Why government bonds at all?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Why government bonds at all?

Post by toto238 » Sat May 23, 2015 8:48 am

Bear with me here, I'm not one of those doomsdayer crazies that thinks all governments are about to go bankrupt. Quite the contrary, I think the US government will be stretched, but mostly fine over the next few decades.

But my general thought behind investing in equities is that I'm buying a piece of a company that is doing something economically productive. The companies that aren't being productive get overtaken and swallowed by the more productive ones. Creative Destruction works to my advantage here. The money I put into the secondary equity market indirectly enables those companies to obtain capital through IPOs to do other economically productive things. Whether they provide a good or a service, they're creating or doing something of value to other people.

In the same way, buying those companies' bonds has the same logic. You're lending them money so that they can do economically productive things. Companies that fail to be productive will go bankrupt and their bonds will be replaced by the bonds of the more productive companies. Creative Destruction is again working in my favor.

But government bonds don't work that way. The government isn't a profit-producing entity and its goal is not necessarily to produce a good or service that is economically productive. Sure the government may do some economically useful things, but there are no market forces acting upon it forcing it to do so or fail. There's no Creative Destruction really occuring. It's like a non-profit organization. A good charity may in fact be a good credit risk, but that doesn't mean I would buy their bonds.

So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?

I understand the argument of it being a good diversifier and reducing risk, but really anything can do that. Gold/Silver can be a good diversifier and reduce risk. Oil/natural gas can be a good diversifier and reduce risk. Options contracts can add diversification and reduce risk. Stuffing money in your mattress can be a good diversifier and reduce risk. None of these are economically productive so I avoid them. There's no person on the other side of the contract trying to do something economically productive. With a corporate stock or corporate bond, someone on the other end is trying to create value for me. The market forces ensure that if he/she fails, he/she will be replaced by someone who can. Government securities have no such mechanism.

jebmke
Posts: 10865
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Why government bonds at all?

Post by jebmke » Sat May 23, 2015 8:52 am

When you buy a government bond you are essentially buying into that government's (Federal, state, municipal ...) power to tax (and to a an extent, the power to create money).
When you discover that you are riding a dead horse, the best strategy is to dismount.

letsgobobby
Posts: 12073
Joined: Fri Sep 18, 2009 1:10 am

Re: Why government bonds at all?

Post by letsgobobby » Sat May 23, 2015 8:54 am

One word: safety. Not risk reduction as in volatility reduction, but risk reduction as in the Great Depression crushes all those gleaming productive assets you waxed poetic about, just exactly when you need your money.

jebmke
Posts: 10865
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Why government bonds at all?

Post by jebmke » Sat May 23, 2015 8:59 am

I'm not familiar with bankruptcy law but if I had to guess, my guess would be that taxing authorities are first in line as a claimant. Equity holders are generally last in line.
When you discover that you are riding a dead horse, the best strategy is to dismount.

User avatar
nisiprius
Advisory Board
Posts: 41037
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why government bonds at all?

Post by nisiprius » Sat May 23, 2015 9:08 am

Bonds aren't participation in anything. They are just a bill the issuer has to pay. You judge whether you want to lend money depending on how much they are willing to pay you to do it, and how confident you are that the issuer can pay their bills.

If you believe the ratings: S&P's AA+, Moody's Aaa, Fitch AAA, A. M. Best Aaa... then you should be as willing to lend money to the U.S. Treasury as you would be to any private enterprise with the same rating.

If you believe that no government, including the U.S. government, can actually be creditworthy, because you believe governments are not economically productive--that is to say, you disagree with the ratings agencies--then obviously you would not buy government bonds.

Usually, the assumption is that an entity that can print money can pay its bills, that a reserve currency is fairly high-quality tender for paying debts, and that the power to tax is a fairly reliable income stream.

The relative performance of the mostly-corporate Vanguard Intermediate-Term Investment Grade bond fund (blue) and the Vanguard Intermediate-Term Treasury bond fund (orange) during 2008-2009 shows that pragmatic capitalists had more confidence in the Treasury than in corporations to pay their bills when the going got really tough.

But there's no need at all to invest in any sovereign bonds if you don't trust them.

Source: Morningstar
Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Re: Why government bonds at all?

Post by toto238 » Sat May 23, 2015 9:25 am

nisiprius wrote:Bonds aren't participation in anything. They are just a bill the issuer has to pay. You judge whether you want to lend money depending on how much they are willing to pay you to do it, and how confident you are that the issuer can pay their bills.

If you believe the ratings: S&P's AA+, Moody's Aaa, Fitch AAA, A. M. Best Aaa... then you should be as willing to lend money to the U.S. Treasury as you would be to any private enterprise with the same rating.

If you believe that no government, including the U.S. government, can actually be creditworthy, because you believe governments are not economically productive--that is to say, you disagree with the ratings agencies--then obviously you would not buy government bonds.

Usually, the assumption is that an entity that can print money can pay its bills, that a reserve currency is fairly high-quality tender for paying debts, and that the power to tax is a fairly reliable income stream.

The relative performance of the mostly-corporate Vanguard Intermediate-Term Investment Grade bond fund (blue) and the Vanguard Intermediate-Term Treasury bond fund (orange) during 2008-2009 shows that pragmatic capitalists had more confidence in the Treasury than in corporations to pay their bills when the going got really tough.

But there's no need at all to invest in any sovereign bonds if you don't trust them.
It's not a question of not trusting them. I do believe the US Government as well as many other sovereign governments are fine credit risks. In fact, they are significantly safer than corporate bonds. But so is cash.

I guess for me I'm challenging the idea that someone should pick their bonds based solely on the borrower's ability to pay it back. I don't doubt that the US Government's taxation power and ability to print more dollars makes it a very very very safe credit risk.

