Great Depression Lesson - Is Total Bond Market Too Risky?

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InKirkWeTrust
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Great Depression Lesson - Is Total Bond Market Too Risky?

Post by InKirkWeTrust » Fri May 26, 2017 11:59 am

Long time lurker, first time poster here. Thanks to all who participate in this amazing community! I've learned so much is such a short time!

I'm reading Benjamin Roth's The Great Depression: A Diary, which is great, and it got me thinking about how risky equities can be! I'm 30, and Vanguard TR 2050 has a 90/10 allocation for me until age 40. Dave Ramsey tells his millions of followers to invest 100 percent in stock. Total Bond Market is 1/3 MBS, which despite their AAA rating, were central to the financial meltdown 10 years ago. This book got me to thinking that keeping a large chunk of good quality bonds in your AA very important.

In one entry from 10/25/1931 Roth writes, "The only conclusion I can come to is that at least half of the investor's money should be in good bonds." Another from 10/16/1931 says "It pays to do business only with the strongest bank in the community...In the same way money should be invested in the best bonds, stocks, real estate even tho the return is less."

What do Bogleheads think about short-term treasuries or short-term TIPS being be a more appropriate fund to balance out the risk associated with equities? Are traditional rules-of-thumb for AA like 50/50 - 60/40 - Age-in-Bonds still as useful today as they were 50+ years ago? Let me know what you think!
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by BogleMelon » Fri May 26, 2017 12:28 pm

For me, Vanguard Vanguard Total Bond Market Index Fund is the only bond fund that I am using. And I am using bonds not for their returns. Bonds for me is primarily to make the stock roller coaster ride more smooth in the tough times.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by alex_686 » Fri May 26, 2017 12:37 pm

InKirkWeTrust wrote:Total Bond Market is 1/3 MBS, which despite their AAA rating, were central to the financial meltdown 10 years ago.
I think you overstate your case here. I think MBS only figure at 20%. Of those MBS almost all are issued by, and thus insured by, Federal agencies. This explicit guarantee is new. We will not have a repeat of the meltdown of 10 years ago. Not saying we won't have a meltdown someplace, just that lightening rarely strikes twice.
InKirkWeTrust wrote:What do Bogleheads think about short-term treasuries or short-term TIPS being be a more appropriate fund to balance out the risk associated with equities? Are traditional rules-of-thumb for AA like 50/50 - 60/40 - Age-in-Bonds still as useful today as they were 50+ years ago? Let me know what you think!
It is a rule of thumb, and while rules of thumb may have a nugget of historical wisdom to share they tend to disintegrate under vigorous analysis.

I question the logic of 100% stocks. If bonds are overpriced and risky then stocks are also overpriced and risky. Less safety here then one may think.

Short term bonds are low risk but their rates tend to mimic inflation, so no real returns here. TIPS of almost any duration offer scant returns. I personally think the sweet spot of risk / return is intermediate corporate bonds.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by Top99% » Fri May 26, 2017 12:39 pm

I have seen so many threads here on Bogleheads and elsewhere with convincing data showing stocks *and* bonds can be very risky short term, medium term and long term that I only conclude the best course of action for me is to diversify across both (plus mix in some alternatives) and stay the course.
I think if the economy just ceases to function one would be pretty doomed with either (including TIPS and other government bonds) so I just can't lose sleep over that. Unless one has a sufficiently massive portfolio to be able to put gold bars in vaults in multiple countries investing will never be without risk.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by lack_ey » Fri May 26, 2017 1:01 pm

I think you have a misunderstanding about what the broad MBS market did. The problems were more in non-government-related issues and derivatives, though things could have gotten worse in the broad market without government intervention. The large majority of MBS, particularly in the broad, investment-grade indexes used for total bond funds, are government related and furthermore have different stipulations ever since Fannie and Freddie were bailed out.

