Why bonds when one's investment horizon is long?

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football236
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Why bonds when one's investment horizon is long?

Post by football236 »

Hi. Many target date funds are invested in bonds to a significant degree. For example, ~10% of the Vanguard Target Retirement 2060 Fund (VTTSX) is in bonds:
7.2% Vanguard Total Bond Market II Index Fund Investor Shares
2.9% Vanguard Total International Bond Index Fund Investor Shares

Simply stated, my question is when someone has such a long investment horizon, why bonds at all? I understand bonds typically temper your losses when the market crashes, but they also temper your gains when the equity market is bullish. Furthermore, though they temper losses during down times, that doesn't seem necessary when one has such a long horizon.

Are there any other arguments for bonds when one has such a long horizon? I ask because I'm thinking of skipping the target date fund and investing in its equity constituents directly.

Thank you for your input and thoughts.
John Laurens
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Re: Why bonds when one's investment horizon is long?

Post by John Laurens »

I would say 10% bonds is not significant. Risk adjusted returns with 10% bonds vs 0% bonds are nearly identical. Bonds are for diversification and to reduce short term volatility. They also give you a bucket for rebalancing. If 100% equities are best for long term investors, borrowing on margin would be even better, right?

I promise you a 90/10 AA is going to give you plenty of return and test your BH mentality/gut.

It seems 100% equity AA questions are coming up more in 16'/17' than they did in 08'/09'...hmm.

Regards,
John
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Re: Why bonds when one's investment horizon is long?

Post by nisiprius »

1) Because the notion that stocks are safe if the investment horizon is long is an overly simplistic statement of a complicated reality.

2) Because we need to consider our own behavior. Suppose investor A says "I will not sell if my portfolio value falls 50%," and his portfolio value falls 50%, and he sells. Suppose investor B says "I will not sell if my portfolio value drops 25%," and his portfolio value falls 25%, and he does not sell. In many scenarios investor B ends up better off despite lower theoretical returns.

3) Because there's no magic in 100.000%. It's not an optimum. It's not special. It's just a number. You have to make a decision, risk tolerance has to be part of your decision, and 100% is only special for psychological reasons. (By the way, stocks are not monogamous, and they will not be any less fickle to the investor who shows them 100% commitment). If you do not feel that there are limits on the risk you are willing to take, or that there is any risk in a 20-year stock investment, then there is no logical reason to stop at 100%, rather than using leverage to go to 120% or 140% (which I've been told is the value suggested by the "Kelly criterion" for betting).

Let me cite two quotations I'm fond of. Both of these can be and have been debated in this forum, but they support what I've said above: it's a very complicated reality.

1) Jeremy Siegel's own words from 2004. Siegel is the author of Stocks for the Long Run and is frequently misrepresented as saying that the risk of stocks decreases with longer holding periods.
...many of you who have gone to my presentations have probably seen that slide before. Now, one thing I should make very clear, I never said that that means stocks are safer in the long run. This is the standard deviation of average annual returns. We know the standard deviation of the average goes down when you have more periods. Even if it’s random walk, it goes down. What I pointed out here is that the standard deviation for stocks goes down twice as much— twice as fast as random walk theory would predict. In other words, they are relatively safer in the long run than random walk theory would predict. Doesn’t mean they’re safe.
2) Pastor and Stambaugh, 2011 Are Stocks Really Less Volatile in the Long Run?
According to conventional wisdom, annualized volatility of stock returns is lower over long horizons than over short horizons, due to mean reversion induced by return predictability. In contrast, we find that stocks are substantially more volatile over long horizons from an investor's perspective. This perspective recognizes that parameters are uncertain, even with two centuries of data, and that observable predictors imperfectly deliver the conditional expected return. Mean reversion contributes strongly to reducing long-horizon variance, but it is more than offset by various uncertainties faced by the investor, especially uncertainty about the expected return. The same uncertainties reduce desired stock allocations of long-horizon investors contemplating target-date funds.
Last edited by nisiprius on Thu Jun 22, 2017 12:30 pm, edited 2 times in total.
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dbr
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

In short volatility compounds so that as time goes on the result becomes more and more uncertain. There is a trade-off of uncertainty with the overall trend to growth of your investments. You get to choose that trade-off and are ignoring important things about what investments do if you make that choice without considering the consequences. The basic handle on how much potential growth should be traded with how much uncertainty is stock/bond allocation.

tl;dr Not having bonds is like driving a car without brakes.
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Re: Why bonds when one's investment horizon is long?

Post by TBillT »

Cap gains is one reason.
I believe 30-yr Treasuries have out-performed S&P 500 by 5.5x since 1980.

Although it is tempting to think interest rates have bottomed, that is not really the correct way to think about it.
The correct way to think about is, if the 30-year Treasury goes from 3% to 2% you get 3/2 = 50% cap gain + interest.
Better move fast though as we are already down to 2.75%.
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Re: Why bonds when one's investment horizon is long?

Post by Day9 »

If stocks have an unprecedented nose dive then even a 90/10 portfolio would preserve much more capital than a 100% stock portfolio. The NASDAQ lost 80% of its value from peak to bottom in the dot com bubble crash.
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Re: Why bonds when one's investment horizon is long?

Post by soupcxan »

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Re: Why bonds when one's investment horizon is long?

Post by dbr »

Day9 wrote:If stocks have an unprecedented nose dive then even a 90/10 portfolio would preserve much more capital than a 100% stock portfolio. The NASDAQ lost 80% of its value from peak to bottom in the dot com bubble crash.
Yes, the numbers would be remaining value of 10% vs 19%, which is both substantially more residual value but hardly comforting.
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Re: Why bonds when one's investment horizon is long?