So I understand that it would add security to have government bonds. But that means that more of my money is going to a non-profit organization than is going to profit-making corporations. I believe that the non-profit organizations like government, although they may be very safe credit risks, are not as directly affected by market forces like Creative Destruction and are therefore less likely to be as efficient.

dbr
Posts: 32825
Joined: Sun Mar 04, 2007 9:50 am

Re: Why government bonds at all?

Post by dbr » Sat May 23, 2015 9:26 am

nisiprius wrote:
If you believe that no government, including the U.S. government, can actually be creditworthy, because you believe governments are not economically productive--that is to say, you disagree with the ratings agencies--then obviously you would not buy government bonds.

Usually, the assumption is that an entity that can print money can pay its bills, that a reserve currency is fairly high-quality tender for paying debts, and that the power to tax is a fairly reliable income stream.
Yes, it really is pretty simple. And, of course, there are governments that renege on their bonds. In the United States, if "government" is construed to include cities and counties and other such ilk, the advice is clearly not to buy the bonds of any few such entitites. Taken worldwide, there are probably more government debt issues one should not buy than that one might buy.

Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Re: Why government bonds at all?

Post by toto238 » Sat May 23, 2015 9:28 am

Once I get closer to retirement, I understand it makes sense to take "chips off the table" and start putting money into economically non-productive products like government bonds because I can't necessarily withstand the volatility that corporate bonds entail.

But when I'm younger and am not as concerned about the volatility, might it make sense to have one's bond allocation 100% corporate?

longinvest
Posts: 4287
Joined: Sat Aug 11, 2012 8:44 am

Re: Why government bonds at all?

Post by longinvest » Sat May 23, 2015 9:33 am

toto238 wrote:But government bonds don't work that way. The government isn't a profit-producing entity and its goal is not necessarily to produce a good or service that is economically productive. Sure the government may do some economically useful things, but there are no market forces acting upon it forcing it to do so or fail. There's no Creative Destruction really occuring. It's like a non-profit organization. A good charity may in fact be a good credit risk, but that doesn't mean I would buy their bonds.

So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
Isn't holding citizenship similar to owning government stocks, or even worse as you get to pay taxes in many cases instead of receiving government dividends (welfare)?

Seriously, though: governments borrow to build infrastructures and provide basic services such as defense and a justice system. Most (or at least, without getting into politics, part) of this spending is very beneficial to the entire society and allows for the economic system to exist! So, let me reverse your question:

Why would you refrain from investing some of your money into government bonds?
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW

Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Re: Why government bonds at all?

Post by toto238 » Sat May 23, 2015 9:37 am

longinvest wrote:
toto238 wrote:But government bonds don't work that way. The government isn't a profit-producing entity and its goal is not necessarily to produce a good or service that is economically productive. Sure the government may do some economically useful things, but there are no market forces acting upon it forcing it to do so or fail. There's no Creative Destruction really occuring. It's like a non-profit organization. A good charity may in fact be a good credit risk, but that doesn't mean I would buy their bonds.

So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
Isn't holding citizenship similar to owning government stocks, or even worse as you get to pay taxes in many cases instead of receiving government dividends (welfare)?

Seriously, though: governments borrow to build infrastructures and provide basic services such as defense and a justice system. Most (or at least, without getting into politics, part) of this spending is very beneficial to the entire society and allows for the economic system to exist! So, let me reverse your question:

Why would you refrain from investing some of your money into government bonds?
Charities also build infrastructure, invest in citizen's education, and do a lot of other things beneficial to the entire society. And many charities have steady cash flow that make them very low credit risks.

I put it back to you: Why don't you invest in the bonds of charities and other non-profits?

longinvest
Posts: 4287
Joined: Sat Aug 11, 2012 8:44 am

Re: Why government bonds at all?

Post by longinvest » Sat May 23, 2015 9:41 am

toto238 wrote:Charities also build infrastructure, invest in citizen's education, and do a lot of other things beneficial to the entire society. And many charities have steady cash flow that make them very low credit risks.

I put it back to you: Why don't you invest in the bonds of charities and other non-profits?
Charities don't have the same credit worthiness as governments, but if my aggregate bond fund ever decided to invest some money into bonds of charities (as long as they are investment-grade) in market-weight proportion, I would be OK with it.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW

Rysto
Posts: 99
Joined: Sun Jan 09, 2011 5:26 pm

Re: Why government bonds at all?

Post by Rysto » Sat May 23, 2015 9:41 am

toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
You don't buy bonds to participate in the future profits of an organization. No matter how well (or poorly) it does financially, you get paid the same amount of money on the same schedule (unless they default, of course). Only equity holders get to benefit from the profits.

Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Re: Why government bonds at all?

Post by toto238 » Sat May 23, 2015 9:50 am

Rysto wrote:
toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
You don't buy bonds to participate in the future profits of an organization. No matter how well (or poorly) it does financially, you get paid the same amount of money on the same schedule (unless they default, of course). Only equity holders get to benefit from the profits.
So, really, from that perspective, investing in bonds at all is basically not participating in the future profits of an organization.

But still, buying corporate bonds does help enable those corporations to make those profits. It feels like a way to still reduce risk from equities, but to still be helping a profit-making entity do something economically productive.

dbr
Posts: 32825
Joined: Sun Mar 04, 2007 9:50 am

Re: Why government bonds at all?

Post by dbr » Sat May 23, 2015 9:54 am

toto238 wrote:Once I get closer to retirement, I understand it makes sense to take "chips off the table" and start putting money into economically non-productive products like government bonds because I can't necessarily withstand the volatility that corporate bonds entail.

But when I'm younger and am not as concerned about the volatility, might it make sense to have one's bond allocation 100% corporate?
I think you are extending an argument about the virtues of "economic productivity" to some illogical conclusions.

User avatar
backpacker
Posts: 1620
Joined: Mon Sep 22, 2014 2:17 pm

Re: Why government bonds at all?

