[mathjak107]

Why hold bonds? Short answer: For me, the allocation to bonds is zero, as it has been for the 26 years of my retirement. My accounts with financial institutions hold about 5% in cash. Longer answer: Some of my assets don't show up at my brokerage, bank, or other financial institutions, yet throw off spendable income or, what's equivalent, reduce my cost of living. I have monthly income from social security and a meager corporate pension. I own outright two homes, one in the West and in the East. The fair rental value of owner-occupied houses counts as part of Gross National Product. (Reference: https://www.bea.gov/faq/?faq_id=488). I consider that value as income on fixed assets since ownership gives my the usefulness of residence without fixed monthly mortgage payments. Adding up the pension, social security, and rental values gives me an annual sum of, say, X. (I'm vague to protect privacy and maybe ward off baseless charges of bragging.) With long-term treasures paying about 2%, the total holding in bonds I would need to generate X per year is 50 times x. That comes to millions of dollars. Further, I don't need bonds because my small pension and social security benefits are enough to support a modest standard of living with no mortgage. YMMV

bonds are used when you want to hedge against short term drops but for long term money there is little logic to using them .


for long term money hedging against temporary short term drops while permanently hurting long term gains has no logic to it .

it is only when we need to match money to the short term that bonds add value .

which is why i like to run 3 separate portfolio's . money i wont need to eat with for decades is still long term money and 100% equity .


money for eating today , tomorrow and the long term are treated very differently in my structure

 

[audreyh1]

here is the chart .

longer retirement time frames did better at higher draws with 100% stock .

The graph I'm thinking of shows an upside down U shaped curve that shows the max safe withdrawal rates to be between about 45% equities and 75-80% equities for the 30 year scenario, thus illustrating that both the 100% stock case and the 100% bond case were suboptimal in terms of portfolio survival.

Your chart illustrates that for the 4% withdrawal rate, 75% stocks outperforms 100% stocks for all the durations in terms of survival, so you have to be careful how you interpret the data. Who plans on pushing it with 5%+ withdrawal rates for 30 years or more (which increases your chances of running out of money to 25% or worse) and thus choosing 100% stocks? Not to mention living with/ignoring the volatility!

 

[mathjak107]

what is missing from the statistics of the chart is the interplay with the statistics of life expectancy .

most of us will not see 30 years in retirement so that boosts success rate since less years will statistically be needed so higher draw rates are really still safe when you play with statistics and success rates . a 90% success rate can become 97% when life expectancy is considered .

 

[mrWinter]

Lsbcal: Yes you did satisfy my original request of finding a scenario of a static AA on a > 10 year time scale that lead to better performance with bond allocation, so thank you much for sharing. I'm curious to see the rest of those time tables, how many years out is the break even point where 100/0 catches up? Picking 1929 as the starting point is definitely cherry picking the worst possible dataset, but it does prove your point, it could happen, touche. Am I willing to roll the dice that a crash the likes of 1929 doesn't happen the year I retire, we'll see I guess.

 

[mrWinter]

Thanks much to all the replies so far, this has been interesting. I originally started this thread inquiring about performance of static AA portfolios. Many people have inevitably brought up various strategies of market timing. At the risk of derailing my original premise a bit I'd like to inquire further about a plan many seem to be suggesting, a bond bucket to ride out bears (I like that name ) :

But once you are drawing, you need (IMO) enough cash and fixed income assets to ride out a bad market time without having to sell. See page 4 of the JP Morgan slide deck that I linked. A retiree having to sell equities in '03-04 or '09-10 would have suffered greatly compared to one who had cash and bonds to live off of for a few years. This despite the fact that he/she might have seen themselves as having the goal of "building assets" with the the equities.

Personally, I think the "bucket" approach is much more sensible than talking ratios. As retirees, we need a bucket of cash sufficient to ride out a few years of bad times. Everything else can be in equities if that is our taste. The bucket might be 10% of the total portfolio or it might be 80%. That doesn't matter. It's having the bucket that matters.

