Why even invest in equities

[InvestorNewb]

Hello,

If Bogleheads are content with 6-9% annual returns over long periods, are there not safer means to achieve this than investing in equities?

I started looking at the various funds on Vanguard's web site, and there are several bond funds with a risk level of 3 with average annual returns of 9% or more since inception. Mind you - these funds have only been around since 2007-2009, but at least they come with peace of mind knowing they won't drop by 30% or more in one day.

I especially don't like how it can take years for an international fund to recover. In 2008 international was hit really hard, and here we are 5 years later and it is still down.

Would it be a bad strategy to go "all in" to a single bond fund?

[Johm221122]

At current interest rates it is unlikely that 6%+ is going to come from bond funds.Most of that gain is from interest rates dropping.If you can save a boat load of your income and inflation does not worry you it may be an option, but if you only save a moderate amount your portfolio will not grow with bonds
John

[Beat The Street]

To understand those returns you see you must understand how bonds/bond funds work. There has been a significant appreciation in the net asset value of bond funds the last 10+ years due to a falling interest rate environment. When interest rates go down, bond prices go up and vice versa. Now we sit at interest rates near zero so all of the capital appreciation of bond funds is probably close to being over and the best way to judge the future performance would be by the funds yield to maturity. We have been experiencing an exceptionally great period for bonds, almost like what the 90's was for stocks. You should not expect the returns from these bond funds to continue to do so well, especially if interest rates go up you could see some negative nominal returns in the near future.

I doubt there has ever been a vanguard stock fund that fell 30% or more in a day, actually I know there hasn't been. Worst case scenario, you see a drop of 30%+ in a full year, but never in a day. And who cares? The expected return from stocks will be higher than bonds because they carry more risk, but there are periods where bonds do better and periods where stocks do better, in the long run stocks will probably greatly outperform bonds. You shouldn't look at these funds in isolation but rather on how they fit into your portfolio. I don't know anything about you so I can't tell you if you should put all your eggs in one bond fund, but I can't think of many situations where that is a good idea. I'd say the expected returns on bond funds going forward is less than 3% per year.

[NYBoglehead]

First, it depends on your age. If you are 80 I would suggest it doesn't matter if you are 100% in bonds.

That said, there is no such thing as a "safe" way to get 6-9% returns.

First, you need to understand why bonds have done so well. As interest rates drop, bond prices (and the NAVs of bond funds) rise. We have come down from double digit interest rates in the early 80s to ~1.5% rates today. A corresponding rise in NAV/price have provided a nice TOTAL RETURN for bond fund investors.

With interest rates as low as they are, you are:
1) Not really earning enough interest to cover annual inflation
2) Vulnerable to a drop in NAV when interest rates recover

While bonds should play a role in any portfolio, to not invest in equities is a big mistake in my opinion. You want to have ownership of profit-generating business enterprises (through low-cost index funds).

[Taylor Larimore]

Newb:

Would it be a bad strategy to go "all in" to a single bond fund?

A single bond fund violates this bedrock of investing: Diversification.

Best wishes and Happy Holiday!
Taylor

[Call_Me_Op]

Hello,

If Bogleheads are content with 6-9% annual returns over long periods, are there not safer means to achieve this than investing in equities?

Would it be a bad strategy to go "all in" to a single bond fund?

Very bad strategy for a young person. You are making the (rather monumental) mistake of looking at results from the greatest bond bubble in US history, and extrapolating the results forward.

[DaleMaley]

If you look at long time periods, like 20, 30, or even 100 years......you find that you will lose money after inflation and taxes investing in a bank savings account (assuming that future returns will look like past returns since historic returns is all we have to work with).

Ok, a bank savings account won't let me grow my wealth, so how about 100% bonds. If you check the very long term returns, you will find you will be lucky just to break-even after inflation and taxes are figured in. The time period from 1980 until 2010 was unusual in that bond returns went up because of lower interest rates. Since interest rates probably won't go below the current zero level, probably won't have a lot of future high bond returns.

