"Bonds: Ballast for your portfolio"

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gkaplan
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"Bonds: Ballast for your portfolio"

Post by gkaplan » Thu Aug 10, 2017 8:38 pm

Bonds can play an important role in a well-diversified investment portfolio by helping to offset the volatility of stocks. But how do you choose from the many types of bonds—corporates, Treasuries, municipal bonds—and maturities—short-, intermediate-, and long-term?

In this 16-minute podcast, Kevin DiCiurcio, an investment analyst in Vanguard Investment Strategy Group, highlights the role of different types of bonds in investor portfolios and discusses the market forces affecting them. . . .
https://investornews.vanguard/bonds-bal ... portfolio/

(This is a transcript from a podcast.)
Gordon

Beensabu
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Re: "Bonds: Ballast for your portfolio"

Post by Beensabu » Thu Aug 10, 2017 11:40 pm

Thank you for posting this. That transcript is a clear and easily digestible intro to learning about bonds.
I think. I do not know.

Dude2
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Re: "Bonds: Ballast for your portfolio"

Post by Dude2 » Fri Aug 11, 2017 2:39 am

No mention of TIPS which is disappointing. Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.

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Lancelot
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Re: "Bonds: Ballast for your portfolio"

Post by Lancelot » Fri Aug 11, 2017 3:16 am

How to choose? Vanguard Total Bond Fund :mrgreen:
No Where for Very Long...

jbolden1517
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Re: "Bonds: Ballast for your portfolio"

Post by jbolden1517 » Fri Aug 11, 2017 3:48 am

Dude2 wrote:No mention of TIPS which is disappointing. Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.
Or someone who works for Vanguard just disagrees somewhat with the advice around here. Maybe they believe an investor might want to consider taking risk on the bond side as well. Vanguard as a house is becoming one of the largest sellers of bond funds in the world. Maybe they want to start encouraging their investors to diversify their bond holdings and start leveraging their skills more. EM bonds for example are becoming a pretty terrific asset with equity like returns and low correlations. That's an area where Vanguard is lagging, they may want to fix that. They run a fantastic junk bond fund for people who want to take on a moderate amount of credit risk. They have a great track record of finding bonds that are underpriced. Vanguard would never use this language but when it comes to higher quality junk bonds they are a first rate value house.

They do a lot with municipal bonds and many of those are looking iffy. Could be that Vanguard attends to expand their municipal bond offerings so they have some way to handle liquidity problems in their larger funds. The SEC has made it harder for funds to carry iffy bonds in open ended funds. But Vanguard is also in the ETF business, and no reason they couldn't do a closed end fund or two to carry defaulted bonds from their broader portfolios.

Bonds are boring right now because the exciting bonds are all being held by hedgefunds. But their are signs of trouble. The quantities of iffy bonds are growing much faster than the market as a whole. Vanguard might not want to sit this round of credit problems out.

Dude2
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Re: "Bonds: Ballast for your portfolio"

Post by Dude2 » Fri Aug 11, 2017 4:53 am

Lancelot wrote:How to choose? Vanguard Total Bond Fund :mrgreen:
I couldn't agree more. I'm a buy-and-holder. My expertise (if any) is not in deciding which risk factors to favor over others (or when/to what extent). I need to keep it simple because I am dumb -- to pick a relatively easy plan and stick to it. The most important decision: what is your stock/bond ratio. Chasing performance on the bond side? Not very Boglehead IMHO. In terms of diversification, well, the premise is that TBM is enough. Personally, I throw in some TIPS because something indexed directly to inflation seems like a good idea.

jbolden -- Vanguard has some good products. No doubt. I think that many other entities beside personal investors are interested in what they provide, and they are the intended audience. For us however, with a fixed lifespan and limited resources, we don't need to dabble in everything they offer.

longinvest
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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Fri Aug 11, 2017 9:12 am

Dude2 wrote:No mention of TIPS which is disappointing.
The entire industry seems to be blind to the existence of TIPS, which are awesome inflation-indexed bonds.

Unfortunately, there's a lot of misunderstanding about TIPS and bonds, in general:
  • Bonds (including TIPS) are not cash investments. A high-quality bond fund fluctuates in value according to its average duration. The higher its average duration, the higher its volatility.
  • Nowhere, on stock certificates and bond contracts, is there any written promise that their market prices should be correlated (or not) at any point in time.
It's not because some gurus claim that "bonds are negatively correlation with stocks during crises" that it becomes true! Yet, because such statements are repeated so often, supported with carefully selected data-mined historical snapshots, some people start to believe them.

As a result, lots of people got confused when total-market TIPS funds lost 12% in 3 months in 2008. Yet, TIPS funds just did what was they're mathematically expected to do: they fluctuated according to their average duration.

The performance of TIPS, in 2008, deserves a closer inspection. Let's look at the three months that got people confused:

Source: Morningstar
Image

The chart shows that the total return of the iShares TIPS Bond ETF (TIP), a total TIPS market index ETF, was a cumulative loss of 12% over that period.

But, that was in nominal dollars! Let's not forget that we're dealing with inflation-indexed bonds, here.

As a matter of fact, the Consumer Price Index (CPI) happened to fluctuate pretty wildly during this period. By considering the CPI-adjusted performance of iShares' TIP, over these three months, we discover that its CPI-adjusted cumulative loss was 8%, a significantly smaller loss, which is totally in line with the average duration of the ETF. This can be confirmed by clicking on the small "i" besides the $8,898 Final Balance to reveal the inflation-adjusted final balance of $9,177 on this PortfolioVIsualizer link.

It can also be useful to look at the bigger picture. Here's a growth chart for the wider 18-month period, spanning from June 2007 to November 2008, inclusively, where I show the performance of three total-market index ETFs representing three assets:
  • TIP: total TIPS market (blue)
  • VTI: total US stock market (orange)
  • VXUS: total non-US stock markets (green)
Source: Morningstar
Image

While TIPS mildly fluctuated according to their duration, stocks wildly fluctuated, US stocks losing 48% and international stocks losing 55% over a period of 13 months.

I would say that TIPS did their work to dampen the volatility of stocks in a portfolio.
Dude2 wrote:Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.
I don't listen to gurus, not even those who suggest to "take your risks on the equity side".

All financial assets are risky, but don't necessarily exhibit the same risks. Of course, some assets (such as stocks) are generally riskier than others (such as bonds).

Personally, I expose my portfolio to an equal-weight allocation of four different investment-grade assets*, using total-market index ETFs, representing a 50/50 allocation to stocks and bonds:
  • Investment-grade domestic stocks
  • Investment-grade international stocks, which are exposed to currency fluctuations
  • Domestic nominal bonds
  • Domestic inflation-indexed bonds
* I exclude speculative assets such as junk bonds, penny stocks, and commodities.

I don't invest into currency-hedged international bonds, because they use derivatives to hedge currency. I don't invest, either, into international bonds exposed to currency fluctuations, as this would be akin to investing into foreign currencies. I consider that my allocation to international stocks already provides me with enough exposure to foreign currencies.

I didn't consider past returns or future return predictions, when choosing my asset allocation. Instead, I studied the fundamental nature of the assets. Stocks are certificates of ownership entitling me to future dividends. International stocks are transacted and pay dividends using foreign currencies. Bonds are legal contracts promising specific payments on specific future dates. Inflation-indexed bonds, in particular, index their future payments to the CPI.

Mathematics limit the volatility of nominal bonds in nominal terms, and the volatility of inflation-indexed bonds in inflation-indexed terms.