This seems to make good sense, but I also question it. Let me clarify the scenario as I understand it just so we are all talking about the same thing.

Let's say my annual withdrawal amount (let's assume it's static) is X. I want to create a bond bucket of 5X that I keep at all times. I draw all my expenses from this bucket, and every year on January 1 I replenish the bucket. That is, unless on January 1 I see that the equity market has taken a nose dive, and I determine it's a bad time to sell equities. In that case I simply don't replenish the bucket that year, but I keep withdrawing until the market has rebounded. I can only do this for 5 years (in this scenario as I chose a bucket of size 5X) then my bucket is empty and I'm forced to pull from equities.

This could come in handy, for example in 2009, on January 1st I look at the market and shudder, and decide not to replenish my bucket that year. I continue until January 2013 at which point I replenish 4 years from equities. It's good that I didn't have to sell 4X equities low between 2009 and 2013. But... in order to have that bucket ready to use in the first place, that means I already sold 5X from the get go, and that 5X didn't get to enjoy the ride up from all the way back in 2004 until 2009. This could very well make it a wash, if not worse. And of course I'm looking back with hindsight to pick the best possible times to make these decisions, who knows if you'd guess as well in the future. Other scenarios would look even worse. If I use the tech bubble as an example, the run up from the previous crash is so much longer it could only be worse. Is the constant sacrifice of growth worth the potential benefit of not having to sell low for a few years?

I'm wondering if we have any backtesting data/tools to support the idea that this performs better, or not, or worse. This kind of logic appears to be beyond firecalc. Does anyone have any spreadsheets or simulations they can run that help lend support or not this idea (granting that backtesting doesn't predict the future)? I'd be interested to see what multiples of X produce the best results, 5X, 10X, or 0X perhaps.

 

[MrFlish]

I know my answer for that in accumulation phase. But, will I have the same mindset in decumulation mode? Another reason why I am comfy with some non-equity as we near the transition....

+1 Exactly...it depends on which side of the fence you're standing on. Stop working live off your investment portfolio only and see how conservative you get.

 

[MrFlish]

+1

+1

 

[RunningBum]

what is missing from the statistics of the chart is the interplay with the statistics of life expectancy .

most of us will not see 30 years in retirement so that boosts success rate since less years will statistically be needed so higher draw rates are really still safe when you play with statistics and success rates . a 90% success rate can become 97% when life expectancy is considered .

I think there is a major flaw in that logic, and I see it a lot on this board.

No one here would, by choice, go with a plan with a 50% chance of success. It's too risky.

Yet you want to base your plan on life expectancy, which you have a 50% chance of exceeding. So your 97% success rate you quote only works 50% of the time. You've got a lower success rate for the other 50%. It makes no sense to me to plan on all but the very worst cases with the market, but only for average life span rather than a nearly "worst" case scenario of living long.

Personally I'd like to have a plan with a 95% or better success rate, and I'm only willing to risk about the most extreme 5% of old age cases. According to this calculator at VG https://personal.vanguard.com/us/insights/retirement/plan-for-a-long-retirement-tool, at 55 I've got a 5% chance of making it to 95, which would be a 46 year retirement for me. I'm sure when I retired at 49 that 5% age was a bit less, but it's still >40 years. (Edit: I plugged in age 49 in the tool, and it gave me 5% for 46 more years.) That's what I'm planning for, not the average life expectancy.

I know someone is going to read this and scoff at me for thinking I'll live to 95, but that's not at all what I'm saying. I'm planning in case I live to 95. Again, planning for worst case, not average case.

 

[audreyh1]

I know my answer for that in accumulation phase. But, will I have the same mindset in decumulation mode? Another reason why I am comfy with some non-equity as we near the transition....