Post by backpacker » Sat May 23, 2015 10:23 am

toto238 wrote:
Rysto wrote:
toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
You don't buy bonds to participate in the future profits of an organization. No matter how well (or poorly) it does financially, you get paid the same amount of money on the same schedule (unless they default, of course). Only equity holders get to benefit from the profits.
So, really, from that perspective, investing in bonds at all is basically not participating in the future profits of an organization.

But still, buying corporate bonds does help enable those corporations to make those profits. It feels like a way to still reduce risk from equities, but to still be helping a profit-making entity do something economically productive.
Governments do economically productive things too. Town A is across the river from town B. The nearest bridge is 60 miles away, so travel between them is relatively expensive. If a company built a toll bridge between the two towns, that would be economically productive. The company would make money and the bridge would save its customers money. If the government builds the same bridge, it is no less economically productive. It is just more likely to be paid for with taxes instead of tolls.

jebmke
Posts: 10865
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Why government bonds at all?

Post by jebmke » Sat May 23, 2015 10:26 am

backpacker wrote:Governments do economically productive things too.
We live outside of "town" so our trash is picked up by a private company.
If we lived in town, the town would pick up our trash.
When you discover that you are riding a dead horse, the best strategy is to dismount.

User avatar
BolderBoy
Posts: 4786
Joined: Wed Apr 07, 2010 12:16 pm
Location: Colorado

Re: Why government bonds at all?

Post by BolderBoy » Sat May 23, 2015 10:33 am

toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
You wouldn't buy equity in government because I don't think you can.

But government bonds are safe, particularly USGovernment bonds. If I read my Constitution correctly, servicing government bond debt is superior to all other uses of the federal budget.

AndrewHMeador
Posts: 38
Joined: Tue Dec 23, 2014 6:00 am

Re: Why government bonds at all?

Post by AndrewHMeador » Sat May 23, 2015 11:17 am

The pragmatic view is that a 1/2 : 1/2 stock/govt. bond portfolio behaves like a 1/3 : 2/3 stock/corporate bond portfolio, but is more tax efficient and more robust because your money is spread across more baskets.

AndrewHMeador
Posts: 38
Joined: Tue Dec 23, 2014 6:00 am

Re: Why government bonds at all?

Post by AndrewHMeador » Sat May 23, 2015 11:31 am

BolderBoy wrote:
toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?
You wouldn't buy equity in government because I don't think you can.

But government bonds are safe, particularly USGovernment bonds. If I read my Constitution correctly, servicing government bond debt is superior to all other uses of the federal budget.
[OT comments removed by admin LadyGeek]

robert88
Posts: 366
Joined: Tue Nov 25, 2014 6:27 pm

Re: Why government bonds at all?

Post by robert88 » Sat May 23, 2015 11:36 am

toto238 wrote:
nisiprius wrote:Bonds aren't participation in anything. They are just a bill the issuer has to pay. You judge whether you want to lend money depending on how much they are willing to pay you to do it, and how confident you are that the issuer can pay their bills.

If you believe the ratings: S&P's AA+, Moody's Aaa, Fitch AAA, A. M. Best Aaa... then you should be as willing to lend money to the U.S. Treasury as you would be to any private enterprise with the same rating.

If you believe that no government, including the U.S. government, can actually be creditworthy, because you believe governments are not economically productive--that is to say, you disagree with the ratings agencies--then obviously you would not buy government bonds.

Usually, the assumption is that an entity that can print money can pay its bills, that a reserve currency is fairly high-quality tender for paying debts, and that the power to tax is a fairly reliable income stream.

The relative performance of the mostly-corporate Vanguard Intermediate-Term Investment Grade bond fund (blue) and the Vanguard Intermediate-Term Treasury bond fund (orange) during 2008-2009 shows that pragmatic capitalists had more confidence in the Treasury than in corporations to pay their bills when the going got really tough.

But there's no need at all to invest in any sovereign bonds if you don't trust them.
It's not a question of not trusting them. I do believe the US Government as well as many other sovereign governments are fine credit risks. In fact, they are significantly safer than corporate bonds. But so is cash.

I guess for me I'm challenging the idea that someone should pick their bonds based solely on the borrower's ability to pay it back. I don't doubt that the US Government's taxation power and ability to print more dollars makes it a very very very safe credit risk.

So I understand that it would add security to have government bonds. But that means that more of my money is going to a non-profit organization than is going to profit-making corporations. I believe that the non-profit organizations like government, although they may be very safe credit risks, are not as directly affected by market forces like Creative Destruction and are therefore less likely to be as efficient.
I think what you're saying is that A) you want to engage in socially responsible investing and B) you think "investing" in government is not "socially responsible". You're certainly free to think that way, but threads debating A and B will almost certainly get locked at some point.

DaufuskieNate
Posts: 394
Joined: Wed May 28, 2014 11:53 am

Re: Why government bonds at all?

Post by DaufuskieNate » Sat May 23, 2015 11:41 am

toto238 wrote: With a corporate stock or corporate bond, someone on the other end is trying to create value for me. The market forces ensure that if he/she fails, he/she will be replaced by someone who can.
At times, those market forces include bankruptcy of the corporation and losses to bondholders. I realize that governments are not immune to this process, but my point here is that the same market forces that result in efficiency also force losses to providers of capital.

User avatar
Archie Sinclair
Posts: 412
Joined: Sun Mar 06, 2011 2:03 am

Re: Why government bonds at all?

Post by Archie Sinclair » Sat May 23, 2015 12:30 pm

These are financial obligations of the United States. The government is an intermediary between you and the American people.

The bonds are backed not only by the government, but (through the government's taxing authority) by the entire national economy. The national economy obviously includes the kinds of free-market forces that you value. These bonds are debts of Google, debts of Exxon, debts of Fred's hardware store, etc., etc.

Topic Author
toto238
Posts: 1891
Joined: Wed Feb 05, 2014 2:39 am

Re: Why government bonds at all?

Post by toto238 » Sat May 23, 2015 1:10 pm

Archie Sinclair wrote:These are financial obligations of the United States. The government is an intermediary between you and the American people.

