Why should young people invest in bonds at all?

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econ11
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Why should young people invest in bonds at all?

Post by econ11 » Fri Mar 08, 2013 11:18 pm

I am 26 and have just started thinking about investing for the future. I'm a grad student in econ, and was aware (though finance is not my area of expertise), that indexing beats active management once costs are taken into account. Thus, I was attracted to Vanguard and the Boglehead forum.

My question is this: why should someone my age invest in bonds at all?

Some allocation rules of thumb, such as 100-age toward stocks would have me investing 26 percent of my portfolio in bonds. But, I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks.

I plan on working until I am at least 65, so any amount I invest before I turn 35 will have at least 30 years to grow before I would need it. What am I missing? Thanks in advance!

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Re: Why should young people invest in bonds at all?

Post by tainted-meat » Fri Mar 08, 2013 11:56 pm

I think it has to do with risk tolerance and not panicking when the market does down by selling and pulling out of the market.

I'm 26 as well and don't own any bonds. Probably won't for 15 years or so.

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Re: Why should young people invest in bonds at all?

Post by gnosis » Sat Mar 09, 2013 12:12 am

Welcome! Here's a helpful link: http://www.bogleheads.org/forum/viewtopic.php?p=538014

I noticed that the person who started that thread was also 26 years old. What is it with you guys at 26 and bonds questions? :happy
econ11 wrote:... there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks...
Never say never. "Past performance is no guarantee of future results". There's one reason to hold some bonds.
Here's another: How would you feel if you lost a million bucks in a year because you were 100% in the stock market? Eventually, your philosophy with your investments will likely change from "How much can I make" to "How much can I afford to lose."

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Re: Why should young people invest in bonds at all?

Post by TRC » Sat Mar 09, 2013 12:44 am

tainted-meat wrote:I think it has to do with risk tolerance and not panicking when the market does down by selling and pulling out of the market.

I'm 26 as well and don't own any bonds. Probably won't for 15 years or so.
Or until you experience investing during a massive crash like 2008 or 2000.

It's easy to have a bullish strategy during a bull market.

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Re: Why should young people invest in bonds at all?

Post by WendyW » Sat Mar 09, 2013 1:23 am

econ11 wrote:Some allocation rules of thumb, such as 100-age toward stocks...
That rule is from the olden days. 120-age and 130-age are more common now for retirement saving.

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Re: Why should young people invest in bonds at all?

Post by rmelvey » Sat Mar 09, 2013 1:42 am

If you believe that stocks are safer the longer they are held, than bonds make no sense for a young investor(conventional wisdom). However, if you think that risk compounds with time as do rewards (what I think, as well as what the put option market thinks) than holding stocks for a long time is definitely not a sure thing.

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Re: Why should young people invest in bonds at all?

Post by shaboob » Sat Mar 09, 2013 2:26 am

I'm 32 and have had the same thoughts. Here's how I look at it. I have 10% in bonds. I consider it a hedge for a 1 in 10 chance that the market will tank in any one year. If it does, the bonds get sold and I buy up more equity at the bottom as I rebalance. Until that happens, I collect interest. As I get older I should begin to appreciate the reduced volitility that bonds can/will provide, but right now I have to rationalize it right now. This seems to be working for me.

I rode out the 2007 and 2008 markets and didn't make a single fund transfer or trade, so I know my risk tolerance and my ability to maintain discipline, but I still keep 10% in bonds because it seems like prudent conventional wisdom.

Having 10% in bonds right now might not make sense to you, but another benefit I think is that from a behavioral finance point of view, it's easier to increase bond allocation at a rate appropriate with your age if you've already made the leap to convince yourself that you should own some now. The first step is the hardest.
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Re: Why should young people invest in bonds at all?

Post by jimkinny » Sat Mar 09, 2013 6:36 am

Here is an article by Rick Ferri that addresses bonds and age/experience of an investor.

http://www.rickferri.com/blog/strategy/ ... llocation/

I have read that a lower limit of 20% in bonds is generally recommended. I do not know why.

Based on my behavior as a younger investor, I would have done fine at 100% stocks, in that I always assumed that what went down would come back up. Now, I am not so sure of that assumption being true, at least in my lifetime.

I think there is a chance that equities might not recover from a crash or that the recovery might take 20 years or more.

I think the best any of us can do is to follow the advice I first read in one of Larry Swedroe's books: take only the risk that one needs, is willing to take and has the ability to take. If you are saving a lot at a young age, maybe you do not need to take a lot of risk, even though you may be willing and able.

jim

I edited this post to add that there was a difference for me as the amount of my possible losses grew larger, not as a % but as a quantity. For me, the potential to lose 50% of 10K or of 100K or of 500K.......was psychologically different as my portfolio grew.

jim

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Re: Why should young people invest in bonds at all?