Ok, 100% bonds did not let me grow my wealth over time either. How about 100% stocks. The good news about stocks is their historic average return of about 10%. The bad news is any given years return can be between -50% and +70% (assuming normally distributed annual returns with one sigma of 20%). The reason stocks have a higher return is they are riskier. About every 8 years we have a Bear market decline of at least 20%.

The periodic Bear market returns drive people to panic and sell low. They have also tended to only buy when prices are high.

Ok, bank accounts and bonds won't let me grow my wealth. Stocks might let me grow my wealth over time, but I might panic and sell out at the wrong time. What strategy is left?

Well, use a mix of stock and bond investments. The bonds dampen out the big swings so you don't panic and sell at the wrong time. Gradually lower your risk level as you age because when you are older, you don't have enough time to recover from a very bad market.

[baw703916]

A lot of the return of bond funds has been due to interest rates dropping from double digits some 30 years ago to essentially zero today. They can't go much lower from here, so trust me: the return of bonds in the next 30 years is going to be much, much lower than it was in the previous 30. That's not market timing, it's just a mathematical fact (the best estimate of the future return of a bond fund with good credit quality is the current yield).

[Call_Me_Op]

Dale,

Nice post.

[BBL]

If you want to invest in the rear-view mirror and try to buy past returns, well, by all means - it's your money.

Do you really think you're on to something that all of the experienced experts here have failed to unearth?

Edit to add:

Maybe I've been relieved of my senses yet again but I thought you were going the 3 fund route, no?

viewtopic.php?f=10&t=88005&newpost=1559754

It's Taylor-approved!

[sschullo]

Hello,



I especially don't like how it can take years for an international fund to recover. In 2008 international was hit really hard, and here we are 5 years later and it is still down.

The NASDAQ is still down after hitting its all time high back in 2000.
I have been rebalancing some of the bonds IN the international fund BECAUSE it is still down. I stay away from the NASDAQ because its too narrow and not one of the major asset classes. I have the NASDAQ equities in the total stock market index.
20 something investors should wish that the market crashes and stays down for years. All of those stocks will be sooooo cheap. Buffett loves cheap stocks.
2 cents

[maddyken]

I think 100% bonds is under-diversified too, although if you were intent upon such a portfolio you might consider multisector and strategic income funds. A healthy dose of alternative classes would also be wise.

I share your concern over stock volatility and whenever this comes up I always mention the following: To equally distribute the volatility from stocks with that from bonds you need 3 to 4 times as much allocated to bonds as is allocated to stocks...25% stocks and 75% bonds. If the stock allocation contains a lot of riskier stocks than 20% stocks and 80% bonds might be more appropriate. This is straightforward risk parity.

Clawing your way back from big losses is tough.

[NYBoglehead]

We shouldn't delude ourselves into thinking bonds are 100% safe. There is huge interest rate risk in the current low yield environment and returns going forward are unlikely to beat inflation.

[maddyken]

After years of investing and my own research I've come to the conclusion the rule-of-thumb recommending large stock allocations for young investors is just the opposite of what I would do if I had the chance to do it all over again.

The long horizon translates to assuming less risk, not more.

If one likes the challenge of recovering from big setbacks then be my guest, but the volatility has consequences for the return needed to meet the retirement requirement.

We've all seen long term efficient frontiers. The take-away should not have been to allocate heavily to stocks, the take-away should have been a highly diversified portfolio which delivers about the same return (if not more) at half (or less) the SD.

[maddyken]

I don't like reaching into the past for comparisons, the past is the past.

But as a result of some simplistic research I did a year ago...

Between 73 and 82 Wellesley just missed keeping pace with inflation, Wellington didn't fare so well. Recall, Wellesley runs about 33/67 (stocks/bonds) and Wellington runs about 67/33.

73 and 74 witnessed rate increases, with inflation following and peaking at about 13% later in the period.

The rate increases impacted Wellesley no doubt, Wellesley experiencing negative returns in 73 and 74, but the losses were hardly horrific. Sorry, I don't know the impact of the rate increases on Wellington.

FYI, commodities were solid over much of the period with REITs coming on strong during the second half of the period. IOW, alternative classes were crucial in beating inflation over the period.

[Clearly_Irrational]

If Bogleheads are content with 6-9% annual returns over long periods, are there not safer means to achieve this than investing in equities?