Last 10 years for certain funds, with asset class coverage labeled (those aren't the actual fund names; "total" is with respect to US market):
Image
http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

The next stock bear market and even the next crisis will likely unfold in different ways but I don't think you should consider total bond meaningfully that different from short-term Treasury bonds. And if you do, the difference is really more in the length of the bonds and thus the duration, less so in the credit risk. And more of the concern and effect of credit risk is from the corporate bonds, really, not the MBS.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by NiceUnparticularMan » Fri May 26, 2017 1:24 pm

If you see bonds as a way of managing your individual risk, I don't see much reason to use Total Bond. I think it makes more sense to choose the specific bonds that are designed to do more or less precisely what you want them to do.

That said, it probably won't make a big difference for most people, and so using Total Bond (or using an All in One fund which uses Total Bond) isn't what I would call a really bad idea. I just don't think it has the same sort of justification behind it as diversifying equities.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by lazyday » Fri May 26, 2017 1:31 pm

InKirkWeTrust wrote:What do Bogleheads think about short-term treasuries or short-term TIPS being be a more appropriate fund to balance out the risk associated with equities?
David Swensen explains in Unconventional Success that TIPS and nominal Treasuries are separate asset classes that can perform differently in some situations. I like the idea of a 50/50 split between them, and prefer that over TBM which has no TIPS and includes some lower quality bonds compared to Treasuries.

I don't have much of on opinion on short vs intermediate term, or maybe long term for TIPS. Can depend on your situation.

You might also consider replacing some or all of the TIPS with I bonds, and some or all of the Treasuries with CDs or EE bonds.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by nisiprius » Fri May 26, 2017 1:35 pm

Yes, I want to chime in too about mortgage-backed securities. I'm basically saying the same thing as lack_ey.

I'm not sure what alex_686 means when he says "Of those MBS almost all are issued by, and thus insured by, Federal agencies. This explicit guarantee is new." I don't think the guarantee is new, unless "new" means "1980" (or maybe earlier), which is the date of inception of the Vanguard GNMA fund, VFIIX.

Unfortunately Google Books no longer seems to include old issues of Kiplinger's Personal Finance, but I can assure you that Vanguard's ads for this fund in the 1980s emphasized the government guarantee. VFIIX is six years older than Total Bond, was used in much the same way, and postings in the forum suggest that older investors who began with VFIIX has stuck with it. There are supposed risk factors because of "convexity" and "prepayment risk," but they are subtle issues of "lower risk-adjusted return," not issues of "lose all your money." The supposed risks of VFIIX have not shown up in any obvious way in the fund's 37 years of existence. It has slightly outperformed Total Bond and has had slightly better risk-adjusted return than Total Bond, and Morningstar considers the average credit risk of VFIIX to be "AAA."

Source
Image

So, these mortgage-backed securities are not believed to be risky. I can't speak to some of the other "government/agency" MBS in Total Bond.

The mortgage-based securities that blew up in 2008 were completely different, and, incidentally, if you search on "Mabel Yu" you will learn that Vanguard did not invest in them. These were the weird tranches-of-tranches things, in which the creators of these extremely artificially-structured product somehow managed to convince the ratings agencies that they had created products that held only very-low-quality, shaky mortgages, and yet the product itself was much less risky than the bonds it held and deserved an AAA rating. They were not, of course, government-guaranteed.

If Total Bond makes you uneasy, then it seems perfectly reasonable to substitute an intermediate-term Treasury fund instead.

I find it very confusing that some authorities complain that Total Bond is too risky and urge using an all-Treasury fund, while others (including John C. Bogle) complain that it is too heavy in government issues and that ordinary investors would be better served by taking on more risk in order tog et higher return. So I shrug and stay put in Total Bond.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by lack_ey » Fri May 26, 2017 1:58 pm

nisiprius wrote:I'm not sure what alex_686 means when he says "Of those MBS almost all are issued by, and thus insured by, Federal agencies. This explicit guarantee is new." I don't think the guarantee is new, unless "new" means "1980" (or maybe earlier), which is the date of inception of the Vanguard GNMA fund, VFIIX.
Most MBS in Total Bond are not GNMAs. A quick check indicates GNMAs are only 28% of the iShares MBS index ETF I mentioned above. Ginnie Mae is a wholly owned government corporation and the MBS it insures are backed by the government. A lot of the other MBS are from Fannie Mae and Freddie Mac, which would count as government-related in the sense of being government-sponsored enterprises. But those were public companies and there was no explicit government guarantee.

