"Why You Shouldn't Substitute Stocks for Bonds"

[Taylor Larimore]

Bogleheads:

Interest rates are low and bond forecasts are scary. Substituting high-dividend stocks for bonds is a strong lure for investors. A recent AARP article by Boglehead Allan Roth explains why substituting stocks for bonds can be a major mistake. These are excerpts:

"One adviser suggested investors in their 60s invest 70 to 80 percent of their portfolio in stocks. I couldn’t disagree more."

"It’s a misconception that interest rates are near an all-time low. What matters is the real return after taxes and inflation. -- Real rates are actually much better today than when we could get 12 percent nominal returns."

"It may seem like AT&T is a very safe company, but so did General Motors and Eastman Kodak at one time. Both paid high dividend yields and were among the 10 most valuable companies on the planet. Both filed for bankruptcy and common shareholders got nothing."

"So far this century, bonds have far outpaced stocks."

"Many of the top economists have correctly predicted the direction of interest rates less than half the time, meaning their forecasting abilities are less accurate than a coin flip."

"Bonds should be safe and boring." -- "I’ve seen too many “new paradigms” end poorly for investors."

Why-you-shouldnt-substitute-stocks-for-bonds/

Thank you, Allan Roth.

Best wishes
Taylor

[nedsaid]

Taylor, this is a good article and it brings up excellent points that investors should consider.

At age 56, I have 68% of my retirement in stocks and 32% in bonds and cash. This is roughly in proportion to what Vanguard, Fidelity, and T. Rowe Price recommend in their 2025 Target Date Retirement Funds. I have to admit this percentage seems high to me but at least I am not "way out there" in my thinking.

I have kept my stock allocation relatively high in part because of the very low interest rates. But Allen Roth is right, you have to consider the yield after inflation which right now isn't bad. Interest rates are very low but inflation is also very low too.

I have been mildly rebalancing my portfolio from stocks to bonds in stages since July of 2013. Had I done nothing, I would be probably over 72% in stocks now.

You will be glad to know two things. First of all, at my new job I am utilizing a two fund portfolio at my workplace savings plan: 60% in a global stock index and 40% in an investment grade bond fund. Secondly, my most recent purchase in my Brokerage IRA account is the Vanguard US Total Bond Market Index ETF.

[TheTimeLord]

"So far this century, bonds have far outpaced stocks."

I agree with the sentiment for the most part although I am more the John Bogle Anchor windward philosophy in regards to why hold fixed income. And personally, I think the struggle would be more between simple S&P 500 index funds versus Bonds than High Dividend Individual stocks. At least that is where I struggle with the S&P 500 yielding at touch over 2%. But I do find the above statement taking the first 15 years of a century as a meaningful measure of time a tad suspect. Bottom line would seem to be whether with stocks or even low quality bonds reaching for yield is fraught with potential peril.

[Ron]

Even if you are older than dirt (as I/wife are ), there are circumstances in which a high stock percentage may be wise to hold.

In our case (late 60's) we are investing not only for ourselves, but also for the future of our adult disabled "child", who will have an expected normal lifespan. While we are blessed to be able to fund our own retirement with our various current/future income streams, along with increasing greatly reduced portfolio withdrawals (due to age 70 SS for both of us in two years), we look at our joint equity holdings as if we were 22 years younger - the age we were when our son was born.

While you might think that he only has to have enough money to "live as one", his future support services (after we're gone) will most certainly require expenditures normally thought of as being the same as a couple.

There are always exceptions to any rule...

- Ron

[Taylor Larimore]

Bottom line would seem to be whether with stocks or even low quality bonds reaching for yield is fraught with potential peril.

TheTimeLord:

I agree.

“More money has been lost reaching for yield than at the point of a gun”

Best wishes.
Taylor

[mickeyd]

If you stay true to your long-term plan, distractions like this are easy to avoid, but fun to read about.

[michaeljc70]

Even if you are older than dirt (as I/wife are ), there are circumstances in which a high stock percentage may be wise to hold.

In our case (late 60's) we are investing not only for ourselves, but also for the future of our adult disabled "child", who will have an expected normal lifespan. While we are blessed to be able to fund our own retirement with our various current/future income streams, along with increasing greatly reduced portfolio withdrawals (due to age 70 SS for both of us in two years), we look at our joint equity holdings as if we were 22 years younger - the age we were when our son was born.