As a result, nominal bonds act as a nominal ballast and inflation-indexed bonds act as an inflation-indexed ballast for my portfolio.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Artsdoctor
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Re: "Bonds: Ballast for your portfolio"

Post by Artsdoctor » Fri Aug 11, 2017 9:56 am

^ Yes. TIPS will always be shrouded in misunderstandings. Around here, there is a pretty good understanding and there are several incredibly smart TIPSters who post regularly. But TIPS can be difficult to understand for many:

There are several moving pieces and there's nothing static about them. There's the price of the bond, there's the coupon, there's the principal appreciation, and there's the coupon appreciation (or depreciation, depending on the CPI).

There is the distinction between individual TIPS and TIPS funds.

There is the distinction between rolling TIPS ladders and TIPS spent at maturity.

There is the illiquidity of individual TIPS which are quite old.

There is the calculation of "real return" of older TIPS which is challenging enough; the "real return" of TIPS with only a year or two left is nearly impossible to understand.

And then there's the tax calculations if you're holding individual TIPS in a taxable account.

So all in all, it's easy to understand the confusion. If you are not willing to put in the time to understand them, I can see why people just walk away. All of that said, I've partially funded my "golden years" with a TIPS ladder so I find them an invaluable piece of my portfolio. However, it literally took me years to get comfortable with them.

jebmke
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Re: "Bonds: Ballast for your portfolio"

Post by jebmke » Fri Aug 11, 2017 10:07 am

longinvest wrote:As a result, lots of people got confused when total-market TIPS funds lost 12% in 3 months in 2008.
A lot of debt markets became a bit wonky during this period. Actually, that was the time I was most concerned. Once the debt markets started working normally I was less worried even though equity still had some downside left.

I seem to recall that there was a particular issue with Tip liquidity in the fall of 2008 related to something like hedge fund holdings that were forced to liquidate. It was a great time to buy but you had to work with the bond desk on the phone because the issues weren't trading regularly. We had to buy in small blocks of $100K I think because there wasn't enough trading. Spreads were volatile. I loaded up in late October of 2008 at real rates of ~3% figuring I'd just hold them to the end (2025). I still have a slice left from that buy.
When you discover that you are riding a dead horse, the best strategy is to dismount.

lazyday
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Re: "Bonds: Ballast for your portfolio"

Post by lazyday » Fri Aug 11, 2017 10:21 am

Kevin DiCiurcio: From a portfolio construction standpoint, choosing corporates or choosing non-market-cap-weighted exposure, you generally do it for two reasons. First would be for diversification. When you add corporates to a Treasury bond portfolio, it actually results in a portfolio that exhibits lower return volatility than an all-Treasury portfolio that has similar duration. So, really, the addition of bonds with credit risk actually diversifies your Treasury holdings.
If all you own is Treasuries, then adding corporates will increase diversification. ok.

I don't think this information is helpful to those of us who also own equities.

jebmke
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Re: "Bonds: Ballast for your portfolio"

Post by jebmke » Fri Aug 11, 2017 10:27 am

Exactly, you have to look at the total portfolio, not just the bond side.
When you discover that you are riding a dead horse, the best strategy is to dismount.

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Re: "Bonds: Ballast for your portfolio"

Post by bigred77 » Fri Aug 11, 2017 10:31 am

longinvest wrote: Personally, I expose my portfolio to an equal-weight allocation of four different investment-grade assets*, using total-market index ETFs, representing a 50/50 allocation to stocks and bonds:
  • Investment-grade domestic stocks
  • Investment-grade international stocks, which are exposed to currency fluctuations
  • Domestic nominal bonds
  • Domestic inflation-indexed bonds
* I exclude speculative assets such as junk bonds, penny stocks, and commodities.
I thought this whole post about TIPS was excellent but I really wanted to point out that I think the AA is a tremendous starting point as a portfolio for retirees. I intend to be somewhere around there myself in the future. I also thought the reasoning and justification for landing on this portfolio allocation was excellent.

indexonlyplease
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Re: "Bonds: Ballast for your portfolio"

Post by indexonlyplease » Fri Aug 11, 2017 10:43 am

jbolden1517 wrote:
Dude2 wrote:No mention of TIPS which is disappointing. Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.
Or someone who works for Vanguard just disagrees somewhat with the advice around here. Maybe they believe an investor might want to consider taking risk on the bond side as well. Vanguard as a house is becoming one of the largest sellers of bond funds in the world. Maybe they want to start encouraging their investors to diversify their bond holdings and start leveraging their skills more. EM bonds for example are becoming a pretty terrific asset with equity like returns and low correlations. That's an area where Vanguard is lagging, they may want to fix that. They run a fantastic junk bond fund for people who want to take on a moderate amount of credit risk. They have a great track record of finding bonds that are underpriced. Vanguard would never use this language but when it comes to higher quality junk bonds they are a first rate value house.

They do a lot with municipal bonds and many of those are looking iffy. Could be that Vanguard attends to expand their municipal bond offerings so they have some way to handle liquidity problems in their larger funds. The SEC has made it harder for funds to carry iffy bonds in open ended funds. But Vanguard is also in the ETF business, and no reason they couldn't do a closed end fund or two to carry defaulted bonds from their broader portfolios.

Bonds are boring right now because the exciting bonds are all being held by hedgefunds. But their are signs of trouble. The quantities of iffy bonds are growing much faster than the market as a whole. Vanguard might not want to sit this round of credit problems out.
Question: someone picks bonds for fixed income/safer investment compared to stocks.
So why would someone pick differnet bonds that have high risk (i.e. em bonds, jund bonds etc) I don't understand this part.

Can you explan in a simple manner please.

longinvest
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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Fri Aug 11, 2017 10:44 am

jebmke wrote:I seem to recall that there was a particular issue with Tip liquidity in the fall of 2008 related to something like hedge fund holdings that were forced to liquidate.
That may be true, but I have yet to read about people actually looking at the CPI index, at the time, and see how its fluctuations affected TIPS values (coupons and face value).

Any bond, whether a government bond or a corporate bond, can face liquidity problems. The idea of investing into a diversified total-market bond fund which contains bonds of all maturities, mitigates liquidity risks. Longer-term bonds can potentially face high liquidity risks. Short-term bonds are limited by mathematics to very low liquidity risks. Any fluctuation in value of a short-term bond represents a huge fluctuation in yield. A mere 5% loss on a 1-year bond means a boost of 5.25% of its yield, yipee! Could you imagine! Wouldn't you buy such a TIPS is a heartbeat?

If we wanted to be really precise, we would reconstruct the actual index TIPS track on a daily basis; it is a linear approximation of the reported CPI numbers of the previous 2 and 3 months. By adjusting the nominal market prices of TIPS to this "shifted CPI" index, we would discover that TIPS behave like any other non-callable government bonds. When close to maturity, they fluctuate less in value than when they're farther from maturity, because small variations in value represent bigger changes in yield.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

CantPassAgain
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Re: "Bonds: Ballast for your portfolio"

Post by CantPassAgain » Fri Aug 11, 2017 10:52 am

indexonlyplease wrote:Question: someone picks bonds for fixed income/safer investment compared to stocks.
So why would someone pick differnet bonds that have high risk (i.e. em bonds, jund bonds etc) I don't understand this part.

Can you explan in a simple manner please.
It's not just about risk in a general sense but different types of risk that may be negatively correlated (ie two high returning, volatile assets, where the volatility moves in opposite directions).