Post by richard » Sat Mar 09, 2013 6:45 am

econ11 wrote:I am 26 and have just started thinking about investing for the future. I'm a grad student in econ, and was aware (though finance is not my area of expertise), that indexing beats active management once costs are taken into account. Thus, I was attracted to Vanguard and the Boglehead forum.

My question is this: why should someone my age invest in bonds at all?
For diversification
econ11 wrote:Some allocation rules of thumb, such as 100-age toward stocks would have me investing 26 percent of my portfolio in bonds. But, I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks.
There have been about three independent 30 year periods with more or less reliable data. Maybe four if we push things. What do your statistics courses tell you about using three or four data points? Are you sure conditions are the same in all periods? If not, you have even fewer data points.

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Re: Why should young people invest in bonds at all?

Post by richard » Sat Mar 09, 2013 6:47 am

WendyW wrote:
econ11 wrote:Some allocation rules of thumb, such as 100-age toward stocks...
That rule is from the olden days. 120-age and 130-age are more common now for retirement saving.
100-age was the rule of thumb until stocks boomed and financial advisors noticed they could make more money by pushing people to higher equity allocations.

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Re: Why should young people invest in bonds at all?

Post by crowd79 » Sat Mar 09, 2013 6:48 am

I am slightly risk adverse, however age - 100 is too conservative. I use my own formula: Age - 108 = bonds.

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Re: Why should young people invest in bonds at all?

Post by richard » Sat Mar 09, 2013 6:51 am

jimkinny wrote:I have read that a lower limit of 20% in bonds is generally recommended. I do not know why.
Legendary investor Ben Graham recommended not going beyond 25/75 or 75/25, for diversification and safety.

Some simplistic "efficient frontier" models suggest 20/80 is safer than 0/100
jimkinny wrote:I edited this post to add that there was a difference for me as the amount of my possible losses grew larger, not as a % but as a quantity. For me, the potential to lose 50% of 10K or of 100K or of 500K.......was psychologically different as my portfolio grew.
Risk is mainly an economic issue. There are clearly behavioral issues in investing, but there are many who pretend there are only psychological risks.

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Re: Why should young people invest in bonds at all?

Post by FillorKill » Sat Mar 09, 2013 6:56 am

TRC wrote: It's easy to have a bullish strategy during a bull market.
Yes it is. :D

Can I add that an an econ grad student I assume you [the OP] know that you won't get those attractive arithmetic returns that often prompt excessively high equity allocations? Those really high equity allocations get you a big additional dose of volatility and a fairly small increase in expected returns. From the portfolio efficiency perspective 100% equity is hard for me to understand. However, it's your money. Go crazy. :P

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Re: Why should young people invest in bonds at all?

Post by stevewolfe » Sat Mar 09, 2013 6:59 am

I use maximum tolerable loss X 2 to determine my stock allocation - it's been printed in a number of books and was also Adrian Nenu's line here for a while... works for me. The 100 - age formula was too aggressive an allocation for me in my 20's. If it's not something you can stick with, it's not the right plan. :beer

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Re: Why should young people invest in bonds at all?

Post by econ11 » Sat Mar 09, 2013 7:53 am

rmelvey wrote:If you believe that stocks are safer the longer they are held, than bonds make no sense for a young investor(conventional wisdom). However, if you think that risk compounds with time as do rewards (what I think, as well as what the put option market thinks)...
This is interesting, could you explain what you mean by risk compounding over time? Or provide a link? Thanks!

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Re: Why should young people invest in bonds at all?

Post by econ11 » Sat Mar 09, 2013 8:09 am

richard wrote:There have been about three independent 30 year periods with more or less reliable data. Maybe four if we push things. What do your statistics courses tell you about using three or four data points? Are you sure conditions are the same in all periods? If not, you have even fewer data points.
Point well taken. However, I would push back somewhat. There are many "dependent" overlapping 30 year periods (e.g. 1950-1980, 1951-1981, ...), and "non-independent" is not the same as "no information". Anyway, your point is worth mulling over for awhile.

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Re: Why should young people invest in bonds at all?

Post by Boglenaut » Sat Mar 09, 2013 8:12 am

If I were 26 today, I'd be perfectly comfortable holding 0% bonds. Just make sure you have emergency cash.

I am at 25% bonds, but am much closer to retirement than you. I hold them mainly so if the market crashes I have some money left. It also gives me something to re-balance with if I need to buy stocks low. I don't expect them to go up in value, but I never know.

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Re: Why should young people invest in bonds at all?