Post by niners9088 »

All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.

The reason people keep bonds is so that when the market drops 50%, 70%, 90% they would have to be absolutely certain they don't change from the 100% allocation or pull their money out of the market.

Once your timeframe shortens you don't want to keep 100% stocks due to the increased chance of sequence of return risk.

I've kept approximately 95% in stocks for the last 15 years. During the last recession I didn't have a very large account so I welcomed the opportunity to buy at a discount. Now ~10 years later with a much larger account balance I'm still at 95% stock but I do contemplate if I would change if I lost $100k's vs. $10k. I'll just have to welcome the discount again.


On a side note has there been any studies or research on allocation adjustments based on timeframe from last recession? For example for every year of positive market gains you shift x% of your portfolio to bonds from stocks and once a negative year hits you move x% from bonds to stocks?
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

niners9088 wrote:All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.
More accurately 100% stocks has higher expected returns than any mix below 100% stocks and also higher expected volatility of returns. Whether or not that is better depends on one's criterion for better. And that is the heart of the discussion.
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Re: Why bonds when one's investment horizon is long?

Post by TBillT »

soupcxan wrote:
TBillT wrote:if the 30-year Treasury goes from 3% to 2% you get 3/2 = 50% cap gain + interest.
lol those numbers are completely wrong
Hmm well I admit I was being approximate,,, but directionally that's the idea. That's why 30-Bond is up 5.5x vs. S&P 500 since 1980.
If you really truly believe long term rates are going down you can purchase the zero coupon 30-year bond and turn a bigger cap gain.
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Re: Why bonds when one's investment horizon is long?

Post by arcticpineapplecorp. »

Day9 wrote:If stocks have an unprecedented nose dive then even a 90/10 portfolio would preserve much more capital than a 100% stock portfolio. The NASDAQ lost 80% of its value from peak to bottom in the dot com bubble crash.
I never understand why people quote the NASDAQ as if that's somehow "the market". It's not. It's essentially a sector bet, mostly technology if you will. If we look at the dot com bubble...though do you know when the bottom of the bubble burst? No, me neither. So let's just look at the whole period from January 1, 2000 to Sept. 30, 2002. Why end then? Because that was the bottom before things started going up again. It wasn't just the dot com crash though, it also included 9-11 and a recession post 9-11. Still let's compare "the market" as in the total U.S. stock market index fund vs. the NASDAQ (measured by the QQQs which Suze Orman just thought was the greatest thing since sliced bread right up until the dot com crash). You can question if even using just the U.S. total stock market index fund is disingenous because we're missing the total international stock market index fund in the mix (which would be more total than total U.S.). But that's another graph and I didn't want to overcomplicate things. Since the NASDAQ is "U.S." and the total U.S. stock market index is "U.S." let's just compare those two to start.

How'd they measure up? The NASDAQ was down 77.65% (in orange below) while the total stock market was down 41.58% (in blue below). Now a 90/10 portfolio for each would have meant your portfolio being down around 69.88% with the NASDAQ vs. 37.42% with the total U.S. Stock Market Index Fund.

Ask yourself how you'd feel losing 37% instead of 42% (as has sorta been mentioned already by dbr). Enjoy the pretty pictures.

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Re: Why bonds when one's investment horizon is long?

Post by freyj6 »

I agree it makes little sense to hold lower than 100% if your time horizon if very long, your risk tolerance is high and you plan to be 100% passive.

My personal opinion is that it does make sense to slowly change allocations based on valuations. The ratio of risk to return changes dramatically when valuations get high enough, and there is a point (maybe around CAPE 40) where stocks really do have lower expected returns than bonds.

I suppose I'm taking a bit of a gamble by lowering my stock allocation down from 100% (just recently). But I think at some point any rational investor must decide that valuations matter, even if it's not until forward expect returns become negative.
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Re: Why bonds when one's investment horizon is long?

Post by KlangFool »

football236 wrote:
Simply stated, my question is when someone has such a long investment horizon,
football236,

The big elephant in the room.

How do you know that you have a long investment horizon?

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Re: Why bonds when one's investment horizon is long?

Post by TD2626 »

Stocks can easily lose 40-60% at any point. A Great Depression like scenario could see 90% losses in stocks. As has been pointed out, the NASDAQ has lost 90% in the relatively recent past. I don't think a 100% stock portfolio is wise - but claiming to have 100% equities implies that one has $0.00 in cash (or doesn't include it in their portfolio). Few truly have a 100% stock portfolio for good reasons.

To make it clear, to invest this heavily in stocks involves real risk of losses on the order of 90% or more. One must truly understand the risks involved and be committed to staying the course to have more than about 75% equities. A traditional 60/40 has far less risk. Assuming an investor has the willingness, ability, and need to take this kind of risk, they still should strongly consider bonds.

Even 80%+ equities people should have long term bonds in their portfolio, in my opinion. Things like long term treasuries have a relatively low correlation with stocks - possibly even negative. In 2008-2009 they were up substantially when total market was down. Having duration risk, and possibly a little credit risk in corporates, can diversiy a portfolio away from betting it all on the equity risk premium. Plus, bonds that are long term or low credit quality have enough return that a small allocation is unlikely to detract from overall portfolio returns very much. Of course, this is very risky and inappropriate for those wanting a bond fund as a safe, stable income source. But those wanting bonds for diversification of equity risk and total return may consider longer term bonds.

Even 80% + equities people should consider short term bonds in their portfolio, in my opinion. Everyone needs safe reserves. Tier 1 of an emergency fund is likely cash in a savings account or money market. Tier 2 may be short term bond investments.