There are folks who like to expound endlessly, in intricate detail, about historical correlations between this or that....to the point that the murk becomes impossible to see through. Personally, I don't put much faith in being able to predict negatively-correlated assets 30 years into the future. But some folks like to play that game. More power to them, but I think it's a ridiculous waste of time and effort.

jbolden1517
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Re: "Bonds: Ballast for your portfolio"

Post by jbolden1517 » Fri Aug 11, 2017 12:21 pm

indexonlyplease wrote: Question: someone picks bonds for fixed income/safer investment compared to stocks.
So why would someone pick differnet bonds that have high risk (i.e. em bonds, jund bonds etc) I don't understand this part.
Because the cost of a "safer" investment is quite high. I'll choose the numbers from Vanguard: https://personal.vanguard.com/us/insigh ... llocations . I think these numbers are high but the

stocks/bonds -- percent return

100/0 -- 10.1%
80/20 -- 9.5%
60/40 -- 8.7%
40/60 -- 7.8%
20/80 -- 6.7%
0/100 -- 5.4%

The difference between 10.1% and 8.7% over 30 years is 51%. That's a lot of extra savings the 60/40 investor has to do over their lifetime. And that number would be a lot worse without rebalancing. If on the other hand one can drive the returns on the bonds up they can get the stability the bonds offer, the rebalancing the bonds offer while not sacrificing all that return. You get paid to hold risk. You don't get paid any better to hold the same risk vs. holding a mix of risk.

The whole reason you invest in stock in the first place is to boost returns. If can boost returns while holding less stock, or boost returns above what stocks can provide, all the better.

longinvest
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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Fri Aug 11, 2017 2:04 pm

Note: I've started a new thread (The Mathematics of Retirement Investing) to discuss this post.

Here's an interesting series of questions and answers with a surprising conclusion at the end.

I'm sure that many would not have believed me if I simply stated the conclusion without first showing the complete calculations.

Enjoy!

Q-1: What is the inflation-indexed amount that must be invested yearly, over a period of 30 year, to accumulate an inflation-adjusted $1,000,000 portfolio, at a nominal growth rate of 10.1% and a 3% inflation rate?

A-1: $10,778.40


This was calculated as follows:
  • Inflation-adjusted growth rate = (1 + 10.1%) / (1 + 3%) - 1 = 6.9%
  • Using a financial calculator: n=30, i=6.9, PV=0, FV=1000000 => PMT = -10778.40



Q-2: What is the inflation-indexed amount that must be invested yearly, over a period of 30 year, to accumulate an inflation-adjusted $1,000,000 portfolio, at a nominal growth rate of 8.7% and a 3% inflation rate?

A-2: $13,805.39


This was calculated as follows:
  • Inflation-adjusted growth rate = (1 + 8.7%) / (1 + 3%) - 1 = 5.5%
  • Using a financial calculator: n=30, i=5.5, PV=0, FV=1000000 => PMT = -13805.39



Q-3: How much more must be invested yearly, over a period of 30 year, to accumulate an inflation-adjusted $1,000,000 portfolio, at a growth rate of 5.5% real instead of 6.9% real?

A-3: 28%


This was calculated as follows:
  • Using the answers of Q-2 and Q-1: $13,805.39 / $10,778.40 - 1 = 28%



Q-4: If future annual returns in the upcoming 30 years were exactly 6.9% real for a 100% stocks portfolio, and 5.5% real for a 60/40 stocks/bond portfolio, how much more should an investor save, assuming he makes an inflation-adjusted $80,000 yearly salary and will be getting an inflation-adjusted $25,000 yearly Social Security pension during retirement?

A-4: 21%


This was calculated as follows:
  • Our objective is for work-years salary minus savings to be equal to total retirement income. We're assuming that savings are invested into a tax-deferred account, and that tax rates will be similar on equal taxable total-income during work years and retirement.
  • Assuming that a portfolio at retirement supports approximately 4% in withdrawals, our objective is to split the excess in work-years salary over future Social Security income, that is ($80,000 - $25,000) = $55,000, between savings and taxable income such that work-years excess taxable income is equal to retirement-years excess taxable income (on top of Social Security).
  • At a growth rate of 6.9%, every $1 of annual savings accumulates to $92.78, 30 years later, supporting $92.78 X 4% = $3.71 in retirement spending.
  • As a consequence, we split the excess $55,000 according to the ratio 1:3.71 between savings and taxable spending. This results into $11,674.49 in tax-deferred yearly savings. This leaves $80,000 - $11,674.49 = $68,325.51 for paying taxes and spending.
  • At a growth rate of 5.5%, every $1 of annual savings accumulates to $72.44, 30 years later, supporting $72.44 X 4% = $2.90 in retirement spending.
  • As a consequence, we split the excess $55,000 according to the ratio 1:2.90 between savings and taxable spending. This results into $14,111.90 in tax-deferred yearly savings. This leaves $80,000 - $14,111.90 = $65,888.10 for paying taxes and spending.
  • The additional ratio of savings is thus: $14,111.90 / $11,674.49 - 1 = 21%



Q-5: What is the impact of the additional 21% in tax-deferred savings on after-tax net spending, for the example shown in Q-4?

A-5: 3.3% or $153.17 per month


This was calculated as follows:
  • We approximate after-tax income using the 2017 marginal tax rates in this Wikipedia table.
  • The first $9,325 of income attract 10% in taxes. That's $9,325 X 10% = $932.50.
  • Additional income up to $37,950 attracts 15% in additional taxes. That's ($37,950 - $9,325) X 15% = $4,293.75.
  • Additional income up to $91,900 attracts 25% in additional taxes.
  • The 100/0 investor has a pre-tax after-savings income of $68,325.51. It attracts ($68,325.51 - $37,950) X 25% = $7,593.88 in additional taxes. He is left with: $68,325.51 - $932.50 - $4,293.75 - $7,593.88 = $55,505.38 for spending.
  • The 60/40 investor has a pre-tax after-savings income of $65,888.10. It attracts ($65,888.10 - $37,950) X 25% = $6,984.53 in additional taxes. He is left with: $65,888.10 - $932.50 - $4,293.75 - $6,984.53 = $53,677.32 for spending.
  • The impact on net spending, in terms of ratio, is thus: $53,677.32 / $55,505.38 - 1 = -3.3%.
  • As an absolute amount, this is: ($55,505.38 - $53,677.32) / 12 = $153.17 per month.



Yes, that's it. By reducing total spending by a mere 3.3%, an investor could use a less volatile 60/40 portfolio all lifelong and still retire with dignity.
Last edited by longinvest on Fri Aug 11, 2017 4:04 pm, edited 2 times in total.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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nedsaid
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Re: "Bonds: Ballast for your portfolio"

Post by nedsaid » Fri Aug 11, 2017 2:27 pm

I grew to appreciate bonds during the 2000-2002 and the 2008-2009 bear markets. Truly, bonds helped cushion my bear market losses and made it easier to stay the course during thus difficult times.
A fool and his money are good for business.

indexonlyplease
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Re: "Bonds: Ballast for your portfolio"

Post by indexonlyplease » Fri Aug 11, 2017 2:30 pm

jbolden1517 wrote:
indexonlyplease wrote: Question: someone picks bonds for fixed income/safer investment compared to stocks.
So why would someone pick differnet bonds that have high risk (i.e. em bonds, jund bonds etc) I don't understand this part.
Because the cost of a "safer" investment is quite high. I'll choose the numbers from Vanguard: https://personal.vanguard.com/us/insigh ... llocations . I think these numbers are high but the

stocks/bonds -- percent return

100/0 -- 10.1%
80/20 -- 9.5%
60/40 -- 8.7%
40/60 -- 7.8%
20/80 -- 6.7%
0/100 -- 5.4%

The difference between 10.1% and 8.7% over 30 years is 51%. That's a lot of extra savings the 60/40 investor has to do over their lifetime. And that number would be a lot worse without rebalancing. If on the other hand one can drive the returns on the bonds up they can get the stability the bonds offer, the rebalancing the bonds offer while not sacrificing all that return. You get paid to hold risk. You don't get paid any better to hold the same risk vs. holding a mix of risk.

