Bond funds? More risk vs stocks, given current Fed policy?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
lkk2161
Posts: 2
Joined: Fri Oct 26, 2012 8:57 am

Bond funds? More risk vs stocks, given current Fed policy?

Post by lkk2161 » Thu Mar 07, 2013 4:40 pm

I'm new to this forum, this is my first post. Please bear with me.

I have always looked at bond funds as a necessary evil, providing some stability but a drag on growth in my portfolio. Prior to retiring, I could usually justify 20%, but only reluctantly. I retired in 2002 at age 60, chose to have my accounts managed after the scare of 2000-2002, but felt concerned that it was a waste of money, and that there must be a better way. It took me ten years to learn that my broker was not my friend. After reading many posts in this forum and much of the recommended reading, I became convinced that passive investing was the answer. So I am working on becoming a
Boglehead. I'm not there yet, but believe me, I am trying real hard.

Recently my wife and I moved our accounts to Vanguard, ditching my managed fees at Fidelity and allocated our assets per the direction of the Flagship Vanguard financial planner. We agreed to 40% total stock, 20% total international, 40% total bond, but I find myself needing to sit on my hands...resisting making any changes, watching our stock portfolio go up and losing money on the bond fund. I keep saying to myself that there is "regression to the mean" but really am apprehensive about extremely low interest rates, current Fed monetary policy, and the greater potential of huge losses. It seems to me that bonds are more risky that stocks right now.

I post this question to the forum. If we have two years in cash for emergency purposes, enough money for our monthly expenses, our required RMD's far exceed our needs, why do we need to consider having 40% in bonds, given the current market conditions? Is the answer..."Don't Worry, Be Happy" and playing in the background?

User avatar
Chan_va
Posts: 762
Joined: Wed Dec 05, 2012 7:15 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Chan_va » Thu Mar 07, 2013 5:17 pm

Hey lk - welcome.

Bonds are NOT more risky than stocks.

But, given your situation, one potential solution to help you sleep better at night.

1. Take the 40% currently in Total Bond, and buy an SPIA. Sounds like that + your other sources of income will more than cover your needs.
2. The remaining 60% is then for your heirs. Invest that as aggressively as you want, but know that historically, having a small bond component actually improves long term expected returns.

User avatar
bottlecap
Posts: 5620
Joined: Tue Mar 06, 2007 11:21 pm
Location: Tennessee

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by bottlecap » Thu Mar 07, 2013 5:20 pm

Bonds will not lose 90% of their value in a short period of time, barring the end of the world. Stocks might. Given that, which poses more risk to you?

Good luck on your effort to become a Boglehead!

JT

retiredjg
Posts: 32956
Joined: Thu Jan 10, 2008 12:56 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by retiredjg » Thu Mar 07, 2013 5:23 pm

Welcome to the forum!

I think your fear is in the wrong place.

The Total Bond Market has a duration of 5.3 years. In theory, if interest rates go up 1%, the value of your bond fund might go down 5.3%, but it will also start paying you higher interest. If interest rates go up another 1%, it all happens again (including the part about paying you higher interest). So just roughly speaking, if interest rates go up 2% (which would probably take several months if not years) less than half your portfolio will suffer a drop of something like 11%. But it will paying you higher interest as well.

Compare that to the probability that your total portfolio value will go down 30% in the next good crash. And if the market recovers, it will probably take 5 or 6 years for that to happen.

Which of these things seems riskier?

If that doesn't not calm your fears, there are several things you can do to help.
  • 1) You could shorten the duration of some or all of your bond allocation. Shorter duration = less drop in value.

    2) You could use CDs instead of bonds for some or all of your bond allocation.