Things are different now that Fannie and Freddie had to be bailed out and were placed into conservatorship by the government, with the Treasury effectively backing what Fannie and Freddie had insured. You'd have to ask somebody who actually knows something about the legal implications and what is explicit vs. implicit. Is there an actual guarantee or is the implicit government backing even stronger now?

My point here is that you're not addressing any of the changes in status of Fannie and Freddie and their MBS by citing a GNMA fund. GNMAs have been like that since the start. Which I think you partially acknowledged further down in the post to some degree.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by 3CT_Paddler » Fri May 26, 2017 2:22 pm

I know Larry Swedroe has often advocated for shorter term high quality (aka Treasury) bonds. Basically take your risk on the equity side, as the premiums are better compensated. And with higher quality bonds, maybe you can inch your portfolio more towards stocks.

The difficulty of the past almost 15 years is that short term Treasuries are just so low, it feels like you are giving up on earning much of anything after inflation on the bond side.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by matjen » Fri May 26, 2017 2:23 pm

nisiprius wrote: I find it very confusing that some authorities complain that Total Bond is too risky and urge using an all-Treasury fund, while others (including John C. Bogle) complain that it is too heavy in government issues and that ordinary investors would be better served by taking on more risk in order tog et higher return. So I shrug and stay put in Total Bond.
So true. It seems to me that Bogle is reaching for yield a bit. Having said that, Swedroe was much more pro-CD than Short/Med Term Treasuries the last couple of years and has really endorsed Stone Ridge's LENDX in the last 6 months (as a portion of one's fixed income) which is alternate lending and certainly riskier than treasuries though shorter duration than an intermediate term bond fund.
Last edited by matjen on Fri May 26, 2017 3:27 pm, edited 1 time in total.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by NiceUnparticularMan » Fri May 26, 2017 2:31 pm

3CT_Paddler wrote:I know Larry Swedroe has often advocated for shorter term high quality (aka Treasury) bonds. Basically take your risk on the equity side, as the premiums are better compensated. And with higher quality bonds, maybe you can inch your portfolio more towards stocks.

The difficulty of the past almost 15 years is that short term Treasuries are just so low, it feels like you are giving up on earning much of anything after inflation on the bond side.
Of course it is a relatively flat yield curve too, so increasing term doesn't help much.

I'm not one to speculate on yields in general, but it seems pretty clear that to the extent longer-term bonds made up for low yields with falling rates, that game is probably mostly over--there just isn't much of anywhere to go:

Image

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by oldcomputerguy » Fri May 26, 2017 2:34 pm

InKirkWeTrust wrote:Long time lurker, first time poster here. Thanks to all who participate in this amazing community! I've learned so much is such a short time!

I'm reading Benjamin Roth's The Great Depression: A Diary, which is great, and it got me thinking about how risky equities can be! I'm 30, and Vanguard TR 2050 has a 90/10 allocation for me until age 40. Dave Ramsey tells his millions of followers to invest 100 percent in stock. Total Bond Market is 1/3 MBS, which despite their AAA rating, were central to the financial meltdown 10 years ago. This book got me to thinking that keeping a large chunk of good quality bonds in your AA very important.

In one entry from 10/25/1931 Roth writes, "The only conclusion I can come to is that at least half of the investor's money should be in good bonds." Another from 10/16/1931 says "It pays to do business only with the strongest bank in the community...In the same way money should be invested in the best bonds, stocks, real estate even tho the return is less."