The whole reason you invest in stock in the first place is to boost returns. If can boost returns while holding less stock, or boost returns above what stocks can provide, all the better.

So, when you are looking at different fixed income you are looking at the yields they give?? Then mix up the bonds for different yields?? I believe you are not that much concerned at the bond fund price increase??

NPT
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Re: "Bonds: Ballast for your portfolio"

Post by NPT » Fri Aug 11, 2017 3:59 pm

longinvest wrote:Q-5: What is the impact of the additional 21% in tax-deferred savings on after-tax net spending, for the example shown in Q-4?

(...)

Yes, that's it. By reducing total spending by a mere 3.3%, an investor could use a less volatile 60/40 portfolio all lifelong and still retire with dignity.
Unfortunately this won't work if you're already maxing out your tax-advantaged accounts.

longinvest
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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Fri Aug 11, 2017 4:33 pm

NPT wrote:
longinvest wrote:Q-5: What is the impact of the additional 21% in tax-deferred savings on after-tax net spending, for the example shown in Q-4?

(...)

Yes, that's it. By reducing total spending by a mere 3.3%, an investor could use a less volatile 60/40 portfolio all lifelong and still retire with dignity.
Unfortunately this won't work if you're already maxing out your tax-advantaged accounts.
NPT,

I replied to your post here: viewtopic.php?f=10&t=225497&p=3488968#p3488968. It's a new thread based on the post you commented about.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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Re: "Bonds: Ballast for your portfolio"

Post by Lancelot » Fri Aug 11, 2017 6:54 pm

Dude2 wrote:
Lancelot wrote:How to choose? Vanguard Total Bond Fund :mrgreen:
I need to keep it simple because I am dumb -- to pick a relatively easy plan and stick to it. The most important decision: what is your stock/bond ratio. Chasing performance on the bond side?
Dumb like a fox? :D

Even Warren Buffet admits that he stays within his circle of competence :sharebeer
No Where for Very Long...

mmcmonster
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Re: "Bonds: Ballast for your portfolio"

Post by mmcmonster » Fri Aug 11, 2017 7:44 pm

I've maxed out the bonds in my tax deferred accounts and end up putting municipal bonds in my taxable account.

To balance out the added risk of municipal bonds over total bond market, a lot of the bonds in the tax deferred accounts are Treasury bonds.

So I have this as my current bond allocation:
25% State Municipal Bonds (VPALX)
25% US Municipal Bonds (VWIUX)
10% Total Bond Market (VBTLX)
40% US Treasury Bonds (VFIUX)

The goal is to be roughly as risky as having all the bonds in Total Bond Market. I don't know how to average out the risk, but it at least "feels" right.

Thoughts?

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Re: "Bonds: Ballast for your portfolio"

Post by jbolden1517 » Fri Aug 11, 2017 7:44 pm

indexonlyplease wrote:
So, when you are looking at different fixed income you are looking at the yields they give?? Then mix up the bonds for different yields?? I believe you are not that much concerned at the bond fund price increase??
Sure. Yields matter. A ten year 3% bond held till maturity generates 3%. If you sell a little short of maturity there is some possibility of a price increase. A ten year bond 7% bond in default selling at eighteen cents on the dollar generates 40% minus whatever you lose in settlement. You gotta do pretty bad in how things shake out to only get 3%.

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Re: "Bonds: Ballast for your portfolio"

Post by patrick013 » Fri Aug 11, 2017 8:22 pm

mmcmonster wrote:
The goal is to be roughly as risky as having all the bonds in Total Bond Market. I don't know how to average out the risk, but it at least "feels" right.

Thoughts?
Well when I have 40% bonds my std dev is quite low but so is estimated
return. Going 100% stocks I can estimate 10% return but with a 20%
std dev. Of course that's a statistical forecast not based on GDP growth
estimates or anything. One other thing is when I use VG Utilities instead
of Intl I can reduce risk without losing estimated return. Not bad.

Have to live with the volatility or just have lower returns barring market
deflation.
age in bonds, buy-and-hold, 10 year business cycle

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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Fri Aug 11, 2017 10:07 pm

indexonlyplease wrote:
jbolden1517 wrote:
Dude2 wrote:No mention of TIPS which is disappointing. Also, this discussion deviates from the notion of "take your risk on the equity side." Risk management via different flavor of bonds is not something recommended for personal investors much around here. Sometimes, with Vanguard, one wonders who the audience is that they are addressing.
Or someone who works for Vanguard just disagrees somewhat with the advice around here. Maybe they believe an investor might want to consider taking risk on the bond side as well. Vanguard as a house is becoming one of the largest sellers of bond funds in the world. Maybe they want to start encouraging their investors to diversify their bond holdings and start leveraging their skills more. EM bonds for example are becoming a pretty terrific asset with equity like returns and low correlations. That's an area where Vanguard is lagging, they may want to fix that. They run a fantastic junk bond fund for people who want to take on a moderate amount of credit risk. They have a great track record of finding bonds that are underpriced. Vanguard would never use this language but when it comes to higher quality junk bonds they are a first rate value house.

They do a lot with municipal bonds and many of those are looking iffy. Could be that Vanguard attends to expand their municipal bond offerings so they have some way to handle liquidity problems in their larger funds. The SEC has made it harder for funds to carry iffy bonds in open ended funds. But Vanguard is also in the ETF business, and no reason they couldn't do a closed end fund or two to carry defaulted bonds from their broader portfolios.

Bonds are boring right now because the exciting bonds are all being held by hedgefunds. But their are signs of trouble. The quantities of iffy bonds are growing much faster than the market as a whole. Vanguard might not want to sit this round of credit problems out.
Question: someone picks bonds for fixed income/safer investment compared to stocks.
So why would someone pick differnet bonds that have high risk (i.e. em bonds, jund bonds etc) I don't understand this part.

Can you explan in a simple manner please.
While they do have higher risk than investment-grade bonds, they still have lower risk than stocks. Some advisors recommend them as a portion of a high bond AA portfolio for retirees to boost the expected returns.

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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Fri Aug 11, 2017 10:14 pm

Very good bond overview by DiCiurcio--best I've seen. Should be watched/read by all novice investors and maybe those not-so-novice.

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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Fri Aug 11, 2017 10:21 pm

lazyday wrote:
Kevin DiCiurcio: From a portfolio construction standpoint, choosing corporates or choosing non-market-cap-weighted exposure, you generally do it for two reasons. First would be for diversification. When you add corporates to a Treasury bond portfolio, it actually results in a portfolio that exhibits lower return volatility than an all-Treasury portfolio that has similar duration. So, really, the addition of bonds with credit risk actually diversifies your Treasury holdings.
If all you own is Treasuries, then adding corporates will increase diversification. ok.

I don't think this information is helpful to those of us who also own equities.
If you're a passive investor, you invest in the "total" market, which happens to include corporate bonds. If you're an active investor, then you can add and omit asset classes.

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Re: "Bonds: Ballast for your portfolio"

Post by lazyday » Sat Aug 12, 2017 10:27 am

pascalwager wrote:
Fri Aug 11, 2017 10:21 pm
If you're a passive investor, you invest in the "total" market, which happens to include corporate bonds. If you're an active investor, then you can add and omit asset classes.
It seems to me that we must actively choose which asset classes to invest in.