But hey, if you're going to have long term bonds and short term bonds, why not just get a Total Bond Index Fund? It invests in short term, intermediate term, and long term bonds of many types. Total bond is recommended in the three fund portfolio.


Just an idea to support the TBM holding:

In the rare event you need your "tier 2 emergency reserves" (i.e. short term bonds) while the long term bonds you hold for total return are simultaneously tanking, you could just partially sell out of TBM and simultaneously buy a long term bond fund to avoid having to reduce exposure to long term bonds in the midst of a down market.

Could someone let me know if the ideas in the previous sentence (TBM instead of a barbell strategy for a high equity investor) seems reasonable?
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Re: Why bonds when one's investment horizon is long?

Post by Detroittl »

Don't forget some years bonds do better than stocks
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Re: Why bonds when one's investment horizon is long?

Post by gordoni2 »

Time is a diversifier, but a weak one. Or to put it another way, you probably need a much longer investment horizon than you might imagine.

A conservative assumption (used in the figure below) might be that going forward stocks will return 4.5% arithmetic real return, an annual standard deviation of 16.8%, and no long term auto-correlation effects (for a 3.2% expected geometric real return). Then over 50 years, the standard deviation in annualized return will be roughly 1/sqrt(50) times 16.8%, or 2.4%. Now you need +/- two standard deviations to generate a 95% confidence interval. So a 95% confidence interval on annualized real return after 50 years would be roughly -1.6% to 8.0%.

Thus even after 50 years stocks might plausibly return a negative real return! You might not want to take that risk. Fortunately, long-term inflation indexed bonds currently pay a guaranteed 0.9% real with very little risk.

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Re: Why bonds when one's investment horizon is long?

Post by stemikger »

I didn't read the other replies, but for me it has always been part of the my investing plan to choose a balanced approach between stocks and bonds. Even when I had decades ahead of me, it helped me understand how my asset allocation worked in different types of environments. I think even a younger investor should hold 10% in bonds and I definitely believe someone my age (53) should be between 70/30 to 50/50.

Now, is the balanced approach right or wrong. IMHO it is neither. It is more important to pick a plan and stay with it through thick and thin.

100% in stocks is neither right or wrong but you have to have the stomach for it.
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Re: Why bonds when one's investment horizon is long?

Post by Angst »

In [url=https://www.bogleheads.org/forum/viewtopic.php?f=10&t=221731&newpost=3419725#p3419684]this post above[/url] gordoni2 wrote: ... Thus even after 50 years stocks might plausibly return a negative real return! You might not want to take that risk. Fortunately, long-term inflation indexed bonds currently pay a guaranteed 0.9% real with very little risk.
Thank you gordoni2 for the great post and the simple but clear graphic. I expect to be around for 30 or more years yet and although I'm still around 85% equity, individual TIPS play a large and growing role in the fixed income side of my portfolio.
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Re: Why bonds when one's investment horizon is long?

Post by Money Market »

I'm curious for the veteran members of this board/the previous morningstar group. This board existed when the 2008/9 crisis hit. How many people were making threads or asking a lot of questions regarding their 100% stock portfolio plummeting? I'm wondering because after an 8 year bull-run, it seems like everyone has the mentality of 100% stocks after seeing all the good times we've had. Psychologically, people are more inclined to invest more and take more risks at the near-highs of a bull market. I could not stomach a 100% stock portfolio myself since the risk-adjusted returns and volatility and lack of ability to rebalance makes it overly risky for me.
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Re: Why bonds when one's investment horizon is long?

Post by core4portfolio »

football236 wrote:Hi. Many target date funds are invested in bonds to a significant degree. For example, ~10% of the Vanguard Target Retirement 2060 Fund (VTTSX) is in bonds:
7.2% Vanguard Total Bond Market II Index Fund Investor Shares
2.9% Vanguard Total International Bond Index Fund Investor Shares

Simply stated, my question is when someone has such a long investment horizon, why bonds at all? I understand bonds typically temper your losses when the market crashes, but they also temper your gains when the equity market is bullish. Furthermore, though they temper losses during down times, that doesn't seem necessary when one has such a long horizon.

Are there any other arguments for bonds when one has such a long horizon? I ask because I'm thinking of skipping the target date fund and investing in its equity constituents directly.

Thank you for your input and thoughts.

When stock market is down, how do you buy shares at cheaper price if you dont have any bonds ?
Your target date fund use that bond fund to buy the cheaper shares at the end of the day....
During recession, if you have alternative way to buy cheaper shares then you dont need bond fund any time
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Re: Why bonds when one's investment horizon is long?

Post by Vanguard Fan 1367 »

I think bonds would be a nicer investment to consider if the interest rates were higher. I do have 12 percent of my portfolio in bonds, but hopefully if I have the stomach to ride out a 10 year bear market that my low percentage will work out for me.
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Re: Why bonds when one's investment horizon is long?

Post by nisiprius »

dbr wrote:
niners9088 wrote:All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.
More accurately 100% stocks has higher expected returns than any mix below 100% stocks and also higher expected volatility of returns. Whether or not that is better depends on one's criterion for better. And that is the heart of the discussion.
"Expected return," in the sense of mathematical expectation if you grab a random sample from past history, is higher for 100% stocks than 90% stocks. And it's higher for 110% stocks than 100% stocks. And it's higher for 120% stocks than 110% stocks. The 100% advocates rarely give a coherent reason for choosing the number 100%, or stating explicitly what are the criteria under which 100% turns out to be the optimum.

Leverage has a cost, of course, but it must be manageable since many of the sophisticated "factor" funds use it heavily.

Even without leverage, we can still point out that people who advocate 100% stocks usually mean eliminating the bond allocation from an otherwise conventional portfolio (including three-fund, Vanguard life-strategy-like, and moderately tilted portfolios like Coffeehouse, or Merriman's, or Swedroe's).