    3) Instead of the individual funds, you could use an all in one fund like a Target Date Fund or a LifeStrategy Fund. This will not reduce the drop in value of your bonds, but you probably won't actually see it.
I think you are overly concerned about bonds - a fear that has been fanned by all the pundits and the media for quite some time. To me, the real risk in your portfolio is having 60% in stocks at the age of 70. Unless you have more money than you'll ever need and are investing for heirs instead of yourself, that is a very aggressive portfolio for your age in my opinion.

lkk2161
Posts: 2
Joined: Fri Oct 26, 2012 8:57 am

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by lkk2161 » Fri Mar 08, 2013 10:32 am

First of all, this post of mine is not because I can't sleep at night. It may have more to do with my aversion to bonds. I have a much better understanding of stock ownership, good companies, etc than I do of the bond market. I understand that bonds are a necessary evil, but I didn't have today what I have by not focusing on achieving growth in my investments. In my investing lifetime, I have experienced the high interest rates of the early 80's, the market crash of 1987, the tech bubble of 2000-2002 and the meltdown of 2007-2009. My stock investments have recovered along the way and are the primary reason I can afford retirement. Holding bond funds had little to do with it other that provide some stability from stock market volatility. Should I wake up someday and read that I have lost 90% of my value, there would be far more problems in this world than my financial situation. I have always felt that when there was blood in the streets of the market, you buy more stock.

What my post is trying to address is current Fed policy of monetizing our debt, printing huge amounts of money, and the extremely low interest rates. Now it can be said that when the Fed starts increasing interest rates, it will cause the stock market to fall too. But who can say what will happen? I feel that there is huge risk in my bond fund position because of near zero prime interest rates.

Now do I need more growth? Probably not. However, I do enjoy watching our money grow. My wife and I live very modestly, have no debt, and probably will leave money to someone. I do see the light regarding passive investing. My reading of William Bernstein and Charles Ellis books have provided new insight to me.

I enjoy reading this forum tremendously. My thanks to all of you that commented on my post and I will carefully process your replies.

bobbobobbo
Posts: 31
Joined: Mon Feb 25, 2013 7:23 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by bobbobobbo » Mon Mar 11, 2013 3:51 am

To the OP, I'd like to hear what you decided with your portfolio? I've had similar notions myself and have done quite a bit of research regarding bond allocation.
I'm 25 years old, currently restructured with a 3 fund portfolio at 20% bonds. My assets came through an inheritance and my father likely had very similar values as you, same age, and left me a portfolio with 0% bonds. I found your posts very intriguing..

Also wouldn't mind hearing wise words from other members. This thread has been a great read for me.

z3r0c00l
Posts: 1097
Joined: Fri Jul 06, 2012 11:43 am
Location: NYC
Contact:

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by z3r0c00l » Mon Mar 11, 2013 6:19 am

Some amount of rising interest rates is quite likely in the near future. But everyone seems fixated on a return to the mean, or even to the 1980s. I want to propose another, very likely outcome (perhaps more likely) and that is a decade of somewhat higher, but generally very low interest rates. How will you feel if the 5 year only goes up 1% during an entire decade? Meanwhile stocks may be extremely volatile, and your bank account is eroded by inflation. There are plenty of likely scenarios where LT bonds continue to do well, earning about 0 or slightly negative real return. Compare that to a bank account that does -2%

User avatar
ddb
Posts: 5509
Joined: Mon Feb 26, 2007 12:37 pm
Location: American Gardens Building, West 81st St.

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by ddb » Mon Mar 11, 2013 6:27 am

Chan_va wrote:...but know that historically, having a small bond component actually improves long term expected returns.
Source?
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB

Call_Me_Op
Posts: 6864
Joined: Mon Sep 07, 2009 2:57 pm
Location: Milky Way

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Call_Me_Op » Mon Mar 11, 2013 6:58 am

ddb wrote:
Chan_va wrote:...but know that historically, having a small bond component actually improves long term expected returns.
Source?
It would have been more correct for him to state that holding some bonds and rebalancing periodically is likely to reduce risk - based upon historical performance. During some periods it has increased returns but not generally.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

rodfatherjr
Posts: 12
Joined: Sun Jan 27, 2013 2:58 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by rodfatherjr » Mon Mar 11, 2013 8:57 am

z3r0c00l wrote:Some amount of rising interest rates is quite likely in the near future. But everyone seems fixated on a return to the mean, or even to the 1980s. I want to propose another, very likely outcome (perhaps more likely) and that is a decade of somewhat higher, but generally very low interest rates. How will you feel if the 5 year only goes up 1% during an entire decade? Meanwhile stocks may be extremely volatile, and your bank account is eroded by inflation. There are plenty of likely scenarios where LT bonds continue to do well, earning about 0 or slightly negative real return. Compare that to a bank account that does -2%
So, you feel that having your money in a more traditional, by Boglehead standards, mix of bonds and stocks that even your scenerio would be "covered"? I am new to this forum and learning a ton! thanks.

DaveS
Posts: 1308
Joined: Fri Jun 15, 2007 9:42 am
Location: Reno, NV

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by DaveS » Mon Mar 11, 2013 10:00 am

ddb wrote:
Chan_va wrote:...but know that historically, having a small bond component actually improves long term expected returns.
Source?
This is in the first two Swedroe books. Also look at Bernstein, Four Pillars of Investing. More accurately the statement should be that over long periods 90/10 to 80/20 does better than 100% equities. The reason is that smoothing out market bottoms with even a small allocation to bonds, is better than 100% equity's volatility. Dave

Nowizard
Posts: 1418
Joined: Tue Oct 23, 2007 5:33 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Nowizard » Mon Mar 11, 2013 10:11 am

Rather than starting a new thread, it appears my question can be answered within this one. We have an overall asset allocation with which we are comfortable regarding stocks/bonds and the diversification within the stock side. The bond side contains Inflation Protected Securities (Admiral), Wellington (Admiral) and Wellesley (Admiral). All are in retirement funds and have no impact on taxation when/if changes are made. The issue is increasing concern over interest rate sensitivity of the Inflation Protected Securities fund which is our largest single holding. We do not want to change the stock/Bond ratio but have considered lowering the amount in Inflation Protected Securities which is our largest, single holding. Moving some to Wellington or Wellesley would increase the stock holdings since they are 65/35 and 39/61 in Stock/Bond ratios. Does it make sense to move some from Inflation Pro. Sec. to Vanguard Short Term Bond Fund (A) which would be done to reduce exposure to interest rate sensitivity within the bond portion of our portfolio? We make very few moves with our portfolio other than with less than .015% of the total that is sometimes invested in stocks to quench the "itch" for what "appear" to be "unusual opportunities."

Tim

User avatar
ddb
Posts: 5509
Joined: Mon Feb 26, 2007 12:37 pm
Location: American Gardens Building, West 81st St.

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by ddb » Mon Mar 11, 2013 10:28 am

DaveS wrote:
ddb wrote:
Chan_va wrote:...but know that historically, having a small bond component actually improves long term expected returns.
Source?
This is in the first two Swedroe books. Also look at Bernstein, Four Pillars of Investing. More accurately the statement should be that over long periods 90/10 to 80/20 does better than 100% equities. The reason is that smoothing out market bottoms with even a small allocation to bonds, is better than 100% equity's volatility. Dave
Hmm, I admit I don't have those books handy, but that doesn't sound correct to me. It has certainly been the case that a 20% stock/80% bond portfolio has had lower risk than a 100% bond portfolio over long periods of time. But I don't think your claim is true. To wit, I've never seen an efficient frontier curve that started sloping downwards on the right side. Doesn't mean I'm right, just that I don't recall seeing this before.
"We have to encourage a return to traditional moral values. Most importantly, we have to promote general social concern, and less materialism in young people." - PB