Even Sharpe has omitted or underweighted commercial real estate including farmland and timber, private equity, hedge funds, and derivatives. You might say that derivatives aren’t investments, but you could probably argue the same for assets he does include.

His theory assumes you’re like the average investor globally. Most of us aren’t, for example we spend more in our home currency. So we should decide if it's personally appropriate to own all bonds globally weighted. Another example: I'm nothing like an endowment, bank, or insurance company.

Swensen, Swedroe, and others have convincingly argued against including junk bonds, corporate bonds, mortgage backed bonds, and international bonds. (not sure about Swedroe and intl bonds)

There may be some risks in blindly owning asset classes just because they exist. If you examine each asset class and decide if it is worth owning, then you might make better decisions in the future. Such as not selling in a panic or buying more in a mania. In Japan, maybe you wouldn’t have owned much Japanese stock at the late ‘89 peak, if you had thought much about why you own stock. Similar for S&P 500 or TSM in early 2000.

Getting back to bonds: to me Total Bond+TIPS is inferior to Treasuries+TIPS, but it isn’t a bad choice. The quote I posted just annoyed me a bit since it seemed a poor argument for owning corporates.

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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Sat Aug 12, 2017 11:32 pm

lazyday wrote:
Sat Aug 12, 2017 10:27 am
pascalwager wrote:
Fri Aug 11, 2017 10:21 pm
If you're a passive investor, you invest in the "total" market, which happens to include corporate bonds. If you're an active investor, then you can add and omit asset classes.
It seems to me that we must actively choose which asset classes to invest in.

Even Sharpe has omitted or underweighted commercial real estate including farmland and timber, private equity, hedge funds, and derivatives. You might say that derivatives aren’t investments, but you could probably argue the same for assets he does include.

His theory assumes you’re like the average investor globally. Most of us aren’t, for example we spend more in our home currency. So we should decide if it's personally appropriate to own all bonds globally weighted. Another example: I'm nothing like an endowment, bank, or insurance company.

Swensen, Swedroe, and others have convincingly argued against including junk bonds, corporate bonds, mortgage backed bonds, and international bonds. (not sure about Swedroe and intl bonds)

There may be some risks in blindly owning asset classes just because they exist. If you examine each asset class and decide if it is worth owning, then you might make better decisions in the future. Such as not selling in a panic or buying more in a mania. In Japan, maybe you wouldn’t have owned much Japanese stock at the late ‘89 peak, if you had thought much about why you own stock. Similar for S&P 500 or TSM in early 2000.

Getting back to bonds: to me Total Bond+TIPS is inferior to Treasuries+TIPS, but it isn’t a bad choice. The quote I posted just annoyed me a bit since it seemed a poor argument for owning corporates.
I don't know why you should be annoyed, if you're really a passive investor. The market portfolio should be a first principle for passive investors, but maybe best suited for retirees. And Sharpe's adaptive asset allocation formula enables increasing the risk for younger investors and reducing the risk for the oldest retirees while still retaining the four Vanguard component total market funds. I asked Sharpe about global market investor identity compared to an individual US investor and possible compensatory tilting and he said some of the tilting would be nuanced and hard to quantify, but his companion riskless portfolio of TIPS (Treasuries) would likely address the major differences.

Sharpe's version of the market portfolio is a practical approximation of a theoretical construct. It can't very well include assets which are uninvestable and illiquid. And nobody includes hedge funds in the market portfolio.

Regarding corporate bonds, you may have it backwards. There's disagreement amongst economists about whether government bonds should even be a part of the market portfolio. Sharpe's view is that a government bond represents a claim on the future earnings of taxpayers and hence an investment in their human capital and he does include them.

When you depart from the market portfolio, you're no longer investing, you're betting. Some bets can be necessary, but need to be acknowledged as such. In my view, BH forum has become a veritable wild west of betting, and newcomers--novice investors--may not understand that it's not passive investing and be misled. That's what annoys me and I wouldn't recommend the forum to inexperienced investors for that reason.

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Re: "Bonds: Ballast for your portfolio"

Post by lazyday » Sun Aug 13, 2017 5:32 am

pascalwager wrote:
Sat Aug 12, 2017 11:32 pm
I don't know why you should be annoyed, if you're really a passive investor. The market portfolio should be a first principle for passive investors, but maybe best suited for retirees.
I'm not a passive investor, but do consider passive to be the default starting point.

The argument I quoted seems misleading to me. It directs focus on one part of the portfolio, as if making that part of the portfolio less volatile would make the whole portfolio less volatile. The words may be correct, but if you didn't know better you might draw the wrong conclusion.
I asked Sharpe about global market investor identity compared to an individual US investor and possible compensatory tilting and he said some of the tilting would be nuanced and hard to quantify, but his companion riskless portfolio of TIPS (Treasuries) would likely address the major differences.
That sounds like an active decision to me.
Sharpe's version of the market portfolio is a practical approximation of a theoretical construct. It can't very well include assets which are uninvestable and illiquid.
Again you have to make choices. Corporate bonds can be illiquid. Microcaps. How do you adjust for free float? Chinese A shares. You could choose an index or investment company and let them decide, or you can choose the index that answers these questions the way you like.
There's disagreement amongst economists about whether government bonds should even be a part of the market portfolio. Sharpe's view is that a government bond represents a claim on the future earnings of taxpayers and hence an investment in their human capital and he does include them.
New to me! Found this from Sharpe:
Some would say that the net public interest in such
securities is zero, since a bond held by an investor is his or her asset and the obligation to pay
interest and principal is a liability for those who will have to pay taxes in the future to cover
such payments. An alternative view is that a government bond represents a claim on the future
earnings of taxpayers and hence an investment in their human capital. While each argument has
merits, we take the latter position.
pascalwager wrote:In my view, BH forum has become a veritable wild west of betting, and newcomers--novice investors--may not understand that it's not passive investing and be misled. That's what annoys me and I wouldn't recommend the forum to inexperienced investors for that reason.
Interesting take. My view is that clearly bad advice almost always is contested, but I'm not a purist on passive investing. I could see how in some cases, you might find the average opinion here to be unacceptable. What do you suggest instead, for new investors?

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Re: "Bonds: Ballast for your portfolio"

Post by Doc » Sun Aug 13, 2017 9:14 am

longinvest wrote:
Fri Aug 11, 2017 10:44 am
That may be true, but I have yet to read about people actually looking at the CPI index, at the time, and see how its fluctuations affected TIPS values (coupons and face value).
At the time of the Lehman crisis the poor performance of TIPS relative to nominal Treasuries the liquidity issue was generally believed to be the main reason with secondary concerns about a recession which would cause deflation and thus a lower CPI the coming months.

This deflation possibility was discussed on this forum at the time but you weren't here yet so probably didn't see it.
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Re: "Bonds: Ballast for your portfolio"

Post by Chip » Sun Aug 13, 2017 10:26 am

longinvest wrote:
Fri Aug 11, 2017 10:44 am
jebmke wrote:I seem to recall that there was a particular issue with Tip liquidity in the fall of 2008 related to something like hedge fund holdings that were forced to liquidate.
That may be true, but I have yet to read about people actually looking at the CPI index, at the time, and see how its fluctuations affected TIPS values (coupons and face value).

Any bond, whether a government bond or a corporate bond, can face liquidity problems. The idea of investing into a diversified total-market bond fund which contains bonds of all maturities, mitigates liquidity risks. Longer-term bonds can potentially face high liquidity risks. Short-term bonds are limited by mathematics to very low liquidity risks. Any fluctuation in value of a short-term bond represents a huge fluctuation in yield. A mere 5% loss on a 1-year bond means a boost of 5.25% of its yield, yipee! Could you imagine! Wouldn't you buy such a TIPS is a heartbeat?