The bonds are backed not only by the government, but (through the government's taxing authority) by the entire national economy. The national economy obviously includes the kinds of free-market forces that you value. These bonds are debts of Google, debts of Exxon, debts of Fred's hardware store, etc., etc.
You know, that's a really fair point. The government really just is an intermediary. In that context it makes more sense to me.

bayview
Posts: 2215
Joined: Thu Aug 02, 2012 7:05 pm
Location: WNC

Re: Why government bonds at all?

Post by bayview » Sat May 23, 2015 1:24 pm

All our bonds are Treasuries (including the G fund.) As they do better at zigging when equity zags than do corporates, we can put a greater percentage of our investments in equities.
The continuous execution of a sound strategy gives you the benefit of the strategy. That's what it's all about. --Rick Ferri

User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Why government bonds at all?

Post by ogd » Sat May 23, 2015 3:54 pm

So in my possibly radical view, government bonds issued by a government controlling its own currency are not [any longer] a way to lend money to the government / a way for the government to borrow. After all, the government can create all the money it needs.

Instead, they are two things: 1) a tool for the branches of arguments to keep tabs on spending vs money creation. For some reason, this whole dance is still being played to the antiquated music of "debt" as if money was an externality, but it's how the system works.

2) is functionally more important to us investors and more directly answers your question: they serve as cash instruments for the various economic players to do various things like putting up collateral for riskier stuff. They are a "savings account" of sorts provided by the government, one that is accessible to the market and unlimited (unlike FDIC accounts). So if you need a safe instrument in this type of package (can be part of fund, instantly tradeable, no limits) you invest in government bonds. You're not lending the government money to do anything it couldn't do otherwise (if it agreed with itself, that is), you're simply refusing to take on the risk of any other entity.

BigJohn
Posts: 1871
Joined: Wed Apr 02, 2014 11:27 pm

Re: Why government bonds at all?

Post by BigJohn » Sat May 23, 2015 8:51 pm

toto238 wrote:I guess for me I'm challenging the idea that someone should pick their bonds based solely on the borrower's ability to pay it back. I don't doubt that the US Government's taxation power and ability to print more dollars makes it a very very very safe credit risk.
I'm a firm believer that the key objective of bonds in your portfolio is stability and safety. As a result, I view this as one of the very best reasons to own government bonds.

HalfMillionaire
Posts: 101
Joined: Sat Feb 28, 2015 7:08 pm

Re: Why government bonds at all?

Post by HalfMillionaire » Sun May 24, 2015 6:40 am

I consider the biggest benefit of bonds to be able to move into stocks when they dive. Only treasuries serve that function well as shown clearly in the chart several posts above. That's why also I think one should have some bonds even if one has high risk tolerance.

Call_Me_Op
Posts: 7853
Joined: Mon Sep 07, 2009 2:57 pm
Location: Milky Way

Re: Why government bonds at all?

Post by Call_Me_Op » Sun May 24, 2015 6:59 am

toto238 wrote:Once I get closer to retirement, I understand it makes sense to take "chips off the table" and start putting money into economically non-productive products like government bonds because I can't necessarily withstand the volatility that corporate bonds entail.

But when I'm younger and am not as concerned about the volatility, might it make sense to have one's bond allocation 100% corporate?
Viewed from that perspective, why invest in bonds at all? Shouldn't you be 100% in stocks to obtain the highest expected return?
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein

Clive
Posts: 1950
Joined: Sat Jun 13, 2009 5:49 am

Re: Why government bonds at all?

Post by Clive » Sun May 24, 2015 7:07 am

toto238 wrote:So my thought is, I wouldn't buy equity in government. Why would I buy bonds in government?

...

With a corporate stock or corporate bond, someone on the other end is trying to create value for me. The market forces ensure that if he/she fails, he/she will be replaced by someone who can. Government securities have no such mechanism.
Corporate bonds don't have printing presses.

Governments can tax more or print more to avoid defaulting. Corporates can't and when stocks are down corporate bonds might also be down.

Look at the stock purchase power of government bonds and they're very volatile. At the end of 2008 for instance long dated treasury bonds bought nearly twice as much stock as a year earlier.

Consider a LTT/STT barbell (equivalent to 10 year bullet). Since 1972 the yearly change in stock (TSM) purchase power (total nominal gain values) of a STT/LTT barbell yielded a -0.7% average with a 21.3 standard deviation. In effect a small insurance cost of around 0.7% on average/year, to in some years potentially be able to buy 82% more stock than a year earlier (as was the case for a STT/LTT barbell in 2008). In other years stock can be sold to buy more bonds, such as in 2013 when the LTT purchase power of stocks bought 53% more LTT bonds than a year earlier.

Of course timing has bearing. But a simple rebalancing back to target weightings once/year or so performs a reasonable job of such timing automatically/transparently.

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Sun May 24, 2015 7:59 am

nisiprius wrote: he relative performance of the mostly-corporate Vanguard Intermediate-Term Investment Grade bond fund (blue) and the Vanguard Intermediate-Term Treasury bond fund (orange) during 2008-2009 shows that pragmatic capitalists had more confidence in the Treasury than in corporations to pay their bills when the going got really tough.

But there's no need at all to invest in any sovereign bonds if you don't trust them.

Source: Morningstar
Image

Yes, it shows exactly that for the 18 month or so applicable period. Had you sold bonds and rebalanced into equities during that period, you would have had more bang for your buck in that time period. Let's not assume your timing is perfect so you didn't get the full measure of difference even if you had rebalanced. If you run that chart again and hit "maximum" for time period you may see a different answer which could impact what you select in your long term planning. Some of us retired folk are not so anxious to sell our relatively "safe" (bonds) money to buy more "risk" (equities) money in the teeth of a major decline. ... especially with an undetermined bottom, others using bands would have been way early to the party and blown out of bonds into still declining equities early on in the drop and probably developed night sweats. I think if you understand a 50% drop in equities is an occasional part of investing I think that understanding also applies to a 10% drop in IT corporate bonds and it passes quickly.
Last edited by midareff on Sun May 24, 2015 9:54 am, edited 1 time in total.