In short, no. Rental real estate or small business ownership are your other viable options but they both come with their own sets of risks.

My personal objective is 8% real return, that may not sound very ambitious but it's actually quite difficult to create a portfolio with that level of return that has any sort of consistency over a variety of different economic climates. It's certainly not possible with just bonds.

[DSInvestor]

I especially don't like how it can take years for an international fund to recover. In 2008 international was hit really hard, and here we are 5 years later and it is still down.

If you had an investment plan that specified an asset allocation of US/INTL stocks and bonds, your plan would have told you to direct all new money to US and INTL stocks in 2008 and 2009. You would have bought low and ridden stocks up from March 2009 to now.

See Growth of 10K chart of Total Stock Market (VTSMX), Total International (VGTSX), Total Bond (VBMFX):


If you weren't adding money, your asset allocation plan would have told you to sell bonds to buy stocks to rebalance the portfolio. This would have meant selling your TBM/BND which gained 5.5% in 2008 to buy stocks which were very low.

As stocks recovered, your stock AA would have risen above target. At this time, your investment plan would have told you to stop buying stocks or even sell some stocks to buy bonds which are now below target.

[Default User BR]

I started looking at the various funds on Vanguard's web site, and there are several bond funds with a risk level of 3 with average annual returns of 9% or more since inception.

You need to do a lot more research and find out how bond funds work, including WHY funds that have been around 5 years or so show those kind of returns, and how likely it is that you can count on that continuing. Find out about yield versus share-value changes and how much of the total return was due to each. Compare to investments like CDs and savings bonds. Why don't those return 9%?


Brian

[crowd79]

How old is the OP?? If he/she is terrified of losing their investment over the long haul, and has many years (30 years or more away) until retirement, I would recommend the OP max out yearly on $10k ($20k couples) EE Bond purchases for at least the next 10 years up until at least 10-20 years before he/she retires. If they can hold onto their EE Bonds for 20 years a-piece, then it's a guaranteed 3.6% return. Sadly, that is about as high as a guaranteed safe return you can get on any investment nowadays.

However, I agree with what everyone else has said. There is no way to get a guaranteed 6-9% return and just invest it in a balanced stock and bond portfolio, and forget about it! The longer until retirement, the more you want to be in stock funds.

[NYBoglehead]

People need to understand the difference between nominal and real return.

Yeah, 3.6% for EE bonds. You are essentially guaranteeing that you get no more than a 1% real return and it will only take a few years of higher than average inflation to make to turn your real return negative.

[bberris]

Hello,

.....

Would it be a bad strategy to go "all in" to a single bond fund?

Just pick the single bond fund that will have the best performance in the future. Or perhaps the single equity fund that will have the best performance in the future.

[maddyken]

If I had to invest under such a limitation I'd pick one of the multi-sector or strategic income funds, they're largely global TAA bond funds.

[grabiner]

I started looking at the various funds on Vanguard's web site, and there are several bond funds with a risk level of 3 with average annual returns of 9% or more since inception. Mind you - these funds have only been around since 2007-2009, but at least they come with peace of mind knowing they won't drop by 30% or more in one day.

To get some idea of the risk and return prospects of a mutual fund, you need to look at the performance of similar funds over a longer time period. The bond ETFs which were created in 2009 don't have performance data before that date, but the bond market itself does.

For example, consider Intermediate-Term Corporate ETF, which has earned 9.95% since inception (11/19/09-11/30/12). Now look at Intermediate-Term Investment-Grade, which has been around for 19 years. If you graph the two funds on the same chart from the same date, their performance is almost identical; Intermediate-Term Investment-Grade isn't an index but stays fairly close to the index. And Intermediate-Term Investment-Grade lost 13% in two months (9/8/08-10/31/08), at the worst part of the bear market.

Either one would be a fine fund for the bond portion of your portfolio, but the longer-term prospects show that the return of over 9% is an anomaly. Intermediate-Term Corporate ETF currently reports a 2.54% SEC yield, which means that if the bonds were held to maturity, you would earn only 2.54% after expenses; the return may be higher if interest rates fall, or lower if they rise.