Post by econ11 » Sat Mar 09, 2013 8:16 am

prh116 wrote:I have 10% in bonds. I consider it a hedge for a 1 in 10 chance that the market will tank in any one year. If it does, the bonds get sold and I buy up more equity at the bottom as I rebalance. Until that happens, I collect interest.
As a first impression, this is the best reason to diversify into bonds that I have yet heard. Using 10% bonds as a sort of reserve to buy up stock at bargain prices during down markets is something I think I could get on board with. Thanks for the insight!

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Re: Why should young people invest in bonds at all?

Post by InvestorNewb » Sat Mar 09, 2013 8:19 am

I'm 30 and I don't have any bonds either.

I do, however, have some cash on the sidelines that I can use in the event of a market downturn.
My Portfolio: VTI [US], VXUS [Int'l], VNQ [REIT], VCN [Canada] (largest to smallest)

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Re: Why should young people invest in bonds at all?

Post by econ11 » Sat Mar 09, 2013 8:34 am

gnosis wrote:Welcome! Here's a helpful link: http://www.bogleheads.org/forum/viewtopic.php?p=538014

I noticed that the person who started that thread was also 26 years old. What is it with you guys at 26 and bonds questions? :happy
Apparently the person was also in grad school, like me! Thanks for the link--there's a lot of good stuff there. Sorry for posting on the same topic--I promise I searched the forum before posting!

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Re: Why should young people invest in bonds at all?

Post by bungalow10 » Sat Mar 09, 2013 8:36 am

I'm 34, married and the mom of three kids. I have about 28% bonds when our entire portfolio is taken as a whole.

Having been through the dot-com burst (admittedly with nothing invested, but many of my classmates in college lost jobs over it), and then the 2008-2009 burst, I think bonds are a good idea. Seeing as we also view the Roth portion of our portfolio (about 1/3 of it) as emergency funds, I sure do want some of it to be left if we have another catastrophe in the financial markets. They are also good for the re-balancing aspect, and it's hard to have a three-fund portfolio without them (I'm admittedly a Lazy Investor).

If anything, having some bonds might keep you from panicking.
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Re: Why should young people invest in bonds at all?

Post by TRC » Sat Mar 09, 2013 9:02 am

InvestorNewb wrote:I'm 30 and I don't have any bonds either.

I do, however, have some cash on the sidelines that I can use in the event of a market downturn.
This is smart. If I were 100% in stocks, I would do the same. The key is having cash available to invest in down-turns to seize the opportunity when the market goes on sale, and it will go on sale again. Folks who are 100% equities with no large amounts cash on the sidelines available or with no bonds available to re-balance can't seize this buying opportunity.

Though will cash in a high yield savings account produce higher returns than a Total Bond Market Index? Vanguard's Total Bond Market Index returns were 3.02% for 1 year, 5.32% over 3 years, 5.37% over 5 years, 4.90% over 10 years, and 6.68% since inception in 1986.

My view is this: there are people WAY smarter out there than I am when it comes to index fund investing. The consensus they all seem to advocate is having some portion of your portfolio in Bonds. Sometimes it takes living and investing through these downturns to appreciate and understand why this strategy makes sense.

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Re: Why should young people invest in bonds at all?

Post by JMacDonald » Sat Mar 09, 2013 9:43 am

econ11 wrote: I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks.
Maybe in your research you missed this chart: http://www.rdkstrategies.com/sites/defa ... 20year.pdf
According to this chart, 2002, 2008, and 2011, bonds led the market. And bonds did well in 2000 and 2001.
Best Wishes, | Joe

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Re: Why should young people invest in bonds at all?

Post by haban01 » Sat Mar 09, 2013 9:49 am

Good Morning,

First off, Congratulations on starting to save and invest. I've been here since 19 and now fast forward 10 years later, as assets grow, the loss and ability to handle that can change. In your early years, being 80/20 or 90/10 is not a big deal, Now fast forward 10 years and you will hopefully build up a larger portfolio, taking a 40/50 loss is a much bigger deal. Additionally, a Re-balancing Bonus is critical as well! Big Low, Sell HIgh in working towards your Asset Allocation.

Additionally, My job is very economically sensitive so using my bond allocation in very bad times can help take advantage of stocks on sale.

For Most- Non Boglehead types, I would just by a Balanced Fund because most people will do the opposite of what they should be doing!!! I see this with many of my co-workers!
Eric | | "Stay the Course" | "Press on Regardless"

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Re: Why should young people invest in bonds at all?