I was almost 100% stocks in accumulation phase, and very concentrated in company stock. It was only when I decided we had enough to retire that I gradually changed over to a broadly diversified portfolio with a significant fixed income component - 40 to 45%.

 

[audreyh1]

what is missing from the statistics of the chart is the interplay with the statistics of life expectancy .

most of us will not see 30 years in retirement so that boosts success rate since less years will statistically be needed so higher draw rates are really still safe when you play with statistics and success rates . a 90% success rate can become 97% when life expectancy is considered .

Still doesn't mean that 100% stocks gives a better survival outcome than 80%/20%. 20% bonds is the minimum amount I usually see recommended for a retiree.

And your chart shows 50% stocks and 75% stocks out surviving 100% stocks for a 5% draw for both the 25 and 20 year time frames. I doubt most folks would choose a 5% withdrawal rate anyway, because they would drop down to near 80% at 25 years (20% chance of running out of money before 25 years are up).

75% stocks out survives 100% stocks for all time periods at a 4% withdrawal rate. And even 50% stocks out survives 100% stocks for 4% draw for 35 years and shorter, so you really need to be careful what conclusions you draw from the chart.

 

[ERD50]

...
This seems to make good sense, but I also question it. Let me clarify the scenario as I understand it just so we are all talking about the same thing.

Let's say my annual withdrawal amount (let's assume it's static) is X. I want to create a bond bucket of 5X that I keep at all times. I draw all my expenses from this bucket, ....

Here's what people keep missing when they talk about the 'fear of selling stocks in a down market':

A portfolio of stocks and fixed income will likely pay ~ 2.5% in divs. If you have a fairly conservative WR, say 3.5% (and many are more conservative than that), you are getting most of your expenses w/o selling anything (> 70% with this 2.5/3.5 example).

So a bond bucket of 5x your withdraw amount (another way to state this is a 82.5/17.5 AA at a 3.5% WR) would actually take you through ~ 16 years w/o selling any equities.

Further to that, if stocks are down, rebalancing would have you selling bonds to make up that 1% delta, not stocks. With any significant % of AA to bonds, it would be a very long time before you ever had to sell any equities.

-ERD50

 

[ERD50]

Originally Posted by mathjak107 View Post
what is missing from the statistics of the chart is the interplay with the statistics of life expectancy .

most of us will not see 30 years in retirement so that boosts success rate since less years will statistically be needed so higher draw rates are really still safe when you play with statistics and success rates . a 90% success rate can become 97% when life expectancy is considered .

I think there is a major flaw in that logic, and I see it a lot on this board.

No one here would, by choice, go with a plan with a 50% chance of success. It's too risky.

Yet you want to base your plan on life expectancy, which you have a 50% chance of exceeding. So your 97% success rate you quote only works 50% of the time. You've got a lower success rate for the other 50%. It makes no sense to me to plan on all but the very worst cases with the market, but only for average life span rather than a nearly "worst" case scenario of living long.

....

I know someone is going to read this and scoff at me for thinking I'll live to 95, but that's not at all what I'm saying. I'm planning in case I live to 95. Again, planning for worst case, not average case.

+1. It makes no sense to throw that kind of life expectancy number on top of the portfolio success estimate.

That would be like the Apollo astronauts figuring they realistically only had a 50% chance of returning to Earth alive, so therefore there is no need to pack enough air or food or water or electricity for the whole trip!

-ERD50

 

[lwp2017]

This is quite a good slide deck:

https://am.jpmorgan.com/blob-gim/1383280028969/83456/jp-littlebook.pdf

If you look at the graph on page 64 you can see how a diversified portfolio has cushioned the ride over the last ten years. The twenty year comparison bar chart is interesting too, especially the little orange block at the lower right. IMO this result comes primarily from trying to time the market.

Old Shooter this is an excellent guide, thanks for sharing !

I cleared up some personal misconceptions.

Moderator, These types of guides would be helpful if saved in a reference section.