[nedsaid]

What funds yield 6 percent now? Probably only junk bond funds.

Keep in mind that a lot of the return you are seeing is the capital gains from the drop of interest rates. Ask yourself, how much more can they drop from here? Rates have been falling since the early 1980's. How long is this trend going to continue?

[illcrx]

You pose an interesting point about the stock market, it does take a long time to recover from significant losses. International or domestic, today were only getting back to the levels of 2008 and were still not quite there yet.

The best way I think is to actively manage your portifolio, before the market tanks you need to get into a low risk mutual fund. Then when the markets bottom you need to get back into risky funds.

Bonds are just a way to get little return on your money, over the long term the US market is the place to be. Period.

[grabiner]

You pose an interesting point about the stock market, it does take a long time to recover from significant losses. International or domestic, today were only getting back to the levels of 2008 and were still not quite there yet.

The best way I think is to actively manage your portifolio, before the market tanks you need to get into a low risk mutual fund. Then when the markets bottom you need to get back into risky funds.

You'll find that this doesn't work, because the market isn't just for you, and everyone else knows the same thing. If you expect a stock to be worth $40 next year, based on the same information that institutional investors such as pension funds and endowments have, then they also expect it to be worth $40. And they can act on it; if someone is willing to buy at $50, they can sell stock until all the buyers at $50, and $45, and even $41, are gone, driving the price down to the correct $40 (or actually $38 given normal stock returns.)
And even the experts can't do it; institutional investors lost money along with everyone else in the 2007-2009 crash.

The key is to understand the risk, and only take the risk that you are prepared to take. If you are going to retire in five years, you don't want to take the risk of having all that money in the stock market; you would want to mix stocks and bonds. Vanguard Target Retirement 2015 is currently 55% stock and will decrease in the future, and it gained 2.89% annually over the last five years. Conversely, if you are planning to retire in 2040, you don't care what your retirement portfolio is worth in 2017, only what it is worth in 2040 and later, so you can take the risk that there will be five-year periods in which the market loses a lot, and five-year periods in which the market more than doubles; you might use a fund like Vanguard Target Retirement 2040 which is 90% stock and is just about even with its 2007 peak.

[Johm221122]

You pose an interesting point about the stock market, it does take a long time to recover from significant losses. International or domestic, today were only getting back to the levels of 2008 and were still not quite there yet.

The best way I think is to actively manage your portifolio, before the market tanks you need to get into a low risk mutual fund. Then when the markets bottom you need to get back into risky funds.

Bonds are just a way to get little return on your money, over the long term the US market is the place to be. Period.

When market bottoms and you buy risky funds,how do you determine when to sell risky assets?
John

[HomerJ]

The best way I think is to actively manage your portifolio, before the market tanks you need to get into a low risk mutual fund. Then when the markets bottom you need to get back into risky funds.

Heh, what's a low-risk mutual fund? And how do you tell when a market hits bottom?

[HomerJ]

it does take a long time to recover from significant losses. International or domestic, today were only getting back to the levels of 2008 and were still not quite there yet.

Also, FYI... remember to include dividends, not just the price of an index.. Including dividends, we're above 2008 levels.... The few dollars I invested in 2008 are higher today.... The dollars I invested in 2009, 2010, 2011 (Oh, and 2007,2006,2005, etc.) are all much higher than the day I bought them.

[Default User BR]

The best way I think is to actively manage your portifolio, before the market tanks you need to get into a low risk mutual fund. Then when the markets bottom you need to get back into risky funds.

It's so simple! All you need to know is when the market is about to tank, and when it's done tanking.


Brian

[zaboomafoozarg]

It's so simple! All you need to know is when the market is about to tank, and when it's done tanking.

Brilliant! Nobel prize for you sir.

[BolderBoy]

After years of investing and my own research I've come to the conclusion the rule-of-thumb recommending large stock allocations for young investors is just the opposite of what I would do if I had the chance to do it all over again.

The long horizon translates to assuming less risk, not more.

My knee-jerk reaction to this was, at first, "Guffaw." But then I remembered that the long term difference between a 60/40 and 40/60 asset allocation is less than 2%. Don't remember where I read that, but was impressed by it.