Post by haban01 » Sat Mar 09, 2013 9:52 am

stevewolfe wrote:I use maximum tolerable loss X 2 to determine my stock allocation - it's been printed in a number of books and was also Adrian Nenu's line here for a while... works for me. The 100 - age formula was too aggressive an allocation for me in my 20's. If it's not something you can stick with, it's not the right plan. :beer

It's hard to argue with a Legend like Adrian! Well spoken!
Eric | | "Stay the Course" | "Press on Regardless"

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Re: Why should young people invest in bonds at all?

Post by gnosis » Sat Mar 09, 2013 9:56 am

econ11 wrote:...Sorry for posting on the same topic--I promise I searched the forum before posting!
That's okay, sometimes we search but the search engine just doesn't give you what you're looking for. I wish our search results could be sorted in order of most replies or views. That would easily give you the better, more informative results up front.

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Re: Why should young people invest in bonds at all?

Post by Harold » Sat Mar 09, 2013 9:58 am

No matter the time period, risk-taking may not be rewarded -- and may actually be punished.

Most people do not need to put all of their assets at risk (and those who feel they do should probably take a look at their current levels of consumption/savings). Hence many prudent people choose not to, no matter what their ages.

There's no fundamental reason why stocks will have higher returns for any given future time period. The underlying premise is that expected stock cash flows are discounted at a higher rate (i.e. the "risk premium") so the higher "risk premium" returns will be realized only if the cash flows are at least as expected. Therein lies the risk, since future stock cash flows are highly variable and can even disappear.

Pricing in active and deep markets (such as the US stock and bond markets) also reflects a risk-adjusted equilibrium. The present value of an X-year investment in bonds is exactly the same as the present value of an X-year investment in stocks -- a consensus assessment of the risk being reflected in the discounting rates.

It comes down to what kind of risk the young person wants to take on -- and is certainly not an obvious choice.

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Re: Why should young people invest in bonds at all?

Post by gnosis » Sat Mar 09, 2013 10:14 am

To me, the most compelling reason to hold no bonds in your portfolio is if you consider your loans as negative bond. Therefore, paying down your debts is equivalent to a guaranteed bond return on your "investment".
Last edited by gnosis on Sat Mar 09, 2013 10:16 am, edited 1 time in total.

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Re: Why should young people invest in bonds at all?

Post by alec » Sat Mar 09, 2013 10:15 am

econ11,

here are some papers/books to read:

What Practitioners Need to Know about Time Diversification - the papers in the reference section of this Vanguard article are good ones to read for an econ person, especially those by Bodie, Samuelson, and Merton.

Paul A. Samuelson, "The Long-Term Case for Equities: and how it can be oversold," Journal of Portfolio Management, Fall 1994, pp. 15-24.

Triumph of the Optimists: 101 Years of Global Investment Returns - your school library probably has this one.

Happy reading
- Alec

edited to add two more:

Global Stock Markets in the Twentieth Century

The Long Term Risks of Global Stock Markets
Last edited by alec on Sat Mar 09, 2013 10:27 am, edited 1 time in total.
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Re: Why should young people invest in bonds at all?

Post by MN Finance » Sat Mar 09, 2013 10:19 am

Couple thoughts, as an aggressive investor myself, though a decade older.

1 - When there's a small amount of money, I agree that it seems easy to take a lot of risk and assume you are risk tolerant. When I had $40k in 100% equity and the dotcom bubble burst, I obviously didn't panic, and of course hoped for the market to reach the lowest possible point as we were starting to save aggressively. When the 08 crash came and the balances were 10 fold the previous, I can tell you that it felt much different (though I really didn't care or give it any thought).

2 - Along the same lines, it's not the risk that occurs at the start, it's the risk that has accumulated 20 yrs later. If you're 100% stock and 20 years from now you're married with kids and a mortgage and you lose your job and the market tanks, your 100% equity position will not feel every comfortable. It's not a black box, where you put money in and open it up 40 yrs later and see what's there. You are seeing it's value all the time which creates emotion.

3 - Rebalancing bonus. Even though I'm aggressive and didn't give either crash in the 00's a second thought, I enjoyed having a bond position which not only did well during the crash, but created a position I could liquidate to move into the market. I didn't time the bottom right, but when the dow was somewhere around 7500, I got pretty excited to take my bond position and plow it into the market. I again hoped for the market to continue it's downturn for a while because I could take advantage. This obviously created a more aggressive portfolio and if the market went all the way down to 3000 I would have been wondering, but you understand the point.

In concept I wouldn't disagree with 100% stock, but find that I'd rather have some small hedge, knowing that the expected return of 100/0 and 90/0 is nearly identical. It's all arbitrary anyway, so there just needs to be a consistent plan

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Re: Why should young people invest in bonds at all?