If we wanted to be really precise, we would reconstruct the actual index TIPS track on a daily basis; it is a linear approximation of the reported CPI numbers of the previous 2 and 3 months. By adjusting the nominal market prices of TIPS to this "shifted CPI" index, we would discover that TIPS behave like any other non-callable government bonds. When close to maturity, they fluctuate less in value than when they're farther from maturity, because small variations in value represent bigger changes in yield.
Adding on to jebmke's and Doc's posts, the liquidity problems with TIPS in late 2008 were real and significant. The CPI adjustment at the time wasn't a factor (though I agree with Doc about the market anticipating future lower inflation). The "reference" CPI went from 216.6 on 7/31/08 to 216.6 on 12/31/08, unchanged over the period. It peaked during that period at 219.9 in September. Reference info here.

I bought a fair amount of 2.00% TIPS maturing 1/15/16 on 11/24/08 at a price of 96.27. The inflation adjusted principal on the settlement date was 110.26. I understand that YTM calculations on TIPS are a bit problematic, but assuming neither inflation nor deflation this represents a 4+% YTM. On the trade confirmation Fidelity reported it as 4.067%. Even assuming rampant deflation the yield to worst would have been 2.8% (TIPS pay minimum of original par value at maturity).

Nominal treasuries didn't have a liquidity issue. They were generally going up in price, not down. The 4.5% Treasury maturing in 2/16 closed at a YTM of 2.93% that day (source).

If you go back to 7/31/08, the YTMs of these issues were: TIPS 1.51% (source), Nominal 3.63% (source)

So, in ~4 months TIPS yields rose from 1.51% to 4.1%, while nominal yields dropped from 3.63% to 2.93%.

The high YTMs for TIPS were ephemeral. Even though the economy was still in very deep trouble by the end of March '09, the above TIPS issue was back to a YTM of 1.51% (source). The nominal bond was at 2.09% (source).

The liquidity explanation makes perfect sense to me. TIPS were only 11% of federal debt held by the public in November, 2008 (source). A big dealer like Lehman dumping their holdings seems likely to have significantly influenced prices.

Edit: fixed typo
Last edited by Chip on Sun Aug 13, 2017 11:34 am, edited 1 time in total.

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Re: "Bonds: Ballast for your portfolio"

Post by Artsdoctor » Sun Aug 13, 2017 11:20 am

I think we all learned a very valuable lesson in 2008: the only bonds that were really liquid were nominal treasuries. Everything else was subject to convulsive freezing. It should not have come as a surprise but I think that in the midst of the meltdown, many of us were pretty surprised to see how TIPS acted. If you didn't want to buy or sell, you weren't bothered; if you had plenty of cash on hand to buy those falling TIPS, you were very lucky, but if you needed to sell your TIPS for whatever reason, you had a problem.

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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Sun Aug 13, 2017 11:36 am

Artsdoctor wrote:
Sun Aug 13, 2017 11:20 am
I think we all learned a very valuable lesson in 2008: the only bonds that were really liquid were nominal treasuries. Everything else was subject to convulsive freezing. It should not have come as a surprise but I think that in the midst of the meltdown, many of us were pretty surprised to see how TIPS acted. If you didn't want to buy or sell, you weren't bothered; if you had plenty of cash on hand to buy those falling TIPS, you were very lucky, but if you needed to sell your TIPS for whatever reason, you had a problem.
It's not clear what you intended the 2008 lesson to be, in your post.

Let me propose one:

Any marketable financial security, even a safe CPI-indexed government bond protecting its holder from inflation, can be subject to an illiquid market. The longer the duration of a bond, the bigger the potential loss when selling it in an illiquid market. Conversely, the shorter the duration of a bond, the smaller the potential loss when selling it in an illiquid market.

In other words, we don't know that a nominal Treasury will always be liquid. It remained liquid in 2008, but will it, in the next crisis?
Last edited by longinvest on Sun Aug 13, 2017 11:46 am, edited 1 time in total.
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Re: "Bonds: Ballast for your portfolio"

Post by Chip » Sun Aug 13, 2017 11:45 am

longinvest wrote:
Sun Aug 13, 2017 11:36 am
In other words, we don't know that a nominal Treasury will always be liquid. It remained liquid in 2008, but will it, in the next crisis?
Has there ever been a time when they weren't liquid? Would you not agree that US nominal treasuries, as a whole, are the most liquid security available to us?

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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Sun Aug 13, 2017 11:52 am

Chip wrote:
Sun Aug 13, 2017 11:45 am
longinvest wrote:
Sun Aug 13, 2017 11:36 am
In other words, we don't know that a nominal Treasury will always be liquid. It remained liquid in 2008, but will it, in the next crisis?
Has there ever been a time when they weren't liquid? Would you not agree that US nominal treasuries, as a whole, are the most liquid security available to us?
Your verbs "has ... been" and "are" are about the past and the present. I was talking about a future crisis. I see no apparent conflict between your statements and mine, so far.
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Re: "Bonds: Ballast for your portfolio"

Post by gilgamesh » Sun Aug 13, 2017 4:48 pm

Artsdoctor wrote:
Sun Aug 13, 2017 11:20 am
I think we all learned a very valuable lesson in 2008: the only bonds that were really liquid were nominal treasuries. Everything else was subject to convulsive freezing. It should not have come as a surprise but I think that in the midst of the meltdown, many of us were pretty surprised to see how TIPS acted. If you didn't want to buy or sell, you weren't bothered; if you had plenty of cash on hand to buy those falling TIPS, you were very lucky, but if you needed to sell your TIPS for whatever reason, you had a problem.
If someone was holding TIPS that matured in 2008, they didn't have any problems either. If such a TIPS was issued - my point is, a TIPS ladder maturing each year is immune to this liquidity "risk".

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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Sun Aug 13, 2017 8:06 pm

gilgamesh wrote:
Sun Aug 13, 2017 4:48 pm
If someone was holding TIPS that matured in 2008, they didn't have any problems either. If such a TIPS was issued - my point is, a TIPS ladder maturing each year is immune to this liquidity "risk".
Effectively, a carefully constructed non-rolling TIPS ladder, with sufficient payments (coupons and principal) maturing each year, is immune to liquidity risk.

While a non-rolling ladder does not protect its holder against longevity risk (e.g. surviving longer than the last rung of the ladder), it is a perfect investment to replace missing payments between retirement and the start of Social Security delayed to age 70.

Forum member #Cruncher has built an awesome tool to create such a ladder. A link to it is found at the end of this post: viewtopic.php?t=124218#p1820346
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Re: "Bonds: Ballast for your portfolio"

Post by aj76er » Sun Aug 13, 2017 11:57 pm

pascalwager wrote:
Sat Aug 12, 2017 11:32 pm
When you depart from the market portfolio, you're no longer investing, you're betting. Some bets can be necessary, but need to be acknowledged as such. In my view, BH forum has become a veritable wild west of betting, and newcomers--novice investors--may not understand that it's not passive investing and be misled. That's what annoys me and I wouldn't recommend the forum to inexperienced investors for that reason.
+1. Well said.