If we don't want to consider leverage (why not?) then why not 100% small value? Or 100% microcap? Or 100% frontier markets?

It is hard to dispute that 100% small value has higher expected return than 100% Total Stock or 100% Total World. Larry Swedroe's "Larry Portfolio"--as far as I know never explicitly documented with actual ticker symbols by Larry--does involve using all or almost all small value stock, but that's in the context of a very low stock allocation, something in the 30% ballpark or less, with a heavy bond allocation. The idea is to hold risk constant by using a smaller amount of riskier stock. The idea isn't even to get a higher risk-adjusted reward, it's to re-shape the risk distribution for less tail risk.

Much as people would like to believe that there is some objective, psychology-free way of making decisions, there isn't. It has to include risk tolerance. I think it is better to acknowledge this and think about it consciously, than to make intuitive and unexpressed decisions, as is done by people who go to 100% Total Stock Market but won't use leverage, or won't go to 100% small-cap value.
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Re: Why bonds when one's investment horizon is long?

Post by niners9088 »

nisiprius wrote:
dbr wrote:
niners9088 wrote:All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.
More accurately 100% stocks has higher expected returns than any mix below 100% stocks and also higher expected volatility of returns. Whether or not that is better depends on one's criterion for better. And that is the heart of the discussion.
"Expected return," in the sense of mathematical expectation if you grab a random sample from past history, is higher for 100% stocks than 90% stocks. And it's higher for 110% stocks than 100% stocks. And it's higher for 120% stocks than 110% stocks. The 100% advocates rarely give a coherent reason for choosing the number 100%, or stating explicitly what are the criteria under which 100% turns out to be the optimum.

Leverage has a cost, of course, but it must be manageable since many of the sophisticated "factor" funds use it heavily.

Even without leverage, we can still point out that people who advocate 100% stocks usually mean eliminating the bond allocation from an otherwise conventional portfolio (including three-fund, Vanguard life-strategy-like, and moderately tilted portfolios like Coffeehouse, or Merriman's, or Swedroe's).

If we don't want to consider leverage (why not?) then why not 100% small value? Or 100% microcap? Or 100% frontier markets?

It is hard to dispute that 100% small value has higher expected return than 100% Total Stock or 100% Total World. Larry Swedroe's "Larry Portfolio"--as far as I know never explicitly documented with actual ticker symbols by Larry--does involve using all or almost all small value stock, but that's in the context of a very low stock allocation, something in the 30% ballpark or less, with a heavy bond allocation. The idea is to hold risk constant by using a smaller amount of riskier stock. The idea isn't even to get a higher risk-adjusted reward, it's to re-shape the risk distribution for less tail risk.

Much as people would like to believe that there is some objective, psychology-free way of making decisions, there isn't. It has to include risk tolerance. I think it is better to acknowledge this and think about it consciously, than to make intuitive and unexpressed decisions, as is done by people who go to 100% Total Stock Market but won't use leverage, or won't go to 100% small-cap value.

I completely agree with a lot of what you are saying. In around about way I would say that anyone who carries debt (student loans, mortgage, low interest car rates) but is maxing out or even investing in the market is "in a way" leveraging.

With regards to small cap, I do carry a tilt in it of 20% of my domestic stock allocation but the volatility of carrying more does worry me. I've also seen some reports that over the last 30 years small cap hasn't performed much better than the total market. Like you mentioned and I mentioned in my original comment you must feel comfortable about your investment.

The main reason I don't invest in more emerging markets or micro-cap is two fold. One the access isn't available in my 401k and ER fees are higher in almost all cases. 2 I haven't seen long-term data on EM or micro to make me feel that comfortable that the long-term, 20+ years, trend is there.
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Re: Why bonds when one's investment horizon is long?

Post by runner540 »

TBillT wrote:Cap gains is one reason.
I believe 30-yr Treasuries have out-performed S&P 500 by 5.5x since 1980.

Although it is tempting to think interest rates have bottomed, that is not really the correct way to think about it.
The correct way to think about is, if the 30-year Treasury goes from 3% to 2% you get 3/2 = 50% cap gain + interest.
Better move fast though as we are already down to 2.75%.
TBillT, cam you please explain/show your calculations for Tbills outperforming S&P 500?
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Re: Why bonds when one's investment horizon is long?

Post by Ari »

nisiprius wrote:I think it is better to acknowledge this and think about it consciously, than to make intuitive and unexpressed decisions, as is done by people who go to 100% Total Stock Market but won't use leverage, or won't go to 100% small-cap value.
Leverage costs money, and it adds a risk of losing more than 100% of your assets. With 100% stocks, the only way to lose all your money is if the market goes to zero. If it doesn't, you get to keep all your shares. Of course there's a special line drawn at 100%. 100% is very different from 101%. Leverage adds costs and risks and complexity that are not present in a non-leveraged portfolio. It's not a smooth continuum. 100% really is special.

As for factors, that's fine to use. Personally I don't have a cheap way to access them without for example buying American funds (which adds costs in terms of currency exchange fees and taxes), but even without that issue, factor tilts are tilts away from total market, and you need to believe that they will pay off. Most factor tilt enthusiasts tell you that you have to really believe in the factors and be able to stick with them even through long periods of underperformance. That might not be the case fot a lot of 100%:ers. If you invest in equity, surely the total world allocation is the sensible way to start.

100% stocks is also a very simple portfolio. A lot of Bogleheads might find that simplicity is a good thing for a portfolio to have. Doing 100% total world is one of the simplest portfolios you could own. Adding factor tilts or leverage makes the portfolio a lot less simple.