Post by relentless » Sat Mar 09, 2013 10:25 am

crowd79 wrote:I am slightly risk adverse, however age - 100 is too conservative. I use my own formula: Age - 108 = bonds.
So you are advocating leverage (negative bonds) until you are 108? That is pretty aggressive portfolio. :wink:

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Re: Why should young people invest in bonds at all?

Post by Occupier » Sat Mar 09, 2013 10:39 am

One see's posts like this every time the stock market is on a upward run. I saw em in 1999 and again in about 2007. But my all time favorite title for a post was either in the market crash of 2001 or 2008 it read, "How's That 100% Equity Portfolio Working Out For Ya?"

You invest in bonds because they stabilize a portfolio. 10-20% bonds over long periods of time do better than 100% stocks because portfolio's with them don't crash as hard. That assumes you hold onto everything. The one sure way to lose money is to sell out at a low and miss a recovery. Having an allocation of bonds up to your tolerance for taking losses helps one avoid selling out at a low. Dave

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Re: Why should young people invest in bonds at all?

Post by baw703916 » Sat Mar 09, 2013 11:08 am

econ11 wrote:
prh116 wrote:I have 10% in bonds. I consider it a hedge for a 1 in 10 chance that the market will tank in any one year. If it does, the bonds get sold and I buy up more equity at the bottom as I rebalance. Until that happens, I collect interest.
As a first impression, this is the best reason to diversify into bonds that I have yet heard. Using 10% bonds as a sort of reserve to buy up stock at bargain prices during down markets is something I think I could get on board with. Thanks for the insight!
That's what I found in 2008. I was almost all equities, and never thought of selling them in panic. But it kind of annoyed me that I didn't have anything to rebalance out of to buy them on sale, other than just continuing to contribute to my retirement accounts.

Brad
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Re: Why should young people invest in bonds at all?

Post by Index Fan » Sat Mar 09, 2013 11:19 am

There's some great answers posted here already, but I'll add the example of Japan to the mix. The world's leading economy in the 1980's has had a stock market that's been down around 60% from its highs for ~20 years. It can happen, there's nothing magic about equities that means you always win given enough time.

Here's the abovementioned thread:

How's that 100% equity allocation working out for ya?
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Re: Why should young people invest in bonds at all?

Post by bobcat2 » Sat Mar 09, 2013 11:33 am

The OP writes.
But, I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks. ...

What am I missing? Thanks in advance!

You are wrong. You are missing the fact that government bonds outperformed stocks for the 30 year period 1981-2011, which is not exactly ancient history. :wink:
How quickly, how very quickly, we forget. :D I suggest for starters that you bone up on your research skills. :oops:
The biggest bond gains in almost a decade have pushed returns on Treasuries above stocks over the past 30 years...

Since 1981, long-term government bonds have gained an average of 11.5% per year, handily besting equities. The S&P 500 index gained the 10.8% per year over the same period, with much more risk and greater volatility. ...

Bloomberg notes that “Not only have bonds knocked stocks from their perch as the dominant long-term investment, their returns proved everyone from Bill Gross to Meredith Whitney and Nassim Nicholas Taleb to Leon Cooperman, wrong.”
Links to articles - Bonds Beat Stocks: 1981-2011
http://www.ritholtz.com/blog/2011/10/bo ... 1981-2011/
http://www.bloomberg.com/news/2011-10-3 ... ntury.html

Given that you can't even get the historical facts straight about stock and bond returns, that in itself should give you pause about your entire strategy. :wink:

BobK
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Re: Why should young people invest in bonds at all?

Post by JW-Retired » Sat Mar 09, 2013 3:20 pm

bobcat2 wrote:
The biggest bond gains in almost a decade have pushed returns on Treasuries above stocks over the past 30 years...

Since 1981, long-term government bonds have gained an average of 11.5% per year, handily besting equities. The S&P 500 index gained the 10.8% per year over the same period, with much more risk and greater volatility. ...

Bloomberg notes that “Not only have bonds knocked stocks from their perch as the dominant long-term investment, their returns proved everyone from Bill Gross to Meredith Whitney and Nassim Nicholas Taleb to Leon Cooperman, wrong.”
Links to articles - Bonds Beat Stocks: 1981-2011
http://www.ritholtz.com/blog/2011/10/bo ... 1981-2011/
http://www.bloomberg.com/news/2011-10-3 ... ntury.html
Even though bonds were paying big and stocks were going down in 1981, this 30-year region looks like an awfully elusive bird. I played with morningstar total return comparing VFINX for stocks and VWESX for LT bonds and can't really find a start date in 1981 where VWESX 30 year total return beats VFINX. See below picture.

