Long investment horizon =/= long-term bonds?

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zombie_lawyer
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Long investment horizon =/= long-term bonds?

Postby zombie_lawyer » Tue Jul 02, 2013 11:05 am

Is there a good reason why someone who has a long investment horizon (i.e. is in their 20s) should not initially invest the bond portion of their portfolio in long-term bond funds? Vanguard's Target Retirement funds for young investors are invested in intermediate term bonds. I'm sure there's a good reason for this, but can anyone explain the rationale?

Thank you.

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CaliJim
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Re: Long investment horizon =/= long-term bonds?

Postby CaliJim » Tue Jul 02, 2013 11:18 am

Liability matching is OK at the first level of approximation - but there are issues. Everywhere and always there is risk.

There are a few sources of risk to consider with long term nominal bonds:
-unexpected inflation (inflation over and above the expected rate of inflation)
-rising interest rates (reinvestment risk)
-current low level of real interest rates


Building a long term TIPS ladder is an alternative and has been discussed. Look for #crunchers post that includes a spreadsheet for how to build such a ladder.
(viewtopic.php?f=10&t=93849&p=1358102&hilit=+ladder#p1358102)

However - real interest rates on LT TIPS are low now. It may be worth waiting a bit - park your LT TIPS funds in high yield CD's and i-bonds, and wait and see if a better opportunity to get into LT TIPS comes up in the next few years.
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nisiprius
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Re: Long investment horizon =/= long-term bonds?

Postby nisiprius » Tue Jul 02, 2013 11:32 am

zombie_lawyer wrote:Is there a good reason why someone who has a long investment horizon (i.e. is in their 20s) should not initially invest the bond portion of their portfolio in long-term bond funds? Vanguard's Target Retirement funds for young investors are invested in intermediate term bonds. I'm sure there's a good reason for this, but can anyone explain the rationale?

Thank you.
I don't know Vanguard's rationale, but I would be very worried about inflation risk.
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Call_Me_Op
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Re: Long investment horizon =/= long-term bonds?

Postby Call_Me_Op » Tue Jul 02, 2013 11:44 am

zombie_lawyer wrote:Is there a good reason why someone who has a long investment horizon (i.e. is in their 20s) should not initially invest the bond portion of their portfolio in long-term bond funds?


Yes, you would be locking in historically low rates for the next 20 or 30 years.
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ogd
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Re: Long investment horizon =/= long-term bonds?

Postby ogd » Tue Jul 02, 2013 11:45 am

zombie_lawyer wrote:Is there a good reason why someone who has a long investment horizon (i.e. is in their 20s) should not initially invest the bond portion of their portfolio in long-term bond funds? Vanguard's Target Retirement funds for young investors are invested in intermediate term bonds. I'm sure there's a good reason for this, but can anyone explain the rationale?

Longer bonds are more volatile. They also yield more, but many believe that the increased volatility is not adequately compensated. Why not? I can speculate that going far enough on the yield curve, the certainty of receiving relatively higher yields for the next 30 years, no matter what happens, begins to acquire positive connotations, so investors demand less yield than pure interest rate risk would suggest. Kind of like some folks are uncomfortable with signing up for mortgage payments every month for the next 30 years through thick and thin, but in reverse.

Anyway, the effect of bond volatility on a far-away Target Retirement fund is low right now, but it will begin to increase as the fund approaches its target and it holds more bonds. I don't think the TR folks want to design its path in such a way that a switch from long to intermediate down the road is necessary.

Larry Swedroe has a good paper on the effects of long bonds as diversifiers for various equity allocations. It's pay to read, but summarized here: https://www.pwlcapital.com/en/Advisor/T ... term-bonds

staythecourse
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Re: Long investment horizon =/= long-term bonds?

Postby staythecourse » Tue Jul 02, 2013 2:02 pm

Take it for what it is worth as I am not a bond expert and hope others will correct me if I am wrong as I would appreciate some insight myself.

Dr. Bernstein in "IAA" discusses the duration of the bond as the point of indifference. That is the point that the re-invested coupons at the higher rate have made up for rising rates.

So if this is true as long as your duration of bonds is LESS then your need for that money you are fine as long as you just reinvest the coupons. The problem of bonds then seems to be if you are using those coupons to live off, i.e. retiree where you DON'T get the advantage of re-investment and are thus exposed to inflation/ interest rate risk.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle


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