(Personally I tilt towards my home market and towards emerging markets.)
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

Yes, people sometimes, maybe even eventually always, get around to mentioning leverage and higher risk tilts. 100% stocks is not presented as an optimum but simply as one endpoint of a three fund approach.

It is probably also true that younger people almost always carry mortgages and invest rather than pay off their house and not invest, certainly at least to max out tax deferment.
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Re: Why bonds when one's investment horizon is long?

Post by nisiprius »

runner540 wrote:
TBillT wrote:Cap gains is one reason.
I believe 30-yr Treasuries have out-performed S&P 500 by 5.5x since 1980.

Although it is tempting to think interest rates have bottomed, that is not really the correct way to think about it.
The correct way to think about is, if the 30-year Treasury goes from 3% to 2% you get 3/2 = 50% cap gain + interest.
Better move fast though as we are already down to 2.75%.
TBillT, cam you please explain/show your calculations for Tbills outperforming S&P 500?
He's talking about 30-year Treasuries, not Treasury bills, but I agree that this sounds wrong. According to the Ibbotson SBBI 2015 Classic Yearbook, from 1980 through 2014 inclusive, using tale B-1 and doing arithmetic, $10,000 invested at the start of 1980 would have grown to these values by the end of 2014:

Large-capitalization stocks, $10,000 x $5,316,850/$106.216 = $50,056,959
Long-term government bonds, $10,000 x $135.85/$5.280 = $7,172,880
Treasury bills, $10,000 x $20.583/$4.128 = $49,862


Large-capitalization stocks, $10,000 x $5,316,850/$106.216 = $500,570
Long-term government bonds, $10,000 x $135.85/$5.280 = $257,292
Treasury bills, $10,000 x $20.583/$4.128 = $49,862
Last edited by nisiprius on Fri Jun 23, 2017 11:16 am, edited 2 times in total.
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Re: Why bonds when one's investment horizon is long?

Post by munemaker »

niners9088 wrote:All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.
Academic studies show a 90/10 portfolio (with rebalancing) outperforms 100% equities.
Greg in Idaho
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Re: Why bonds when one's investment horizon is long?

Post by Greg in Idaho »

Money Market wrote:I'm curious for the veteran members of this board/the previous morningstar group. This board existed when the 2008/9 crisis hit. How many people were making threads or asking a lot of questions regarding their 100% stock portfolio plummeting? I'm wondering because after an 8 year bull-run, it seems like everyone has the mentality of 100% stocks after seeing all the good times we've had. Psychologically, people are more inclined to invest more and take more risks at the near-highs of a bull market. I could not stomach a 100% stock portfolio myself since the risk-adjusted returns and volatility and lack of ability to rebalance makes it overly risky for me.
Funny...very similar point to the one I just made on this thread:

viewtopic.php?f=10&t=221260&p=3413250#p3413250

Go back to late 2008 and people are using 60/40, 50/50, 40/60 references all over the place...100% stocks - not so much...
dbr
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

Greg in Idaho wrote:
Money Market wrote:I'm curious for the veteran members of this board/the previous morningstar group. This board existed when the 2008/9 crisis hit. How many people were making threads or asking a lot of questions regarding their 100% stock portfolio plummeting? I'm wondering because after an 8 year bull-run, it seems like everyone has the mentality of 100% stocks after seeing all the good times we've had. Psychologically, people are more inclined to invest more and take more risks at the near-highs of a bull market. I could not stomach a 100% stock portfolio myself since the risk-adjusted returns and volatility and lack of ability to rebalance makes it overly risky for me.
Funny...very similar point to the one I just made on this thread:

viewtopic.php?f=10&t=221260&p=3413250#p3413250

Go back to late 2008 and people are using 60/40, 50/50, 40/60 references all over the place...100% stocks - not so much...
See Plan B https://www.google.com/search?sitesearc ... g&q=plan+b
TBillT
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Re: Why bonds when one's investment horizon is long?

Post by TBillT »

runner540 wrote:
TBillT wrote:Cap gains is one reason.
I believe 30-yr Treasuries have out-performed S&P 500 by 5.5x since 1980.

Although it is tempting to think interest rates have bottomed, that is not really the correct way to think about it.
The correct way to think about is, if the 30-year Treasury goes from 3% to 2% you get 3/2 = 50% cap gain + interest.
Better move fast though as we are already down to 2.75%.
TBillT, cam you please explain/show your calculations for Tbills outperforming S&P 500?
If you know me, I am quoting preeminent American economist A. Gary Shilling.
https://seekingalpha.com/article/403683 ... lling-says <no it is still alive!>

However, with so many stock market advocates and bond vigilantes bad-mouthing bonds in the worst way, it is very hard to have the guts to follow Gary Shilling's advice. And of course, investing in 30-year Treasury Bond is the extreme case.

Presumably the key point is that your bond fund needs to have some exposure to the long end to see this element...if you just have a bond fund paying 3% without much cap gain potential, then you are missing the boat in some ways.

I think the 5.5x statistic goes back to late 2016, so it could be off a little now.

Hey they don't call me TBill for nothing, I am a Gary Shilling fan
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Re: Why bonds when one's investment horizon is long?

Post by Valuethinker »

gordoni2 wrote:Time is a diversifier, but a weak one. Or to put it another way, you probably need a much longer investment horizon than you might imagine.

A conservative assumption (used in the figure below) might be that going forward stocks will return 4.5% arithmetic real return, an annual standard deviation of 16.8%, and no long term auto-correlation effects (for a 3.2% expected geometric real return). Then over 50 years, the standard deviation in annualized return will be roughly 1/sqrt(50) times 16.8%, or 2.4%. Now you need +/- two standard deviations to generate a 95% confidence interval. So a 95% confidence interval on annualized real return after 50 years would be roughly -1.6% to 8.0%.