I couldn't find which precise dates were used in the links. Certainly doesn't work for 12/31/81 to 12/31/2011. Possibly the date data in morningstar is too course and there is a pair of dates that works. Perhaps an end date near where the yellow line minimum almost but not quite touches the blue line in 2011. Or maybe the indexes used were different. Seems like at least a faint odor of cherry picking in this. Anyone find exactly what the article source used for stocks and bonds?
JW

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Re: Why should young people invest in bonds at all?

Post by bobcat2 » Sat Mar 09, 2013 4:58 pm

Hi JW Nearly Retired,

As of September 30, 2011, long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.
Link for above statement - http://www.bloomberg.com/news/2011-10-3 ... ntury.html
Despite a reputation for being a slow-growing alternative to stocks for the risk-averse, bonds just passed stocks' long-term performance over the past 30 years.

The fact bonds have topped stocks over such a long period shakes up preconceived notions and further insults stock investors, who have endured historic volatility as they got lower returns.

"No one thought the tortoise could catch up, and it just did," says Ken Winans of Winans International.

Given the rally in bonds in 2011, it might not be surprising that the Ibbotson Associates SBBI bonds index, a broad bond measure, returned 28% last year, crushing the 2.1% return of the Standard & Poor's 500 including dividends. The bond index also topped stocks for the past 10 and 20 years.

What's more surprising, though, since it contradicts the widespread belief that stocks beat bonds, is that the Ibbotson Associates SBBI bond index has returned 11.03% a year on average over the past 30 years, edging out the 10.98% return of stocks.
http://usatoday30.usatoday.com/money/ma ... 52381380/1

As others have noted we don't have many 30 year periods of US financial data since 1900, but for one of those 30 year periods bonds beat stocks. There are other countries, however, from 1900-2000 where bonds have beaten stock returns over periods of 30 years or more including Denmark 1920-1949, Netherlands 1920-1949, Spain 1930-1959, Sweden 1910-1949, and Switzerland 1910-1949.
source - Triumph of the Optimists

In France over the last 50 years bonds have outperformed stocks by an average of 1.4% per year. (5.4% annual bond real return vs stock real return of 4.0%) In Japan over the last 30 years bond returns have far outstripped equity returns. Germany has also seen bonds beat stocks over the last 30 years.
Sources - Triumph of the Optimists & Credit Suisse Global Investment Returns Yearbook 2013

If we look at the last 50 years globally (1963-2012) there hasn't been much of an advantage in investing in stocks over bonds.

Code: Select all

World Real Annual Returns  (1963-2012)
 Equities     5.2%       Bonds 4.3%  
source - Credit Suisse Global Investment Returns Yearbook 2013

BobK
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Re: Why should young people invest in bonds at all?

Post by Rick Ferri » Sat Mar 09, 2013 5:26 pm

Bull markets are generational.

It's good to see a new generation of investors who have no fear enter this market. Over the next decade, this new generation who has no experience with bear markets or what risk really is will drive equity valuations higher so that baby-boomers like me can sell to them at high prices as we move into retirement.

I am being sarcastic. This is actually what will happen.

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Re: Why should young people invest in bonds at all?

Post by baw703916 » Sat Mar 09, 2013 6:09 pm

Rick Ferri wrote:Bull markets are generational.

It's good to see a new generation of investors who have no fear enter this market. Over the next decade, this new generation who has no experience with bear markets or what risk really is will drive equity valuations higher so that baby-boomers like me can sell to them at high prices as we move into retirement.

I am being sarcastic. This is actually what will happen.

Rick Ferri
It does seem quite reminiscent of 1979. :happy

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Re: Why should young people invest in bonds at all?

Post by market timer » Sat Mar 09, 2013 7:11 pm

A portfolio of stocks + bonds will likely provide a higher risk-adjusted return than all stocks.

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Re: Why should young people invest in bonds at all?

Post by JW-Retired » Sat Mar 09, 2013 9:07 pm

bobcat2 wrote:Hi JW Nearly Retired,

As of September 30, 2011, long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.
Link for above statement - http://www.bloomberg.com/news/2011-10-3 ... ntury.html
BobK
Hi BobK,
I would just like to see this for myself and not just believe the financial press. Your link is to a bloomberg.com financial web article quoting Jim Bianco of Bianco Research. I would just like to find out what this Jim Bianco is basing his press release on. He doesn't say he just makes the statement. If I plot the Morningstar total return of SP500 (VFINX) against long-term gov bonds (VWESX) between Sept 30, 1981 and Sept 30, 2011, it quite obviously contradicts his assertion.

http://quote.morningstar.com/fund/chart ... ture=en_US

Sorry, the link won't produce the Sept 30, 1981 and Sept 30, 2011 comparison graph, you will have to add VFINX and fiddle with the dates for a while.
JW
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Re: Why should young people invest in bonds at all?