I recently found this passage in Sharpe's RISMAT-7 to be pretty compelling:
To see this, consider a simple policy calling for a mix of 60% stocks and 40% bonds. Now assume that stocks outperform bonds so the portfolio proportions change to 65% stocks and 35% bonds. To rebalance to a 60/40 mix, one would have to sell some stock holdings and buy bonds with the proceeds. But not everyone can sell stocks and buy bonds, since for every buyer there must be a seller. More generally, rebalancing to predetermined mixes will require selling relative winners and buying relative losers, and for this to be possible, some other investor or investors must be buying relative winners and selling relative losers. If the former strategy is smart, the latter must be dumb. And the intelligence of investors who “buy and hold” must fall somewhere in the middle.
In investment jargon, selling relative winners and buying relative losers is termed a “reversal” policy, while that of selling relative losers and buying relative winners is called a “momentum strategy”. But neither is macro-consistent. Despite protestations to the contrary, financial advisors who recommend rebalancing periodically to pre-determined value proportions are active managers who should recognize that they are acting as if markets are inefficient.
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Sun Aug 13, 2017 11:59 pm

lazyday wrote:
Sun Aug 13, 2017 5:32 am
pascalwager wrote:
Sat Aug 12, 2017 11:32 pm
I don't know why you should be annoyed, if you're really a passive investor. The market portfolio should be a first principle for passive investors, but maybe best suited for retirees.
I'm not a passive investor, but do consider passive to be the default starting point.

The argument I quoted seems misleading to me. It directs focus on one part of the portfolio, as if making that part of the portfolio less volatile would make the whole portfolio less volatile. The words may be correct, but if you didn't know better you might draw the wrong conclusion. I don't know what you mean by "part of the portfolio" unless you're referring to corporate bonds, which you seemed to prefer to omit.
I asked Sharpe about global market investor identity compared to an individual US investor and possible compensatory tilting and he said some of the tilting would be nuanced and hard to quantify, but his companion riskless portfolio of TIPS (Treasuries) would likely address the major differences.
That sounds like an active decision to me. I don't think of it as active. It just attempts to address a possible investor identity issue.
Sharpe's version of the market portfolio is a practical approximation of a theoretical construct. It can't very well include assets which are uninvestable and illiquid.
Again you have to make choices. Corporate bonds can be illiquid. Microcaps. How do you adjust for free float? Chinese A shares. You could choose an index or investment company and let them decide, or you can choose the index that answers these questions the way you like. The indexes Sharpe chose are broad and the funds are low cost. That satisfies me at this point.
There's disagreement amongst economists about whether government bonds should even be a part of the market portfolio. Sharpe's view is that a government bond represents a claim on the future earnings of taxpayers and hence an investment in their human capital and he does include them.
New to me! Found this from Sharpe:
Some would say that the net public interest in such
securities is zero, since a bond held by an investor is his or her asset and the obligation to pay
interest and principal is a liability for those who will have to pay taxes in the future to cover
such payments. An alternative view is that a government bond represents a claim on the future
earnings of taxpayers and hence an investment in their human capital. While each argument has
merits, we take the latter position.
pascalwager wrote:In my view, BH forum has become a veritable wild west of betting, and newcomers--novice investors--may not understand that it's not passive investing and be misled. That's what annoys me and I wouldn't recommend the forum to inexperienced investors for that reason.
Interesting take. My view is that clearly bad advice almost always is contested, but I'm not a purist on passive investing. I could see how in some cases, you might find the average opinion here to be unacceptable. What do you suggest instead, for new investors?
I don't find the average opinion here to be unacceptable, just active in nature, and (contrarian) rebalancing is a given. But advice is often not passive and could mislead new investors who had a prior understanding that it's a passive investing website.

I would just let newbies read Sharpe's ebook, RISMAT, and also his adaptive asset allocation paper. At least this would provide some level of awareness. Then, they might even decide to invest exclusively in Vanguard's low-cost, multi-manager, actively managed funds, and avoid all index funds and any pretense of passivity.

4.25% over riskless rate, 12.50% standard deviation. That's the expected real return/risk for the market portfolio. If you want/need
more/less, Sharpe provides a simple adaptive formula using the same four market funds. That's my idea of simple, passive investing.

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Re: "Bonds: Ballast for your portfolio"

Post by lazyday » Mon Aug 14, 2017 2:42 am

pascalwager wrote:
Sun Aug 13, 2017 11:59 pm
I don't know what you mean by "part of the portfolio" unless you're referring to corporate bonds, which you seemed to prefer to omit.
Here's my original post:
lazyday wrote:
Fri Aug 11, 2017 10:21 am
Kevin DiCiurcio: From a portfolio construction standpoint, choosing corporates or choosing non-market-cap-weighted exposure, you generally do it for two reasons. First would be for diversification. When you add corporates to a Treasury bond portfolio, it actually results in a portfolio that exhibits lower return volatility than an all-Treasury portfolio that has similar duration. So, really, the addition of bonds with credit risk actually diversifies your Treasury holdings.
If all you own is Treasuries, then adding corporates will increase diversification. ok.

I don't think this information is helpful to those of us who also own equities.
If all you own is Fixed Income, and your FI is just Treasuries, then yes, swapping some Treasuries for Corporates will reduce your volatility. If your FI is just Treasuries, and you also own equities, then swapping some Treasuries for Corporates will reduce the volatility of the FI part of the portfolio. But that doesn't mean it will reduce the volatility of your portfolio as a whole, as some might have assumed from the Morningstar quote above.

pascalwager" wrote:I would just let newbies read Sharpe's ebook, RISMAT, and also his adaptive asset allocation paper.
From a very quick look, I'm not sure the newbies I know would get very far. But I might try to tackle them.

RISMAT, electronic book https://web.stanford.edu/~wfsharpe/RISMAT/
Adaptive Asset Allocation Policies paper http://www.cfapubs.org/doi/pdf/10.2469/faj.v66.n3.3
W Bernstein's comment on that paper: http://www.cfapubs.org/doi/full/10.2469/faj.v66.n5.11
Sharpe's response http://www.cfapubs.org/doi/full/10.2469/faj.v66.n5.9
Old Perold&Sharpe paper that Bernstein mentions in point 4 https://web.stanford.edu/class/msande34 ... Sharpe.pdf

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Re: "Bonds: Ballast for your portfolio"

Post by longinvest » Mon Aug 14, 2017 7:52 am

aj76er wrote:
Sun Aug 13, 2017 11:57 pm
I recently found this passage in Sharpe's RISMAT-7 to be pretty compelling:
To see this, consider a simple policy calling for a mix of 60% stocks and 40% bonds. Now assume that stocks outperform bonds so the portfolio proportions change to 65% stocks and 35% bonds. To rebalance to a 60/40 mix, one would have to sell some stock holdings and buy bonds with the proceeds. But not everyone can sell stocks and buy bonds, since for every buyer there must be a seller.
Prof. Sharpe is simplifying things a little too much. What he is saying is not exactly right. Let me explain.

What would happen, if all investors wanted to rebalance their portfolio to 60/40, is that prices would adjust accordingly; that's how markets work.

In other words, the price of stocks for which there's no buyer would drop to attract buyers and the price of bonds for which there's no seller would go up to attract sellers. This would continue until either the aggregate market prices of stocks and bonds settles to 60/40 (removing the need for anybody to rebalance), or until some investors decide to switch off 60/40 investing.

Assuming that stocks and bonds were initially fairly priced, affecting prices to match a target 60/40 allocation (in the chosen 65/35 example) would naturally increase the future returns of stocks (because their price would drop below fair value) and decrease the future returns of bonds (because their price would go up above fair value).

What is more likely to happen is for arbitrageurs to take advantage of the situation and beat the market, leading 60/40 investors to underperform the market.

In other words, the real problem Sharpe is trying to avoid, is for a passive investor to be putting excessive pressure on market prices and get taken advantage of, in the process.

Personally, I don't care. I don't think that stock markets and bond markets are so closely integrated. Money taken off the stock market does not necessarily move into the bond market; it can go elsewhere (bank account, private real estate, spent, etc.).