While you might think that he only has to have enough money to "live as one", his future support services (after we're gone) will most certainly require expenditures normally thought of as being the same as a couple.

There are always exceptions to any rule...

- Ron

Great point. It can also be as simple as you don't need all of your investments to live on and your heirs don't need the money. In that case, I would be more aggressive even if retired.

[pascalwager]

"Reaching for yield" is subject to interpretation.

Some advisors consider going out beyond 2 1/2 years duration to be reaching for yield. Actually, my advisor DFA portfolios never exceeded one or two years duration/maturity and, as I recall, the basic IFA portfolio overall duration (using four DFA bond funds) has been about 1.8 years.

This viewpoint considers the VG TBM fund (5.8 years duration) a definite reach, unless it's combined with shorter term bond funds (John Bogle does this to a modest degree).

I combine two VG Treasury funds for an overall duration of 4.1 years which is longer than I'm used to; but I only have 5% in these bonds (and another 2% in Treasury I Savings Bonds), so the portfolio volatility is dominated by the high (93%) stocks allocation. (I may gradually increase AA to 10% bonds, possibly using a DFA short-term fund(s), or else stick with VG Treasuries.)

I can understand that many retirees are reaching for yield by necessity and hopefully the risk will not be realized; but even investment grade bonds can be a reach.

[Fallible]

Thanks Allan for putting "boring bonds" in all-important perspective, which is often lost amid bond and rate fears and predictions and just plain misinformation. Especially liked this (and the bit of humor):

Finally, though I’ll buy the argument that we are all living longer, that doesn’t necessarily translate into owning less in bonds. In fact, so far this century, bonds have far outpaced stocks. I keep hearing that “everyone knows rates have to rise” (which will cause bond prices to decline) and can’t help but wonder who those “everyones” might be. If it’s many of the top economists, keep in mind that they have correctly predicted the direction of interest rates less than half the time, meaning their forecasting abilities are less accurate than a coin flip.

Also, the market is typically unkind to those investing on knowledge everyone knows. If rates do rise, your yields will go up as bond funds buy new bonds at higher rates as bonds mature. Your bonds should be safe and boring. Bank CDs with easy early withdrawal penalties are an even better place to stash your cash.

Thanks Taylor for posting.

[burt]

Need, ability, and willingness to take risk.
I have “just enough” to retire this year. No heirs needing help.

Need: none
Ability: very little
Willingness: very little.

30/70 : stock/bond

burt

[SeeMoe]

Timely article, especially for us oldsters ! My folio , I'm taking RMD's, is 45/55 with all bonds in the IRA's .

[abuss368]

Excellent advice and thank you for sharing. We are staying the course with age less 10 in bonds.

Keep investing simple!

[small_index]

...

[Allan Roth]

[quote="TheTimeLord"][quote]"So far this century, bonds have far outpaced stocks."

But I do find the above statement taking the first 15 years of a century as a meaningful measure of time a tad suspect. /quote]

We are closing in on 16 years. It is very meaningful but not predictive.

[Allan Roth]

But I do find the above statement taking the first 15 years of a century as a meaningful measure of time a tad suspect.

We are closing in on 16 years. It is very meaningful but not predictive.

[TheTimeLord]

"So far this century, bonds have far outpaced stocks."

But I do find the above statement taking the first 15 years of a century as a meaningful measure of time a tad suspect.

We are closing in on 16 years. It is very meaningful but not predictive.

What are the number of 20 year periods that bonds have out performed stocks and when was the first one?

[Allan Roth]

"Reaching for yield" is subject to interpretation.

Some advisors consider going out beyond 2 1/2 years duration to be reaching for yield. Actually, my advisor DFA portfolios never exceeded one or two years duration/maturity and, as I recall, the basic IFA portfolio overall duration (using four DFA bond funds) has been about 1.8 years.

For the last several years, everyone knew that rates had to increase. As usual, everyone was wrong. CDs with easy early withdrawal penalties are one way that investors can get intermediate-term yields with short-term interest rate risk.