Thus even after 50 years stocks might plausibly return a negative real return! You might not want to take that risk. Fortunately, long-term inflation indexed bonds currently pay a guaranteed 0.9% real with very little risk.

Image
Thank you that was such a very clear explication of the point-- really helpful!
dbr
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

TBillT wrote:
I think the 5.5x statistic goes back to late 2016, so it could be off a little now.

Hey they don't call me TBill for nothing, I am a Gary Shilling fan
That article doesn't say what 5.5x means. It should mean that the CAGR from 1986 to 2016 is 5.5 times the CAGR of the S&P 500. The latter is 10.26% so the claim would be that the CAGR of holding 30 year Treasuries bought in 1986 and redeemed in 2016 is 56.43%. Since that is absurd the meaning must be something else that we don't understand. The actual CAGR of a long Treasury mutual fund from 1986 to 2016 was 7.54% (VUSTX). The final balance of $10,000 invested would have been $88,500 vs $224,400 for holding the S&P 500.
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Re: Why bonds when one's investment horizon is long?

Post by indexonlyplease »

For a more simple answer why the Target Dated Fund????

It makes investing so easy just pick and then fund it monthly
The Pros decide what AA you should be at your age and the change it over time as you get older toward retirement (we know more?? doubt it).
It has the 3 funds we alway talk about here. Then they added international bond funds. They most know something
The best is you can move on with your life at a young age and not worry about the market.

I put my son in the Vanguard 2060 fund. While in college and part time work he has no interest in learning now. Just fund it monthly the best he can.

What could be worse is the mistake you make on trying to do better over the next 40 years.
dbr
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

indexonlyplease wrote:For a more simple answer why the Target Dated Fund????

It makes investing so easy just pick and then fund it monthly
The Pros decide what AA you should be at your age and the change it over time as you get older toward retirement (we know more?? doubt it).
It has the 3 funds we alway talk about here. Then they added international bond funds. They most know something
The best is you can move on with your life at a young age and not worry about the market.

I put my son in the Vanguard 2060 fund. While in college and part time work he has no interest in learning now. Just fund it monthly the best he can.
Because you should not take investing advice from a mutual fund company and you should invest only in what you mostly understand. That said, if you know what the fund does and it fits what you want, target retirement funds can be an effective choice.
JW-Retired
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Re: Why bonds when one's investment horizon is long?

Post by JW-Retired »

IMO, the main reason for bonds in your retirement portfolio is to be as prepared as possible for a long term economic emergency. A Boglehead type 1-year emergency fund is great for a temporary job loss but it's not going to go far enough for a prolonged depression.

In the Great Depression bonds held their value while the equity market dropped by 90%. Stocks took 6 years to get back to even half the value they had in 1929. http://www.macrotrends.net/1319/dow-jon ... ical-chart

What's your plan for surviving something like that? If the worst should happen, 20% bonds in your retirement account would be a godsend. Plus, it doesn't do much harm if the emergency never comes.
JW
ps: Suggest reading the Great Depression Diary by Ben Roth.
https://www.amazon.com/dp/B002TJLEVE/re ... TF8&btkr=1
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niners9088
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Re: Why bonds when one's investment horizon is long?

Post by niners9088 »

munemaker wrote:
niners9088 wrote:All past performance says that a 100% stock portfolio has better returns over long periods then any mix below 100% stocks.
Academic studies show a 90/10 portfolio (with rebalancing) outperforms 100% equities.
Can you share any links? I'd be interested to read them as I haven't seen any to this point.
niners9088
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Re: Why bonds when one's investment horizon is long?

Post by niners9088 »

JW-Retired wrote:IMO, the main reason for bonds in your retirement portfolio is to be as prepared as possible for a long term economic emergency. A Boglehead type 1-year emergency fund is great for a temporary job loss but it's not going to go far enough for a prolonged depression.

In the Great Depression bonds held their value while the equity market dropped by 90%. Stocks took 6 years to get back to even half the value they had in 1929. http://www.macrotrends.net/1319/dow-jon ... ical-chart

What's your plan for surviving something like that? If the worst should happen, 20% bonds in your retirement account would be a godsend. Plus, it doesn't do much harm if the emergency never comes.
JW
ps: Suggest reading the Great Depression Diary by Ben Roth.
https://www.amazon.com/dp/B002TJLEVE/re ... TF8&btkr=1

At least for myself and the original poster both mentioned having long term horizons, 20+ years. As one nears retirement or needing the funds (5-10 years out) absolutely sequence of return risk is real and should be acknowledged.
dbr
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Re: Why bonds when one's investment horizon is long?

Post by dbr »

niners9088 wrote: At least for myself and the original poster both mentioned having long term horizons, 20+ years. As one nears retirement or needing the funds (5-10 years out) absolutely sequence of return risk is real and should be acknowledged.
It is real but should also be quantified. The dependence of the outcome on stock/bond allocation might surprise you.

Hint: The worst portfolio to hold when withdrawing at a reasonable level over a long time is all nominal bonds, the one with least sequence of return risk but the most risk of inadequate real return.

On the other hand a 30 year TIPS ladder bought at today's real interest rate of about 1% will guarantee an inflation indexed rate of withdrawal of 3.8% and an inflation indexed life annuity is probably possible today with a payout of 4% or maybe better. The TIPS ladder is also guaranteed to deliver no income and be exhausted at the end of those 30 years, and the annuity guarantees the value of the portfolio is exactly zero from the beginning.
saveinvestbecomefree
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Re: Why bonds when one's investment horizon is long?