Dandy
Posts: 6283
Joined: Sun Apr 25, 2010 7:42 pm

Re: Why government bonds at all?

Post by Dandy » Sun May 24, 2015 9:40 am

US Government bonds have unique features - e.g. "no" risk of default, taxing power to raise funds vs the "risk" of attracting discretionary customers, a save haven for investors when there is economic or political fear. State government bonds avoid federal taxes and federal bonds avoid state taxes. These unique features make them a possible buy for many investors. It has nothing to do with capitalism, productivity etc. you either value these features or not.

Johno
Posts: 1883
Joined: Sat May 24, 2014 4:14 pm

Re: Why government bonds at all?

Post by Johno » Sun May 24, 2015 11:32 am

I agree with the posts describing government issuers as basically intermediaries between the investor and the human and physical assets of the jurisdiction. It's more like being at a different level of the capital structure like equity v bond, here it's 'tax', than relying on something different than the assets of a capitalist economy.

But by the same token the declaration of the bonds of governments which issue their own currency as 'riskless' by definition is questionable IMO. Governments which strictly issue in own currency have seldom defaulted (though govt's which issue in both own and foreign currencies have defaulted on own currency debt). But there's a strong correlation between fundamentally strong finances and the possibility or advantage to issue just in local currency. Again, the issuer intermediates between the public borrowing needs of the society and investors with money. It would seem economic nonsense to claim that a society can't possibly borrow more than it can repay without sharp devaluation of the currency; if that were the case the capital constraints faced by private entities could all be lifted by just having the government intermediate all borrowing. And no rational investor is seeking nominal technical fulfillment of a debtor's promise but a real loss. So 'they can just print the money' is a technicality albeit an important one. It only helps if 'just printing the money' doesn't greatly devalue it. The world has seen a lot of 'just printing' lately which contrary to some expectation has not much impaired real debt values of various govts, or even coincided with their rise, but there's no fundamental reason that must always be true.

The current very high global debt level public and private in a slow growing world is an experiment I believe. I don't think it's possible to firmly claim that investors in own currency debt of developed (let alone other) govt issuers aren't taking credit risk. And if there's even a limited realization that they actually might be taking a non-negligible amount, the market consequences could be significant since so many investors now believe otherwise.
Last edited by Johno on Sun May 24, 2015 11:34 am, edited 1 time in total.

User avatar
nisiprius
Advisory Board
Posts: 41037
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why government bonds at all?

Post by nisiprius » Sun May 24, 2015 11:33 am

midareff wrote:
nisiprius wrote:...The relative performance of the mostly-corporate Vanguard Intermediate-Term Investment Grade bond fund (blue) and the Vanguard Intermediate-Term Treasury bond fund (orange) during 2008-2009 shows that pragmatic capitalists had more confidence in the Treasury than in corporations to pay their bills when the going got really tough....
Yes, it shows exactly that for the 18 month or so applicable period....
I wasn't suggesting that government bonds were superior, or that one should time the bond market and get into Treasuries just to catch the "flights to safety." My personal taste is for Total Bond, which... interestingly enough... had about the right balance of corporates and government that it sailed through 2008-2009 almost in a straight line. I really liked that!

I was suggesting that the obvious "flight to safety" suggests that most investors agree with the ratings agencies that U.S. Treasuries truly do have lower risk than the average corporate. That doesn't make them better, just less risky.

Vanguard Interm-Term Treasury VFITX--Morningstar average credit quality AA.
Vanguard Intermediate-Term Corp Bd ETF VCIT--Morningstar average credit quality A.

As for which is best, at a quick peek:

Vanguard Interm-Term Treasury Inv VFITX, 15-year Sharpe ratio 0.82
Corporate-heavy Vanguard Interm-Term Invmt-Grade Inv VFICX, 15-year Sharpe ratio 0.92

So, over the last 15 years you can say corporates had slightly better risk-adjusted return.

As for what a young person should do within a balanced portfolio that includes stocks, I think the question is "how much of the portfolio should be in something relatively low-risk?" I just can't believe that an investor who is 50% stocks is ever going to notice the difference, in their whole portfolio, between one flavor of intermediate-term government bonds and another. I think one should just pick some reasonable bond fund, adjust risk to taste by adjusting stock/bond ratio, and leave it at that.

If one were 95% bonds, 5% stocks then it might make some sense trying to think about the risk/reward proposition for bonds, and whether there is an argument for "corporate bonds for the long run" that similar to the (debated!) argument for "stocks for the long run."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

User avatar
dodecahedron
Posts: 5059
Joined: Tue Nov 12, 2013 12:28 pm

Re: Why government bonds at all?

Post by dodecahedron » Sun May 24, 2015 11:44 am

toto238 wrote:
Charities also build infrastructure, invest in citizen's education, and do a lot of other things beneficial to the entire society. And many charities have steady cash flow that make them very low credit risks.

I put it back to you: Why don't you invest in the bonds of charities and other non-profits?
Some people actually do invest in such bonds. Nonprofit colleges and hospitals, for example, can and do issue bonds for construction projects, for example. They are attractive to certain kinds of investors.

http://www.sgrlaw.com/resources/briefin ... ctice/459/

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Sun May 24, 2015 3:39 pm

Quote 'Nisiprius': "As for what a young person should do within a balanced portfolio that includes stocks, I think the question is "how much of the portfolio should be in something relatively low-risk?" I just can't believe that an investor who is 50% stocks is ever going to notice the difference, in their whole portfolio, between one flavor of intermediate-term government bonds and another. I think one should just pick some reasonable bond fund, adjust risk to taste by adjusting stock/bond ratio, and leave it at that. "

I think I have to differ on this one. If as example we take the two funds you used in your example (VFITX and VFICX) and ask M* for maximum period you find more than a 10% difference in return. A 10% or more difference in return on 50% of my portfolio does make a difference. What I suspect will become meaningful moving forward is the significant current difference in SEC yields, 1.37% for VFITX vs. 2.41 for VFICX. I believe the coming decade will see a greater variation of returns than the existing prior history does. Others opinion can and will vary.

rustymutt
Posts: 3948
Joined: Sat Mar 07, 2009 12:03 pm

Re: Why government bonds at all?