Post by ebeard » Sat Mar 09, 2013 9:59 pm

gnosis wrote:Welcome! Here's a helpful link: http://www.bogleheads.org/forum/viewtopic.php?p=538014

I noticed that the person who started that thread was also 26 years old. What is it with you guys at 26 and bonds questions? :happy
econ11 wrote:... there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks...
Never say never. "Past performance is no guarantee of future results". There's one reason to hold some bonds.
Here's another: How would you feel if you lost a million bucks in a year because you were 100% in the stock market? Eventually, your philosophy with your investments will likely change from "How much can I make" to "How much can I afford to lose."

My favorite line for that thread by bigH:

Remember: the stock market is not a magic pill to create wealth. The risk it asks for is real and it can leave you high and dry.

true that.
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Re: Why should young people invest in bonds at all?

Post by Clever_Username » Sat Mar 09, 2013 10:28 pm

Rick Ferri wrote:Bull markets are generational.
Am I the only under-30 (I turn 30 at the end of this upcoming June) with a sizable bond portion? I'm at 30% - slightly more than my age, even! - and, even with the stock portion going up quicker than my bond portion of my portfolio, I'm not tempted to switch over to more equities. If anything, I'm wondering if I should re-balance before my birthday (but then I remember that doing so is a form of market timing on my part).

I was 100% stocks in 2008, largely because that's how I allocated my 401(k) at my then-internship, and that primarily because I didn't want to give up matching funds (who gives immediate vesting on a 401(k) to interns? For some reason, two of my internships did). I remember wishing I could contribute more when they were dropping that fall and winter. Maybe that's why I'm happy holding bonds?
"What was true then is true now. Have a plan. Stick to it." -- XXXX, _Layer Cake_ | | I survived my first downturn and all I got was this signature line.

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Re: Why should young people invest in bonds at all?

Post by bobcat2 » Sat Mar 09, 2013 10:34 pm

JW Nearly Retired wrote:
bobcat2 wrote:Hi JW Nearly Retired,

As of September 30, 2011, long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.
Link for above statement - http://www.bloomberg.com/news/2011-10-3 ... ntury.html
BobK
Hi BobK,
I would just like to see this for myself and not just believe the financial press. Your link is to a bloomberg.com financial web article quoting Jim Bianco of Bianco Research. I would just like to find out what this Jim Bianco is basing his press release on. He doesn't say he just makes the statement. JW
How about this column by Larry Swedroe on the same topic. Here is an excerpt.
For the period October 1981-September 2011, the S&P 500 Index returned an annualized 10.8 percent, compared to the 11.5 percent annualized return on long-term (20-year) Treasury bonds. Should you be surprised? Yes. It certainly shouldn't have been the expected outcome. However, the right perspective is that it should have been a possible outcome. Let's see why this must be the case. ...

The media has ignored the fact that there's an even longer period over which stocks underperformed bonds. For the 40-year period 1969-2008, the CRSP Total Stock Market Index returned 8.8 percent a year, on average, compared to the 9.0 percent annualized return on long-term Treasury bonds.
Link to Swedroe column - http://www.cbsnews.com/8301-505123_162- ... s-so-what/

BobK
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Re: Why should young people invest in bonds at all?

Post by DavidC » Sat Mar 09, 2013 10:55 pm

Clever_Username wrote:Am I the only under-30 (I turn 30 at the end of this upcoming June) with a sizable bond portion? I'm at 30% - slightly more than my age, even! - and, even with the stock portion going up quicker than my bond portion of my portfolio, I'm not tempted to switch over to more equities.
Well, this 27 year old holds ~35% of his portfolio in bonds (mostly Savings Bonds but still). So if you ever get any grief from anyone, you can always say "I'm not crazy, haven't you heard about this David guy... now he is crazy." ;-)
In true boglehead fashion my chief concern is saving enough to withstand 7 consecutive biblical plagues. - TheNightsToCome

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Re: Why should young people invest in bonds at all?

Post by norookie » Sat Mar 09, 2013 10:58 pm

Ummmm, for rebalancing ? Its better than cash loosing +3% annually. :| Correct?
" Wealth usually leads to excess " Cicero 55 b.c

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Re: Why should young people invest in bonds at all?

Post by baw703916 » Sat Mar 09, 2013 11:22 pm

BobK,

I'm not sure it really matters whether equities did a little better or a little worse than long-term government bonds over a 30-40 year time period. The central point is that bonds did about as well, and with a lot less volatility.