Post by saveinvestbecomefree »

For this topic, I think the key question is whether you truly have a really long time horizon or not. I need my investments to do well for 50 more years, but I will still need spending money along the way. It's not like you're only starting to spend 50 years from now. So a little mix of shorter-term investments can help a lot based on when you're actually starting to use your investments for income.

So if you plan to retire in 10 years then some of your investment savings have a time horizon of ten years. Stocks can have pretty bad 10 years runs.

I agree that being stock-heavy in your allocation is best for long times. I've been 90-100% stocks until this last year where I dialed back to 75% stocks and 25% cash/bonds. The reason for this is sequence of returns risk in a era of high valuations. I will need some spending money in the next few years even though I plan for most of my investments to be untouched for several decades. My investment time horizon is mixed.

Plus I've made good gains and am leery of being too greedy in an era of record high profit margins and high valuations (as they say on Wall Street, bulls make money and bears make money but pigs get slaughtered). I also shifted significantly to emerging markets based mainly on valuations and profit margin differentials.

saveinvestbecomefree
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Re: Why bonds when one's investment horizon is long?

Post by rkhusky »

I have no problem with being 100/0 if one is 40 years from retirement with $10K in their 401K. But as the portfolio grows and retirement gets closer, one should add bonds.
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Re: Why bonds when one's investment horizon is long?

Post by nisiprius »

TBillT wrote:I think the 5.5x statistic goes back to late 2016, so it could be off a little now.

Hey they don't call me TBill for nothing, I am a Gary Shilling fan
I'm sorry. I think it's nonsense. I really do. I've cited my source. Now please go find something written by Shilling that shows how he or anyone else can get that "5.5 times" number.

To repeat :) (Actually not because I screwed up in my previous post, but I've fixed it) according to the Ibbotson SBBI 2015 Classic Yearbook, from 1980 through 2014;

Large-capitalization stocks, $10,000 x $5,316.850/$106.216 = $500,570
Long-term government bonds, $10,000 x $135.85/$5.280 = $257,292
Treasury bills, $10,000 x $20.583/$4.128 = $49,862

I can also read average annualized (CAGR) total returns directly from table C-1, and they were:

Large-capitalization stocks, 11.8%
Long-term government bonds, 9.7%
Treasury bills, 4.7%

Now, it can be argued that long-term government bonds, although having lower return than stocks, were in roughly the same ballpark. In fact, if you measure to the precise bottom of the 2008-2009 crash, March 6th, 2009, it's possible that during the previous 35-year period they earned a bit more. But no way was it 5.5 times as much.

Now, the actual statement in the article--repeated twice--is:
In 1981... The 30-year Treasury bond yield was 15.2%. Today, it's 3%. His long bond has outperformed the S&P 500 by 5.5 times.
All I can say about this is that it's the craziest no sequitur I've ever seen. The fact that the bond yield has declined by a factor of 5.07 doesn't tell us anything at all about the S&P 500 or how it did relative to the S&P 500.

Even off the top of my head, I can say "Well, if the yield was 15.2% and it declined to 3% then maybe the average was sorta-kinda somewhere around the midpoint, 9.1%. And I know off the top of my head that the return of the stock market was sorta-kinda something like 10%."

Please. Give us a source that explains the number "outperformed the S&P by 5.5 times."
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Re: Why bonds when one's investment horizon is long?

Post by JW-Retired »

niners9088 wrote: At least for myself and the original poster both mentioned having long term horizons, 20+ years. As one nears retirement or needing the funds (5-10 years out) absolutely sequence of return risk is real and should be acknowledged.
That long term horizon is subject to things going more or less as planned. It's possible that unforeseen stuff like another serious depression could happen and blow up that plan. You might need what you thought was retirement money in a couple of years.

IMO, it's just prudent to preserve an option to be able to tap some of the funds much sooner than you think.
JW
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Re: Why bonds when one's investment horizon is long?

Post by indexonlyplease »

dbr wrote:
indexonlyplease wrote:For a more simple answer why the Target Dated Fund????

It makes investing so easy just pick and then fund it monthly
The Pros decide what AA you should be at your age and the change it over time as you get older toward retirement (we know more?? doubt it).
It has the 3 funds we alway talk about here. Then they added international bond funds. They most know something
The best is you can move on with your life at a young age and not worry about the market.

I put my son in the Vanguard 2060 fund. While in college and part time work he has no interest in learning now. Just fund it monthly the best he can.
Because you should not take investing advice from a mutual fund company and you should invest only in what you mostly understand. That said, if you know what the fund does and it fits what you want, target retirement funds can be an effective choice.
I agree. But young people getting a their first job and know nothing about the market the Target Dated Fund is a good start. This is why so many companys put there new employees in the Target Date Fund. When you learn maybe you can do better. But that will take 40 to find out. In this past this was not an option for us older investors. So, we had to learn the hard way. Making mistakes along the way. Even with the simple 3-4 fund portfolio there is stil much to learn and do.
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Re: Why bonds when one's investment horizon is long?

Post by TBillT »

dbr wrote:
TBillT wrote:
I think the 5.5x statistic goes back to late 2016, so it could be off a little now.