Post by rustymutt » Sun May 24, 2015 3:47 pm

Because they do really well during market crashes, or sharp sell offs. Treasuries are the one thing that didn't drop for me, but roose up nicely do to market demands. I was taught to keep the risk on the equity side of investments, and not the fixed income side. CDs, Treasuries.
Even educators need education. And some can be hard headed to the point of needing time out.

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Sun May 24, 2015 3:57 pm

rustymutt wrote:Because they do really well during market crashes, or sharp sell offs. Treasuries are the one thing that didn't drop for me, but roose up nicely do to market demands. I was taught to keep the risk on the equity side of investments, and not the fixed income side. CDs, Treasuries.

Out of curiosity, did you sell Treasuries to buy equities? or did you keep what you had?

User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Why government bonds at all?

Post by ogd » Sun May 24, 2015 5:25 pm

midareff wrote:Quote 'Nisiprius': "As for what a young person should do within a balanced portfolio that includes stocks, I think the question is "how much of the portfolio should be in something relatively low-risk?" I just can't believe that an investor who is 50% stocks is ever going to notice the difference, in their whole portfolio, between one flavor of intermediate-term government bonds and another. I think one should just pick some reasonable bond fund, adjust risk to taste by adjusting stock/bond ratio, and leave it at that. "

I think I have to differ on this one. If as example we take the two funds you used in your example (VFITX and VFICX) and ask M* for maximum period you find more than a 10% difference in return. A 10% or more difference in return on 50% of my portfolio does make a difference. What I suspect will become meaningful moving forward is the significant current difference in SEC yields, 1.37% for VFITX vs. 2.41 for VFICX. I believe the coming decade will see a greater variation of returns than the existing prior history does. Others opinion can and will vary.
Ah, but assets are not held in isolation. Treasuries enable you to get more stocks into your portfolio for the same level of risk. My gut feeling was that about 5% more (55/45) for the period 1994-2014 you mentioned, to keep risk constant, but it turns out I was way off.

The 55/45 US/Treasuries portfolio matches the return of the 50/50 US/Corp, but with much lower stddev and drawdown, resulting in a much more efficient portfolio.

https://www.portfoliovisualizer.com/bac ... entage=0.0

The 60/40 portfolio is more evenly matched, but it has superior returns and still slightly smaller stddev / drawdown.

https://www.portfoliovisualizer.com/bac ... entage=0.0

Now if you insist you want 50% of something called "bonds" in your portfolio, with IMHO insufficent regard for the quality, then I suppose you'd go with the higher yielder.

rustymutt
Posts: 3948
Joined: Sat Mar 07, 2009 12:03 pm

Re: Why government bonds at all?

Post by rustymutt » Sun May 24, 2015 5:48 pm

midareff wrote:
rustymutt wrote:Because they do really well during market crashes, or sharp sell offs. Treasuries are the one thing that didn't drop for me, but roose up nicely do to market demands. I was taught to keep the risk on the equity side of investments, and not the fixed income side. CDs, Treasuries.

Out of curiosity, did you sell Treasuries to buy equities? or did you keep what you had?
I did sell bonds during my normal rebalancing act in June of 09.
Even educators need education. And some can be hard headed to the point of needing time out.

Bfwolf
Posts: 2030
Joined: Thu Oct 14, 2010 11:19 am

Re: Why government bonds at all?

Post by Bfwolf » Mon May 25, 2015 1:17 am

I think part of the problem here is that we often see posts that discourage people from buying gold with an argument that goes something along the lines of "Gold is just a commodity with very limited use. It doesn't produce anything. Stocks and bonds, however, bestow participation in companies that earn real profits. Therefore, they are likely to have superior returns to gold."

The reality is that the argument is right, but only for stocks. As mentioned above, bonds do NOT participate in ANYTHING.

Bonds are valuable because they reward the lender for the time value of money. Somebody else in the world needs the cash NOW and is willing to pay a premium for it. That's why we buy bonds--lending money is profitable.

Whether the borrower is a corporation or a government is irrelevant. Both often need cash now and are willing to pay a premium to get it. The only thing that matters is the borrower's credit-worthiness and how much of a premium they are willing to pay you for the cash (i.e. what's the interest rate).

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Mon May 25, 2015 8:05 am

rustymutt wrote:
midareff wrote:
rustymutt wrote:Because they do really well during market crashes, or sharp sell offs. Treasuries are the one thing that didn't drop for me, but roose up nicely do to market demands. I was taught to keep the risk on the equity side of investments, and not the fixed income side. CDs, Treasuries.

Out of curiosity, did you sell Treasuries to buy equities? or did you keep what you had?
I did sell bonds during my normal rebalancing act in June of 09.

Thanks for the reply.... rustymutt... part of my point is that using chart illustrations showing a maximum difference rarely affect the individual investor. While you did well rebalancing in 6/09, by 6/12/09, as an example, the S&P500 had already risen 39% from bottom and VTIFX had declined about 12% from it's top, but as I say, you did well and much better than many others.