Also, Sharpe's Global Portfolio doesn't include all traded securities; it doesn't include things such as junk bonds and commodities, for example.

Furthermore, Sharpe's argument fails when it comes to international bonds, because he is recommending the use of funds which hedge currency. There are two problems with this. For one thing, currency hedging requires the use of derivative investments. This, in itself, causes a departure from passive indexing; it's not even clear if there's a good argument to explain how hedging counterparties would naturally be in the proper proportion so as not to cause excessive pressure on hedging costs. For a second thing, the "hedge return" will cause total returns to differ from those of the underlying markets. This will force investors willing to keep their international bond holdings in proportion of international bond markets to make transactions to rebalance their holdings (based on currency fluctuations), putting excessive pressure on market prices and opening the way for arbitrageurs to take advantage of the situation. This is actually pretty bad, as short-term currency fluctuations can be quite brutal.

Finally, Sharpe's overall proposal contains a significant departure from his Global Portfolio concept; that is, he lets investors choose the amount of TIPS they want to include in their portfolio, as if this wouldn't put excessive pressure on prices and open the way for arbitrageurs to take advantage of it. Considering TIPS as riskless is an oversimplified concept. There is simply no such thing as a riskless marketable financial security; TIPS investors who thought otherwise learned as much in 2008.

The closest thing to a riskless security is an I-Bond, which is not a tradable security, and thus, for which there is no market. Unfortunately, there are rather low annual limits to how much one can buy. (In Canada, where I live, there is nothing equivalent to I-Bonds, unfortunately).

As a result, I've decided to keep things simple:
  • I use total-market index funds to invest into four selected types of investment-grade securities: domestic stocks, international stocks, domestic nominal bonds, and domestic inflation-indexed bonds.
  • I do not include international bonds (currency-hedged or not) into my portfolio.
  • I do use a fixed target allocation (25/25/25/25) which is 50/50 stocks/bonds.
  • I rebalance my portfolio very lazily:
    • I mostly rebalance by diverting fund distributions and new portfolio contributions into assets below their target allocation. In retirement, I will take withdrawals from assets above their target allocation.
    • Infrequently, when it gets too much off target, I actively rebalance my portfolio using a rather sloppy two-step rebalancing process, which conveniently sidesteps tax problems (such as wash sales) and keeps my trades difficult to anticipate by arbitrageurs.
I know that what I'm doing is not perfect, but there is simply no perfect solution. As I've explained above, even Sharpe's proposal has significant problems.

I'm not saying that Sharpe's proposal is bad; far from it. I'm just saying that, given its own problems, it doesn't provide any foreseeable improvement over my simpler approach.

Note that I used the name Global Portfolio to refer to his recommended portfolio, in my text; Sharpe actually uses the name World Bond/Stock Portfolio, which is more accurate.

Added: I posted a copy of this post on the following existing thread about Sharpe's proposed portfolio, where it would be more appropriate to discuss it: Bill Sharpe's preferred portfolio
Last edited by longinvest on Wed Aug 16, 2017 12:56 am, edited 14 times in total.
Bogleheads investment philosophy | Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds | VCN/VXC/VAB/ZRR

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aj76er
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Re: "Bonds: Ballast for your portfolio"

Post by aj76er » Mon Aug 14, 2017 12:06 pm

longinvest wrote:
Mon Aug 14, 2017 7:52 am
In other words, the real problem Sharpe is trying to avoid, is for a passive investor to be putting excessive pressure on market prices and get taken advantage of, in the process.
I don't think Sharpe is denying the basic mechanics of supply and demand, rather he is simply just saying that with the WBS portfolio an investor does not have to make an active bet in terms of either risk or reward.

By rebalancing to fixed percentages, an individual investor is trying to extract a certain risk and/or reward that the market currently does not possess. Most of the time, the rebalancing percentages are chosen based on past history of markets. As such, an investor is trying to make an educated guess or a probable bet that the markets will mean revert. However, it is still an active bet and no mean reversion is guaranteed.
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

pascalwager
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Re: "Bonds: Ballast for your portfolio"

Post by pascalwager » Mon Aug 14, 2017 11:52 pm

lazyday wrote:
Mon Aug 14, 2017 2:42 am
pascalwager wrote:
Sun Aug 13, 2017 11:59 pm
I don't know what you mean by "part of the portfolio" unless you're referring to corporate bonds, which you seemed to prefer to omit.
Here's my original post:
lazyday wrote:
Fri Aug 11, 2017 10:21 am
Kevin DiCiurcio: From a portfolio construction standpoint, choosing corporates or choosing non-market-cap-weighted exposure, you generally do it for two reasons. First would be for diversification. When you add corporates to a Treasury bond portfolio, it actually results in a portfolio that exhibits lower return volatility than an all-Treasury portfolio that has similar duration. So, really, the addition of bonds with credit risk actually diversifies your Treasury holdings.
If all you own is Treasuries, then adding corporates will increase diversification. ok.

I don't think this information is helpful to those of us who also own equities.
If all you own is Fixed Income, and your FI is just Treasuries, then yes, swapping some Treasuries for Corporates will reduce your volatility. If your FI is just Treasuries, and you also own equities, then swapping some Treasuries for Corporates will reduce the volatility of the FI part of the portfolio. But that doesn't mean it will reduce the volatility of your portfolio as a whole, as some might have assumed from the Morningstar quote above.

This seems true as corporate bonds are more highly correlated to the equity market than Treasuries. (I believe DiCiurcio is an investment officer at Vanguard, not M*.)

pascalwager" wrote:I would just let newbies read Sharpe's ebook, RISMAT, and also his adaptive asset allocation paper.
From a very quick look, I'm not sure the newbies I know would get very far. But I might try to tackle them.

RISMAT, electronic book https://web.stanford.edu/~wfsharpe/RISMAT/
Adaptive Asset Allocation Policies paper http://www.cfapubs.org/doi/pdf/10.2469/faj.v66.n3.3
W Bernstein's comment on that paper: http://www.cfapubs.org/doi/full/10.2469/faj.v66.n5.11
Sharpe's response http://www.cfapubs.org/doi/full/10.2469/faj.v66.n5.9
Old Perold&Sharpe paper that Bernstein mentions in point 4 https://web.stanford.edu/class/msande34 ... Sharpe.pdf
Thanks for the link lineup. I hadn't seen the Bernstein/Sharpe dialogue before. Of course, you're right about the newbies; but I don't know of any better resources and I wouldn't want to expose them to any other authors if only due to the universal adherence to contrarian rebalancing. The Christopher Jones (Sharpe's former Chief CIO) book is a possibility, but it's based on typical work plan funds where total market funds are unavailable.

Just from studying the RISMAT and AAA, I was able to initiate and purchase the WBS portfolio and later assembled the AAA table for possible future use. The end results are a few function enabled rebalancing tables at the bottom of my portfolio spreadsheet: some for quarterly "rebalancing" (adjusting) the basic market portfolio and one for adapting a more aggressive version of the "representative" (Sharpe's terminology) portfolio.

Would I want to invest in the WBS if I were young? No, but I would either use the stock portion of the WBS only, or if I wanted some bonds, then the AAA version.

The AAA was written primarily for fund/portfolio managers, but he includes a reference to using it in "other contexts", and I assumed that to include individual investors.

lazyday
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Re: "Bonds: Ballast for your portfolio"

Post by lazyday » Tue Aug 15, 2017 7:34 am

pascalwager wrote:
Mon Aug 14, 2017 11:52 pm
(I believe DiCiurcio is an investment officer at Vanguard, not M*.)
Yes, thank you. Transcript link in the top post of this thread.

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