Still, I'm not quite sure what that means going forward. LT bonds don't have a higher expected return than equities today, just as they didn't in 1980. Obviously, that's a good example of expected returns not always being the same as actual returns. But given current interest rates, the historical return of long term bonds over the last 30 years is mathematically impossible to duplicate in the next 30 years.

Best wishes,
Brad
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Re: Why should young people invest in bonds at all?

Post by EDN » Sun Mar 10, 2013 12:00 am

The whole "S&P 500 vs 20YR Government Bond comparison" is a farce. The Equity Risk Premium is defined as the return of TSM minus t-bills. Now, if you want to compare stocks to a more traditional bond holding like TBM or 5YR t-notes, fine. The expected ERP will be lower and less persistent in this case. But you are also introducing bond risk to the equation, so you are just measuring which risks will pay off more, not if risk pays vs no risk.

But big, successful LC stocks compared to extremely long-term bonds that carry extreme risks themselves (40+ years of negative real returns from '42-'81)? That's ridiculous. So one really risky investment beat another really risky investment over some 30 year period. So what? Why LT bonds? Why not Junk Bonds or Convertable Bonds? Why not Preferred Stocks. How bout REITs, they have a big yield.

If we're taking liberties with our definition of "bonds", maybe we should change our definition of stocks to the "FF SV index"?

These "should young investors consider all stocks" threads are silly. Of course you should! And if you don't feel it's appropriate for you, fine, add bonds. Just stick with what you decide. Why people feel the need to arm wrestle everyone into holding some bonds is beyond me. What's next, are you gonna tell me I can't buy a Big Gulp? Oh, wait...

Eric

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Re: Why should young people invest in bonds at all?

Post by bobcat2 » Sun Mar 10, 2013 12:05 am

baw703916 wrote:BobK,

I'm not sure it really matters whether equities did a little better or a little worse than long-term government bonds over a 30-40 year time period. The central point is that bonds did about as well, and with a lot less volatility.

Still, I'm not quite sure what that means going forward. LT bonds don't have a higher expected return than equities today, just as they didn't in 1980. Obviously, that's a good example of expected returns not always being the same as actual returns. But given current interest rates, the historical return of long term bonds over the last 30 years is mathematically impossible to duplicate in the next 30 years.

Best wishes,
Brad
I agree with you Brad. I was objecting to the following statement by the OP.
But, I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks.
It is hardly a secret that that isn't true. It was all over the financial news in 2011 that LT bonds had outperformed stocks for thirty years. And, as Larry Swedroe points out, LT bonds outperformed stocks for 40 years from 1969-2008. In addition bonds have outperformed stocks over 30 year periods or more in many other countries over the last 100 years.

Does all this mean I expect bonds to outperform stocks over the next 30 years? No - I definitely don't expect that, but it is possible. What bothers me the most about this is that when bonds outperform stocks over long time periods it is usually because stocks have had spectacularly bad long-run returns, not because bonds have had particularly great LR returns. :(

Best,
BobK

PS - Hope to see you at one of our local meetings in the near future. :D
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Re: Why should young people invest in bonds at all?

Post by Valuethinker » Sun Mar 10, 2013 1:28 am

econ11 wrote:I am 26 and have just started thinking about investing for the future. I'm a grad student in econ, and was aware (though finance is not my area of expertise), that indexing beats active management once costs are taken into account. Thus, I was attracted to Vanguard and the Boglehead forum.

My question is this: why should someone my age invest in bonds at all?

Some allocation rules of thumb, such as 100-age toward stocks would have me investing 26 percent of my portfolio in bonds. But, I have been doing some research and there has apparently never been a 30 year period (since we've started measuring such things) that bonds have outperformed stocks.

I plan on working until I am at least 65, so any amount I invest before I turn 35 will have at least 30 years to grow before I would need it. What am I missing? Thanks in advance!
Actually if you think like a financial economist, the rational young investor would be:

- 80-90% TIPS bonds
- balance in equitities

What you'd never hold is nominal bonds (ST nominal bonds have a correlation with TIPS, so an imperfect substitute).

Then you'd be rationally deferring consumption now in return for future consumption, at no risk ASSUMING:

- no taxation on the imputed inflationary gain of the TIPS (ie tax deferred accounts)

The life cycle hypothesis would be nicely obeyed.

The problem for most of is we cannot save enough. At current TIPS yields, you'd need something like 25-30% of your gross labour income aged 22-65 (assuming a 30 year retirement) to be saved every year.

Note Zvi Bodie, who wrote the best introductory economics of finance textbook (Financial Economics, Zvi Bodie & Robert Merton) recommends precisely this*.

* he is 100% TIPS + buying call options on the S&P500, I don't understand enough about this aspect of his strategy

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