Marginal improvement in drawdown for every 5% in bond allocation

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K8ya
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Marginal improvement in drawdown for every 5% in bond allocation

Post by K8ya »

I've heard that a small amount of bonds goes a long way to help reduce drawdown during bear markets, on stock heavy portfolios. Have any blogs run the numbers on what recent drawdowns would have looked like at their lows for a 100/0 portfolio, vs 95/5, 90/10, 85/15, 80/20 ?
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David Jay
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Re: Marginal improvement in drawdown for every 5% in bond allocation

Post by David Jay »

I am not sure where you heard this. For an individual drawdown, I think the benefit closely approximates the ratio of stocks to bonds.

For example:
Stocks drop 40%
80/20 portfolio drops 32% (40 * .8)

Now the calculations become more complex over a period of time with a series of ups and downs and even more so if there is consistent rebalancing throughout the period.
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whereskyle
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Re: Marginal improvement in drawdown for every 5% in bond allocation

Post by whereskyle »

K8ya wrote: Sat May 15, 2021 11:45 am I've heard that a small amount of bonds goes a long way to help reduce drawdown during bear markets, on stock heavy portfolios. Have any blogs run the numbers on what recent drawdowns would have looked like at their lows for a 100/0 portfolio, vs 95/5, 90/10, 85/15, 80/20 ?
Depends on the bond. Small allocations to long-term, or even extended-duration, US Treasuries, have provided the best equity-drawdown protection for the past 30 years or so because of their inverse correlations to US equities over that period. I have a very small allocation to long-term bonds (almost entirely treasuries) as my sole bond holding. You can read more about this strategy here:

viewtopic.php?f=10&t=287627
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dbr
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Re: Marginal improvement in drawdown for every 5% in bond allocation

Post by dbr »

K8ya wrote: Sat May 15, 2021 11:45 am I've heard that a small amount of bonds goes a long way to help reduce drawdown during bear markets, on stock heavy portfolios. Have any blogs run the numbers on what recent drawdowns would have looked like at their lows for a 100/0 portfolio, vs 95/5, 90/10, 85/15, 80/20 ?
You could try an experiment in Portfolio Visulizer. That program does not go way far back in data, but the result could give you an idea. "Goes a long way" is certainly an overstatement. 100% total stock turns up at -51% and 90/10 at -46%. That is not a long way in my book. Total bond by itself had a max drawdown of -4% and a 50/50 portfolio -25%. That data is for the years 2001-2021 and the max drawdowns were all in the time range 2007-2009.


I support that a first approximation is that it is in proportion to the stock allocation. The second order approximation is to consider correlation effects between stocks and bonds.

I personally tend to think there is no special purpose to adding bonds to a portfolio until you are adding 25% or 30%. It also makes sense to me that the maximum stock allocation be no more than 75%, but each investor has to decide that for themselves.
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K8ya
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Re: Marginal improvement in drawdown for every 5% in bond allocation

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dbr wrote: Sun May 16, 2021 11:37 am It also makes sense to me that the maximum stock allocation be no more than 75%, but each investor has to decide that for themselves.
Can you justify this one in your personal context? I take it you simply have no use for the extra returns at your stage?
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Forester
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Re: Marginal improvement in drawdown for every 5% in bond allocation

Post by Forester »

K8ya wrote: Sat May 15, 2021 11:45 am I've heard that a small amount of bonds goes a long way to help reduce drawdown during bear markets, on stock heavy portfolios. Have any blogs run the numbers on what recent drawdowns would have looked like at their lows for a 100/0 portfolio, vs 95/5, 90/10, 85/15, 80/20 ?
https://paulmerriman.com/fine-tuning-yo ... tion-2021/
dbr
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Re: Marginal improvement in drawdown for every 5% in bond allocation

Post by dbr »

K8ya wrote: Mon May 17, 2021 12:51 am
dbr wrote: Sun May 16, 2021 11:37 am It also makes sense to me that the maximum stock allocation be no more than 75%, but each investor has to decide that for themselves.
Can you justify this one in your personal context? I take it you simply have no use for the extra returns at your stage?
It isn't just a question of the utility of extra returns. It is a dislike for excessive volatility. Asset allocation choices are mainly about drawing a line where risk is excessive. If a high stock allocation is necessary to achieve a certain goal then a consequence is that there will be worst case outcomes that may be intolerable and also don't meet the goal. If the worst case is acceptable should it occur then high stock allocations give the best chance of meeting goals on average and over the majority of cases. That also assumes stocks won't fail in some spectacular and unanticipated way while bonds don't so fail.

But risk is not just volatility, which gives rise to wide uncertainty in end point wealth. Another example of risk is the chance of running out of money while withdrawing over time. 100% stock allocations are not optimum for reducing that risk. High volatility introduces chances of low returns for the period of retirement or of getting bad sequences of returns within a given average return in retirement. That is offset by chances for higher returns. The optimum comes out statistically at not all stocks and not all bonds.

My actual allocation is 50/50, but I am 14 years retired already.
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