OTOH, someone using 5% total AA balance bands and a 60/40 portfolio would have seen (from the 10/12/07 peak) would have seen S&P500 10% declines (5% portfolio AA shift) triggering a rebalance 6 times, possibly 7 before absolute bottom. This would have consumed their bond portfolio, or what they were willing to sell from it before bottom while they watched their newly purchased additional shares sink again and again. Obviously, a more aggressive portfolio or conservative portfolio would effect the number of rebalances before depletion. Realistically, how many here would sell their "safe" money into a steadily declining market until it's ALL gone? ... how about you ogd? I know I don't have either the intestinal fortitude or desire to put 20+ years of retired drawdown at risk by doing that exercise a 4th, 5th or more times and I rode out the bottoms of 2002 and 2008.

FWIW, the difference in bond funds at the point of exhaustion (or giving up) were already meaningful, but at what meaning other than differences on a chart? Are you really throwing the remaining few thousand $ into the 7th rebalance? That brave?
Last edited by midareff on Mon May 25, 2015 8:24 am, edited 3 times in total.

rustymutt
Posts: 3948
Joined: Sat Mar 07, 2009 12:03 pm

Re: Why government bonds at all?

Post by rustymutt » Mon May 25, 2015 8:19 am

I was taught to re-balance once a year at the same time, and that's what I did. The organization seemed to work well. That was one heck of turn back in 08, and I wasn't sure in June 09 if I was doing the right thing. Turns out I did. It also helped me that I was retired in June of 09, and had been mostly cash in my 401K getting ready for that.
So the 401K did really well in the down turn, and became part of my IRA in June 09. I got lucky, and know it.
Even educators need education. And some can be hard headed to the point of needing time out.

User avatar
Robert T
Posts: 2620
Joined: Tue Feb 27, 2007 9:40 pm
Location: 1, 0.2, 0.4, 0.5
Contact:

Re: Why government bonds at all?

Post by Robert T » Mon May 25, 2015 10:00 am

.
Swensen (2009) Pioneering Portfolio Management.
No other asset type comes close to matching the diversifying power created by long-term, noncallable, default-free, full-faith-and-credit obligations of the US government.

Gulko (2002) Decoupling. Journal of Portfolio Management.
The returns of U.S. stocks and Treasury bonds are usually positively correlated, or coupled. As the stock market plunges, Treasury bonds tend to rally, and the daily returns become negatively correlated, or decoupled. In this article, the author examines the decoupling that accompanies stock market crashes. He begins by presenting empirical evidence of the stock–bond decoupling and next examines some implications. The main practical implication is that U.S. Treasury bonds offer effective diversification during financial crises, at the time it is needed most.

Harper (2003) Asset Allocation, Decoupling, and the Opportunity Cost of Cash. Journal of Portfolio Managment.
Shifting portfolio allocations to cash during periods of market volatility can be counterproductive. Instead, the use of longer-term U.S. Treasuries can increase returns and still hold portfolio risk constant. The rationale behind this result is decoupling, when the correlation of returns between equities and U.S. Treasuries becomes negative. Decoupling occurs during periods of high market uncertainty and can significantly improve returns.
.

User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Why government bonds at all?

Post by ogd » Mon May 25, 2015 12:45 pm

midareff wrote: OTOH, someone using 5% total AA balance bands and a 60/40 portfolio would have seen (from the 10/12/07 peak) would have seen S&P500 10% declines (5% portfolio AA shift) triggering a rebalance 6 times, possibly 7 before absolute bottom. This would have consumed their bond portfolio, or what they were willing to sell from it before bottom while they watched their newly purchased additional shares sink again and again. Obviously, a more aggressive portfolio or conservative portfolio would effect the number of rebalances before depletion. Realistically, how many here would sell their "safe" money into a steadily declining market until it's ALL gone? ... how about you ogd? I know I don't have either the intestinal fortitude or desire to put 20+ years of retired drawdown at risk by doing that exercise a 4th, 5th or more times and I rode out the bottoms of 2002 and 2008.
You don't need to rebalance to observe the higher quality of the Treasuries. In the portfoliovisualizer links I sent, rebalancing is "annually" so you already don't do much of it, but you can also select "no rebalancing" -- which gives the same conclusions about the 60/40 portfolio that uses Treasuries vs the 50/50 with corporates.

No, I didn't rebalance. Was way too inexperienced to handle what happened in 2008. On the other hand, I didn't sell and I maxed out the 401k with equities in the first few months of 2009, which ended up working quite well. I would probably do it today, subject to a fixed income minimum.

Pizzasteve510
Posts: 635
Joined: Sun Jul 27, 2014 3:32 pm

Re: Why government bonds at all?

Post by Pizzasteve510 » Mon May 25, 2015 12:55 pm

toto238 wrote:...
But government bonds don't work that way. The government isn't a profit-producing entity and its goal is not necessarily to produce a good or service that is economically productive. Sure the government may do some economically useful things, but there are no market forces acting upon it forcing it to do so or fail. There's no Creative Destruction really occuring. It's like a non-profit organization. A good charity may in fact be a good credit risk, but that doesn't mean I would buy their bonds....
As an employee of an entity that issues govt bonds, formerly an advisor to over 100 commercial entities around the globe I respectfully disagree.

For example, my current entity funded building a bridge, roads and a badly needed new tunnel, as well as the replacement of hundreds of public transit buses within the last few years.

[OT comments removed by admin LadyGeek]

Just saying....

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Mon May 25, 2015 3:28 pm

ogd wrote:
midareff wrote: OTOH, someone using 5% total AA balance bands and a 60/40 portfolio would have seen (from the 10/12/07 peak) would have seen S&P500 10% declines (5% portfolio AA shift) triggering a rebalance 6 times, possibly 7 before absolute bottom. This would have consumed their bond portfolio, or what they were willing to sell from it before bottom while they watched their newly purchased additional shares sink again and again. Obviously, a more aggressive portfolio or conservative portfolio would effect the number of rebalances before depletion. Realistically, how many here would sell their "safe" money into a steadily declining market until it's ALL gone? ... how about you ogd? I know I don't have either the intestinal fortitude or desire to put 20+ years of retired drawdown at risk by doing that exercise a 4th, 5th or more times and I rode out the bottoms of 2002 and 2008.
You don't need to rebalance to observe the higher quality of the Treasuries. In the portfoliovisualizer links I sent, rebalancing is "annually" so you already don't do much of it, but you can also select "no rebalancing" -- which gives the same conclusions about the 60/40 portfolio that uses Treasuries vs the 50/50 with corporates.