User avatar
Chan_va
Posts: 762
Joined: Wed Dec 05, 2012 7:15 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Chan_va » Mon Mar 11, 2013 10:31 am

ddb wrote:
DaveS wrote:
ddb wrote:
Chan_va wrote:...but know that historically, having a small bond component actually improves long term expected returns.
Source?
This is in the first two Swedroe books. Also look at Bernstein, Four Pillars of Investing. More accurately the statement should be that over long periods 90/10 to 80/20 does better than 100% equities. The reason is that smoothing out market bottoms with even a small allocation to bonds, is better than 100% equity's volatility. Dave
Hmm, I admit I don't have those books handy, but that doesn't sound correct to me. It has certainly been the case that a 20% stock/80% bond portfolio has had lower risk than a 100% bond portfolio over long periods of time. But I don't think your claim is true. To wit, I've never seen an efficient frontier curve that started sloping downwards on the right side. Doesn't mean I'm right, just that I don't recall seeing this before.
You are correct. My point was more to do with the option to re balance and lower volatility with nearly the same return with a small bond component.

FoolStreet
Posts: 521
Joined: Fri Sep 07, 2012 12:18 am

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by FoolStreet » Mon Mar 11, 2013 11:01 am

Nowizard wrote:Rather than starting a new thread, it appears my question can be answered within this one. We have an overall asset allocation with which we are comfortable regarding stocks/bonds and the diversification within the stock side. The bond side contains Inflation Protected Securities (Admiral), Wellington (Admiral) and Wellesley (Admiral). All are in retirement funds and have no impact on taxation when/if changes are made. The issue is increasing concern over interest rate sensitivity of the Inflation Protected Securities fund which is our largest single holding. We do not want to change the stock/Bond ratio but have considered lowering the amount in Inflation Protected Securities which is our largest, single holding. Moving some to Wellington or Wellesley would increase the stock holdings since they are 65/35 and 39/61 in Stock/Bond ratios. Does it make sense to move some from Inflation Pro. Sec. to Vanguard Short Term Bond Fund (A) which would be done to reduce exposure to interest rate sensitivity within the bond portion of our portfolio? We make very few moves with our portfolio other than with less than .015% of the total that is sometimes invested in stocks to quench the "itch" for what "appear" to be "unusual opportunities."

Tim

Interestingly, I have even heard strategies of going out farther on duration because if things stay flat, you get better yield. If stocks tank, then long bonds should do well as a safety net. If stocks soar, and the bonds get hurt, well, who cares because stocks soared booyah. Well, I have no numerical analysis for you on this strategy but I heard it here on bogleheads and sounds fun if you have the stones. :-)

epilnk
Posts: 2603
Joined: Wed Apr 18, 2007 7:05 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by epilnk » Mon Mar 11, 2013 12:20 pm

FoolStreet wrote:Interestingly, I have even heard strategies of going out farther on duration because if things stay flat, you get better yield. If stocks tank, then long bonds should do well as a safety net. If stocks soar, and the bonds get hurt, well, who cares because stocks soared booyah. Well, I have no numerical analysis for you on this strategy but I heard it here on bogleheads and sounds fun if you have the stones. :-)
Yes, Swenson argues for long treasuries to counterbalance equity risk.

In the summer of 2003 we bought a house with a record low mortgage rate. Pundits and bogleheads were warning that bonds were going to get hammered by rising interest rates, because the only way to go was up. But my concerns about the white hot housing bubble led me to reconsider our bond approach, and after reading Swenson I ended up selling TBM and increasing our weightings to long treasuries. Though not as much as I would had if I'd been entirely able to tune out the noise. Nine years later I'm still waiting for interest rates to rise.

VUSUX average annual performance:
5 year (predates most recent crash): 9.57%
10 year: 7.56%
Since inception (predates the 9/11 attacks): 8.06%

Not exactly what I would call a drag on a portfolio. Which does not mean you should do this now. It's not what I'm doing now (much has changed for us). But the strategy worked well during the volatile 2000s.

bobbobobbo
Posts: 31
Joined: Mon Feb 25, 2013 7:23 pm

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by bobbobobbo » Mon Mar 11, 2013 2:30 pm

Chan_va wrote:
You are correct. My point was more to do with the option to re balance and lower volatility with nearly the same return with a small bond component.
I believe the idea is that you can achieve near identical returns, while certain to reduce volatility. Since we don't really know what the future holds.