What do Bogleheads think about short-term treasuries or short-term TIPS being be a more appropriate fund to balance out the risk associated with equities? Are traditional rules-of-thumb for AA like 50/50 - 60/40 - Age-in-Bonds still as useful today as they were 50+ years ago? Let me know what you think!
The majority of our fixed-income allocation is in funds that benchmark to Barclay's Aggregate index (in my tIRA and in DW's 401k). The exception is an allocation targeted for tapping in two to three years, that is in Fidelity Short-term Treasury Index Fund (FSBAX). As I see it, there are two basic schools of thought on this question. On the one hand, diversification of bonds, although not as essential as for stocks, serves a useful purpose, and so Total Bond is a better choice. On the other hand, if your allocation is more oriented to safety and less to return, going 100% US Treasuries for your bond AA is a good choice. I fall into the former category except (as noted) that I have a short-term investment in a "near-cash" Treasury index fund allocation.

While the idea of bonds that are guaranteed to be indexed to the rate of inflation seems on the surface to be a good idea, I prefer to let my stock allocation be my counter to inflation, and don't invest in TIPS at all.

My AA is one that I reached after doing some math on the following questions: (a) how much money will I need to cover expenses in retirement; (b) how much of that will have to come from my retirement funds; (c) how much does my current nest egg need to grow to get there; and (d) how much risk do I need to carry to meet that goal. If one is just starting out in their saving/investing career, a rule of thumb is as good as doing the math, and probably easier to reach and to stick with. As one progresses through the years, the AA can be fine-tuned to meet changing life events.
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Total Bond Market and Risk?

Post by Taylor Larimore » Fri May 26, 2017 2:56 pm

Is Total Bond Market Too Risky?
InKirkWeTrust:

Welcome to the Bogleheads Forum!

Vanguard's Total Bond Market was invented and introduced by our mentor, John Bogle in 1986 (the year I began investing in Vanguard). It's worst annual loss was -2.7% in 1994 (it gained +16% in 1995).

If you are concerned about risk in your portfolio, reduce your stock allocation and increase Total Bond Market.

Best wishes.
Taylor
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by TheTimeLord » Fri May 26, 2017 3:26 pm

Haven't read the whole thread but I think building an investment strategy on the unlikely outcome of another Great Depression will disadvantage you in most of the likely outcomes.
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Re: Total Bond Market and Risk?

Post by TheTimeLord » Fri May 26, 2017 3:29 pm

Taylor Larimore wrote:
Is Total Bond Market Too Risky?
InKirkWeTrust:

Welcome to the Bogleheads Forum!

Vanguard's Total Bond Market was invented and introduced by our mentor, John Bogle in 1986 (the year I began investing in Vanguard). It's worst annual loss was -2.7% in 1994 (it gained +16% in 1995).

If you are concerned about risk in your portfolio, reduce your stock allocation and increase Total Bond Market.

Best wishes.
Taylor
But that was during the greatest bond rally in U.S. history so I think it is hard to classify it as typical behavior.
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.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by azanon » Fri May 26, 2017 4:33 pm

I think it's more risky than it has to be. Let me explain.

My opinion on Total Bond fund changed one day ago when I just happened to pull up its portfolio mix, and pay a bit more attention to it than I had in times past. Up until then, I had just assumed the fund was a mixture of various types of bonds, all of which were intermediate duration (because it was in the intermediate duration box). For some reason, I never noticed that it was actually a mixture of bonds at short, intermediate, and long term duration which to me, isn't near as optimal.

Every book on bonds (such as The Bond Book) I've read has more or less said the same thing which is, on average, the sweet spot of risk-return duration, or sweet spot of the yield curve is in the intermediate range. So why is everyone flocking to a bond fund where 2/3rds of the bonds held are outside of the optimal duration range?

So for that reason, I think the better bond fund that I'd consider to be less risky (at least with respect to duration) since it has no long-term bonds, and more optimal in terms of risk/reward since it's all IT bonds, is Intermediate-Term Bond Index Admiral. This fund also has the advantage of having a closer treasury to corporate mix that Bogle has been quoted as preferring (a 50/50 mix).