No, I didn't rebalance. Was way too inexperienced to handle what happened in 2008. On the other hand, I didn't sell and I maxed out the 401k with equities in the first few months of 2009, which ended up working quite well. I would probably do it today, subject to a fixed income minimum.

I am not arguing against the higher quality of treasuries ogd and quickly agree they are a higher quality holding vs. corporates. ... no doubt at all. I also agree that since they went up a bit when corporates went down, in 2008 as an example, the total portfolio dollar balance would have been higher with less volatility if treasuries replaced corporates. Also no doubt on paper this provides better diversification. What I question is the real value of this to the average investor. My first point is to what gain is the variation in behavior? My sleep is the same either way, others may not be so constitutionally inclined. My point #2 is that if you didn't rebalance, which may have had it's own set of dire consequences and timing issues as I described in an earlier thread, to what end is this also? A higher paper balance with less volatility in a crisis using treasuries vs. a higher continual monthly income with corporates providing a higher monthly monetary benefit in the short and longer term? .... and I speak only of investment grade corporates at that so this isn't a discussion of HY or junk. Whether you look at investment grade SEC or distribution yields it is what it is, treasuries to corporates of similar duration.

Ninegrams
Posts: 557
Joined: Sun Aug 17, 2014 6:12 pm

Re: Why government bonds at all?

Post by Ninegrams » Mon May 25, 2015 4:21 pm

midareff wrote:
ogd wrote:
midareff wrote: Whether you look at investment grade SEC or distribution yields it is what it is, treasuries to corporates of similar duration.
True, but you should also consider what the default rate on corporates would be in say a depression or even a brutal and protracted recession. You may be waiting quite a while to recover.

User avatar
midareff
Posts: 6900
Joined: Mon Nov 29, 2010 10:43 am
Location: Biscayne Bay, South Florida

Re: Why government bonds at all?

Post by midareff » Mon May 25, 2015 5:36 pm

Ninegrams wrote:
midareff wrote:
ogd wrote:
midareff wrote: Whether you look at investment grade SEC or distribution yields it is what it is, treasuries to corporates of similar duration.
True, but you should also consider what the default rate on corporates would be in say a depression or even a brutal and protracted recession. You may be waiting quite a while to recover.
Since we are talking about investment grade corporate funds you have to remember that when a companies bonds are downgraded and drop below investment grade this is generally prior to default. Default risk would be much greater in a high yield fund or junk fund.

User avatar
backpacker
Posts: 1620
Joined: Mon Sep 22, 2014 2:17 pm

Re: Why government bonds at all?

Post by backpacker » Mon May 25, 2015 5:51 pm

midareff wrote:
Ninegrams wrote: True, but you should also consider what the default rate on corporates would be in say a depression or even a brutal and protracted recession. You may be waiting quite a while to recover.
Since we are talking about investment grade corporate funds you have to remember that when a companies bonds are downgraded and drop below investment grade this is generally prior to default. Default risk would be much greater in a high yield fund or junk fund.
Default risk is more than just the risk that the bond issuer defaults while you hold the bond. It is also the risk that the bond is downgraded because the market thinks that the odds of default have increased. When an investment grade bond is downgraded to a junk bond, you lose money even if you manage to sell before the company actually defaults.

[Inner quote source fixed by admin LadyGeek (was ogd)]

User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Why government bonds at all?

Post by ogd » Mon May 25, 2015 7:56 pm

midareff wrote: I am not arguing against the higher quality of treasuries ogd and quickly agree they are a higher quality holding vs. corporates. ... no doubt at all. I also agree that since they went up a bit when corporates went down, in 2008 as an example, the total portfolio dollar balance would have been higher with less volatility if treasuries replaced corporates. Also no doubt on paper this provides better diversification. What I question is the real value of this to the average investor. My first point is to what gain is the variation in behavior? My sleep is the same either way, others may not be so constitutionally inclined. My point #2 is that if you didn't rebalance, which may have had it's own set of dire consequences and timing issues as I described in an earlier thread, to what end is this also? A higher paper balance with less volatility in a crisis using treasuries vs. a higher continual monthly income with corporates providing a higher monthly monetary benefit in the short and longer term? .... and I speak only of investment grade corporates at that so this isn't a discussion of HY or junk. Whether you look at investment grade SEC or distribution yields it is what it is, treasuries to corporates of similar duration.
"On paper" and "losing sleep" are really the two sides of the balance. If you don't care about "paper losses" then 100% stocks (or more) is the way to go. Of course, the reason you do care and the reason you do lose sleep is that you know what could happen / could have happened and that's why you're not there. Rebalancing has little to do with it -- the 60/40 US /Treasuries was simply the better portfolio. Now if you convince yourself that there is no difference between IG and Treasuries at the same allocation, then you get to make more money that way, but there is still the small question of "what could happen", and for me that says the Treasuries and IG are not the same thing, so I can't simply penalize Treasuries on account of yield without accounting for risk and without (as consequence) accounting for the amount of stocks I could hold instead.

There are no easy answers to this, including yours, midareff. Perhaps the best, cleanest way to decide is state taxes.
backpacker wrote:
midareff wrote:
Ninegrams wrote: True, but you should also consider what the default rate on corporates would be in say a depression or even a brutal and protracted recession. You may be waiting quite a while to recover.
Since we are talking about investment grade corporate funds you have to remember that when a companies bonds are downgraded and drop below investment grade this is generally prior to default. Default risk would be much greater in a high yield fund or junk fund.
This is misquoted. I didn't write the inner quote. [It's fixed now (was ogd) -- admin LadyGeek]

Post Reply