Image

Angst
Posts: 1765
Joined: Sat Jun 09, 2007 11:31 am

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Angst » Mon Mar 11, 2013 4:04 pm

lkk2161 wrote:What my post is trying to address is current Fed policy of monetizing our debt, printing huge amounts of money, and the extremely low interest rates. Now it can be said that when the Fed starts increasing interest rates, it will cause the stock market to fall too. But who can say what will happen? I feel that there is huge risk in my bond fund position because of near zero prime interest rates.
Hi lkk,
I don't mean to be harsh at all, so forgive me, but I think many people on this forum would benefit by showing more humility w/respect to what we really know about the current interest rate environment and the future of rates and the effects thereupon of past and future Fed policy. We don't know rates are going up anytime soon and they might stay low for the next 20 or 30 years. (We don't know what equity is going to return in the next 20 years either.) The best predictors of future rates are not our intuitions and gut feelings, nor the last 20 years of history, but are the current rates, and there's little to suggest they're heading higher anytime soon. Japan has been mentioned many times as an object lesson. Furthermore, I don't think this proximity of rates to 0% is really so profound as it's sometimes implied to be; rates can theoretically continue to drop fractionally for years, even indefinitely, and still never arrive at zero. I think it's simply not obvious that rates are going to rise anytime soon or even in the next 20 years. I've found no persuasive arguments that the risk of holding bonds is anywhere close to the risk of holding equity. That's not to say one wouldn't be justified to review their asset allocations given where rates have ended up today, but we still don't know that rates are going anywhere anytime soon. My 2 cents.

Scooter57
Posts: 778
Joined: Thu Jan 24, 2013 9:20 am

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Scooter57 » Mon Mar 11, 2013 5:36 pm

Angst,

None of us knows for sure what rates will do, but we can calculate worst cases. I pick the option with the worst case I am most comfortable with. By avoiding most bond funds I lose a percent or two in yield and some possible appreciation if our economy totally stagnates to a Japanese level-- a condition I believe unlikely because of both cultural and economic factors. Worst case with bond funds, I lose 15-30% of NAV and must wait a decade until interest restores lost principal. (Very worst case is a perfect storm of interest rate risk, credit risk, and fund shareholder panic during which who knows what happens to my money.)

Since this is the only big chunk of money I get for the rest of my life, I prefer the worst case that preserves capital. Mind you I am dealing with money to be newly invested at the current very low rates. If I had bond fund holdings that had been bought when intermediate bond fund interest rates were 6% or more I would be far less concerned as all I'd be losing would be appreciation, not my original investment. That makes a difference.

Angst
Posts: 1765
Joined: Sat Jun 09, 2007 11:31 am

Re: Bond funds? More risk vs stocks, given current Fed poli

Post by Angst » Mon Mar 11, 2013 7:48 pm

Scooter,
I need to remind myself of the different perspectives out there. I still have 15 - 20 years of accumulation to go and expect to be able to maintain a significant portion of my portfiolio in equity when I retire, although I'm not sure I'll choose to do so. Whether I do or don't may depend upon my expectations about how investment options look closer to retirement. It's a work in progress and I'm comfortable now with my ~15% FI being fairly intermediate term and annually adding to my EE/I Bonds "barbell" portfolio at Treas direct. For now though, it seems like we might need another 5 years or more to digest 2008 before we can be more confident about where the US economy and markets and rates really are going, let alone what Europe, China and the rest of the planet are going to do. I appreciate the concerns that anyone who has a large portion of their savings in bonds must have these days. I've thought about how I'd deal with it, and I'm glad I don't have to decide, for now at least. Best of luck to you!

Post Reply