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by stevewolfe » Fri May 26, 2017 6:27 pm

It's an interesting debate. However in my situation, lions share of bonds in 401 (k) which offers Total Bond, Stable Value, Inflation protected bond and a junk bond fund. So unless I want to move things around all over the place, those are the options for a bulk of the bonds. I'd suspect investment options rule the day for many others as well. Makes me think of the perfect as the enemy of the good. :beer

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by jalbert » Fri May 26, 2017 6:37 pm

Only a tiny fraction of the residential MBS in the total bond market index are GNMAs. Most are FNMAs and Freddie Macs, neither of which have an explicit credit guarantee by the US govt. That said, they are considered to have high credit quality with an implicit, but not contractual guarantee.
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by LadyGeek » Fri May 26, 2017 7:08 pm

I removed an off-topic post conjecturing what might happen on a second bailout of Fannie and Freddie. As a reminder, see: Politics and Religion
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by LadyGeek » Fri May 26, 2017 7:10 pm

To help new investors follow the discussion, the wiki has some background info:

- Fannie Mae, a.k.a. "Fannie"
- Freddie Mac, a.k.a. "Freddie"
- Mortgage-backed security, "MBS"
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by Earl Lemongrab » Sat May 27, 2017 11:51 am

For me, it's relatively simple. All of my fixed-income is in the 401(k). That offers three funds, Bond Index (near equivalent to Total), stable-value, and an active international bond fund. Discarding the last, I have two choices, so I split it 50/50. Done
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by aj76er » Sat May 27, 2017 2:29 pm

Vanguards Total Bond Market Fund has had a historical stddev of around 3% and currently it's yield is about the expected inflation rate (or perhaps a bit more). I use it to dampen equity exposure, without losing to inflation. In other words, it's cheap insurance, and that's good enough for me :).
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by cpan00b » Sat May 27, 2017 5:57 pm

aj76er wrote:Vanguards Total Bond Market Fund has had a historical stddev of around 3% and currently it's yield is about the expected inflation rate (or perhaps a bit more). I use it to dampen equity exposure, without losing to inflation. In other words, it's cheap insurance, and that's good enough for me :).
WHat's your AA between bonds and stocks?

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by garlandwhizzer » Sun May 28, 2017 1:00 pm

For me, there's a simple answer the question: Great Depression Lesson - Is Total Bond Market Too Risky?

No.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by Theoretical » Sun May 28, 2017 1:09 pm

I don't think it's too risky. I do think the negative convexity of mortgage bonds is a counter-productive component for managing tail risks because of the interplay between interest rates and duration.

Bogle and Ferri say it doesn't have enough corporates. Swedroe and Bernstein don't like that it has corporates and mortgage bonds. As Taylor often reminds "where experts disagree, it probably doesn't make a difference" (I know that's a bit butchered.)

Personally, I'm a Treasury, CD and Muni guy. But there's nothing wrong with BND, and the fact that it was smooth sailing in the midst of a massive collapse in the mortgage market specifically and credit all-around should give you peace of mind, because whatever the next crisis is, it'll probably be different.

Also, the fact that it includes both short and long bonds means you get some outsized protection in either the inflationary (1970s and t-bills) or deflationary (1930s/2008) swings than a narrow intermediate fund.

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by aj76er » Sun May 28, 2017 3:50 pm

cpan00b wrote:WHat's your AA between bonds and stocks?
67% Equities (70/30 US/Intl)
23% Total Bond Mkt
10% Cash (high yield saving account)

The high cash allocation is remnants of a house sale from 9mos ago that I've been DCAing into the market. However I'm considering holding at 10% as im finding that it has a certain SWAN factor for me :)
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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by Nova1967 » Mon May 29, 2017 8:26 am

My bond allocation is in the TSP G fund 30% and F fund 10% , in the crash of 08 they were both up 5%, I believe TBM was also up 5% in 08

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Re: Great Depression Lesson - Is Total Bond Market Too Risky?

Post by InKirkWeTrust » Tue May 30, 2017 11:54 am

Thanks everyone for your replies! My default reaction to the totality of the responses is summed up in Taylor Larimore's saying, "When experts disagree, it is often because it makes no foreseeable difference." Right now I am 70% Total Stock Market and 30% Total Bond Market. I feel good about that allocation, but there's still that urge to tinker and wonder if there's a better way. I guess that's why we come to Bogleheads! I still have much to learn but you all have given me plenty to think about. Cheers! :sharebeer
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