Hey they don't call me TBill for nothing, I am a Gary Shilling fan
That article doesn't say what 5.5x means. It should mean that the CAGR from 1986 to 2016 is 5.5 times the CAGR of the S&P 500. The latter is 10.26% so the claim would be that the CAGR of holding 30 year Treasuries bought in 1986 and redeemed in 2016 is 56.43%. Since that is absurd the meaning must be something else that we don't understand. The actual CAGR of a long Treasury mutual fund from 1986 to 2016 was 7.54% (VUSTX). The final balance of $10,000 invested would have been $88,500 vs $224,400 for holding the S&P 500.
I do not have a final calc, but I can see that Shilling is probably saying if you purchased a 30-year T-Bond in 1981 at the peak, you would have 15% interest per year and the cap gains on top of that. So that's cherry picking of the most favorable time. But the overall point Shilling is trying to make is that he still sees potential big gain opportunity in the 30-year T Bond, and he really likes the zero coupon to further accentuate the gains. But he keeps a close look at the economy and market to help with purchase timing and trends.

PS- It is fun to go back and read the 1981 articles about T-Bond at 15% peak, since you got me thinking. The articles say nobody is buying Bonds at 15% because it is widely believed interest rates will keep going up and bonds will be a terrible investment. We have now had 35-years of this same rhetoric.
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Re: Why bonds when one's investment horizon is long?

Post by saltycaper »

TBillT wrote:
I do not have a final calc, but I can see that Shilling is probably saying if you purchased a 30-year T-Bond in 1981 at the peak, you would have 15% interest per year and the cap gains on top of that.
When comparing CAGR of the S&P 500, I don't believe this is the mathematically correct way to evaluate the comparative performance of a coupon bond held to maturity. The decrease in rates (coupon) would have hurt performance, as you would have to reinvest coupons at lower rates. (Yield-to-maturity is calculated on the assumption you can reinvest coupons at the rate available at the time of purchase.) If you sell before maturity, the lower rates still can decrease the benefit of compounding more so than the decrease in rates increases the price of the bond. You have more principal to invest, but the coupon will be lower. There is no escaping the lower rate.

Also, if we replicate the environment of 1981 further, to include availability of retirement accounts, taxes, inflation, etc., after-tax real return of the long bond issued in 1981 would be even less impressive compared to the S&P 500.
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Re: Why bonds when one's investment horizon is long?

Post by niners9088 »

JW-Retired wrote:
niners9088 wrote: At least for myself and the original poster both mentioned having long term horizons, 20+ years. As one nears retirement or needing the funds (5-10 years out) absolutely sequence of return risk is real and should be acknowledged.
That long term horizon is subject to things going more or less as planned. It's possible that unforeseen stuff like another serious depression could happen and blow up that plan. You might need what you thought was retirement money in a couple of years.

IMO, it's just prudent to preserve an option to be able to tap some of the funds much sooner than you think.
JW
I agree but in the past, for every year but the last, my retirement balance has been less than my salary. I have 30+ years before I reach full retirement age per SS. So my balance wouldn't last long one way or the other if I had to live off of my savings alone.

Also in a very worse case I do have family that would help support me. I would only consider this in an absolute worse case scenario but then again I could die tomorrow as well.
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Re: Why bonds when one's investment horizon is long?

Post by raven15 »

football236 wrote:
Simply stated, my question is when someone has such a long investment horizon, why bonds at all? I understand bonds typically temper your losses when the market crashes, but they also temper your gains when the equity market is bullish. Furthermore, though they temper losses during down times, that doesn't seem necessary when one has such a long horizon.

Are there any other arguments for bonds when one has such a long horizon? I ask because I'm thinking of skipping the target date fund and investing in its equity constituents directly.

Thank you for your input and thoughts.
The biggest reason is for a psychological pacifier. The second use is as a big emergency fund, as klangfool suggests. If you are confident you can dollar cost average into stocks through thick and thin, then 100% is likely best until you are about halfway / 15 years from retirement, when you should start moving a portion to bonds (say to 40% at retirement). Further, something like 50% small value, 25% developed country small, 25% emerging markets is probably even better.* If you can make regular contributions continuously without pause for several decades, then risk and return should be nearly synonymous.

But you need to actually evaluate your tolerance for risk. Psychological tolerance is very important and probably easy to over estimate. Second is your ability to take risk. If you are a single parent of 4, working for Tesla or a landscape architect work for a housing developer, then bonds are probably a good decision, and lots of them. If you are in a stable relationship with no children but lots of insurance, and one of you is a nurse and the other a teacher and you both love your jobs, then you can probably max out your risk tolerance.

*Bill Bernstein describes this in one of his books along with an explanation of why it is better than leverage. He also says you probably don't know your true risk tolerance, so you should start with 50% in bonds.
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Re: Why bonds when one's investment horizon is long?

Post by KlangFool »

niners9088 wrote:
JW-Retired wrote:
niners9088 wrote: At least for myself and the original poster both mentioned having long term horizons, 20+ years. As one nears retirement or needing the funds (5-10 years out) absolutely sequence of return risk is real and should be acknowledged.
That long term horizon is subject to things going more or less as planned. It's possible that unforeseen stuff like another serious depression could happen and blow up that plan. You might need what you thought was retirement money in a couple of years.

IMO, it's just prudent to preserve an option to be able to tap some of the funds much sooner than you think.
JW
I agree but in the past, for every year but the last, my retirement balance has been less than my salary. I have 30+ years before I reach full retirement age per SS. So my balance wouldn't last long one way or the other if I had to live off of my savings alone.

Also in a very worse case I do have family that would help support me. I would only consider this in an absolute worse case scenario but then again I could die tomorrow as well.
niners9088,

<< So my balance wouldn't last long one way or the other if I had to live off of my savings alone. >>

Yes, but there is a difference between lasting 6 months versus 9 months. And, sometimes, you need that 3 extra months to find a job. Or, you can hold out for a better job offer a bit longer.

<<Also in a very worse case I do have family that would help support me.>>

Then, you should assume that you may need to help your family too. Or, this is only one-way street.

Do not think in such a binary fashion.

KlangFool
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