When Stocks and Bonds Fall

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sjwoo
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When Stocks and Bonds Fall

Post by sjwoo » Fri Feb 23, 2018 9:45 am

From http://theirrelevantinvestor.com/2018/0 ... onds-fall/:
It’s true, bonds might not help you in the short run when stocks fall. Now what do we do with this information? Investors have a few options.
  • First and foremost, you can add assets outside the United States to your portfolio. You can also include things that are neither stocks nor bonds.
  • If you want to include something in your portfolio that is not only not correlated to stocks, but negatively correlated, then you’re probably going to have to add something that has negative expected long-term returns, like a put option for example. These will expire worthless most of the time and will be a drag on your long-term returns, but they would rise when stocks fell.
  • Hold more cash. Cash is a drag on long-term returns, but if you’re incapable of being fully invested in a balanced portfolio, then the drag from cash is nothing compared to the drag on selling into a decline.
  • If you’re constantly worried, it’s probably a good idea to own less stocks and more bonds. But what about if stocks and bonds fall? Well, what do you want me to tell you? Investing comes with few guarantees.
I like Batnick's final bullet point there -- "investing comes with few guarantees."

Seems like what we have now (and perhaps for the near future, say, a couple of years) with bonds is lower downside than stocks but no more non-correlation. Just curious what Bogleheads are doing here, if anything at all. If you are doing a traditional 60/40 Three-Fund Port, say:

Vanguard Total Stock Market (VTSMX) - 40%
Vanguard Total International (VGTSX) - 20%
Vanguard Total Bond Market (VBTLX) - 40%

Would you consider breaking up VBTLX into something like:

VBTLX - 50%
VBIRX - 50% (Vanguard Short-Term Bond Index Fund Admiral Shares)

Or is this just not worth it? Just take the lumps and deal with the market doing what it does?

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Sandtrap
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Re: When Stocks and Bonds Fall

Post by Sandtrap » Fri Feb 23, 2018 9:57 am

This is a good case for diversification of income streams. IE: SPIA's, Rental Income, etc etc.
mahalo,
j :D

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randomizer
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Re: When Stocks and Bonds Fall

Post by randomizer » Fri Feb 23, 2018 10:05 am

If your investment horizon is long, I see no reason to move out of Total Bond.
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Re: When Stocks and Bonds Fall

Post by oldcomputerguy » Fri Feb 23, 2018 10:11 am

I currently hold some Short-term Treasury to meet a need coming in about two years; other than that, all our bond holdings are "total-bond" funds (i.e. funds tracking Barclays Aggregate).
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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Re: When Stocks and Bonds Fall

Post by magneto » Fri Feb 23, 2018 10:39 am

sjwoo wrote:
Fri Feb 23, 2018 9:45 am
Investors have a few options.
1. First and foremost, you can add assets outside the United States to your portfolio.
2. You can also include things that are neither stocks nor bonds.
3. If you want to include something in your portfolio that is not only not correlated to stocks, but negatively correlated, then you’re probably going to have to add something that has negative expected long-term returns, like a put option for example.
4. Hold more cash. Cash is a drag on long-term returns, but if you’re incapable of being fully invested in a balanced portfolio, then the drag from cash is nothing compared to the drag on selling into a decline.
5. If you’re constantly worried, it’s probably a good idea to own less stocks and more bonds. But what about if stocks and bonds fall? Well, what do you want me to tell you? Investing comes with few guarantees.
Mmm - thoughts :-
1. Stocks are Stocks, whether domestic or international.
2. Actionable.
3. Not all Stock sectors are fully correlated with main indices, but qualify for the +ve long-term return.
4. Cash (and/or ST Bonds), can be part of a 'Well Balanced Portfolio'.
5. But the worry here is about Bonds falling with Stocks. More Bonds might not be the answer, unless the investor is happy to accept possible further losses, albeit less than Stocks. In this scenario even derided Cash would outperform.

What we have here is a broken investment model. :!:
New ideas are required. :idea:
Last edited by magneto on Fri Feb 23, 2018 10:43 am, edited 2 times in total.
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dbr
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Re: When Stocks and Bonds Fall

Post by dbr » Fri Feb 23, 2018 10:42 am

sjwoo wrote:
Fri Feb 23, 2018 9:45 am

Seems like what we have now (and perhaps for the near future, say, a couple of years) with bonds is lower downside than stocks
This presumption is absurd. Where did you get it?

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nisiprius
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Re: When Stocks and Bonds Fall

Post by nisiprius » Fri Feb 23, 2018 10:42 am

Non-correlation isn't negative correlation. I think stocks and bonds will continue to exhibit non-correlation, i.e. move independently. Hoping that they will always move in opposite directions is the investing equivalent of perpetual motion.
But it's not that important, anyway. The dream that any ordinary bond fund, suitable as a core holding, is going to offset stock losses in any important way, is just a dream.
Even during 2008-2009, when intermediate-term Treasuries did experience a boost, presumably because of a "flight to safety," they only went up about 10% (green) while stocks were going down 50% (yellow).
They couldn't have prevented a crushing loss unless you were holding five times as much Treasuries as stocks, i.e. your stock allocation was lower than 17/83.
Meanwhile, even the worst of the everyday, investment-grade, intermediate term bonds (orange)--as illustrated by the corporate-heavy VFICX--only went down about 12%. Yeah, they went in the same direction as stocks, bummer, salt in the wound... but not very much salt. While Total Bond (blue) sailed almost straight through.
Forget the dream that bonds will magically wipe out your stock risk, giving you with the equity risk premium without the risk, and settle for the idea that bonds have less risk and less return than stocks--and will be a drag on your portfolio in a booming bull market but will reliably do good, more than a token amount of good, in a bear market. Not by wiping out losses, just by mitigating them. Notice that all three bond funds would have been very reassuring to have in 2008-2009, and really the differences didn't amount to much.
Source
Image

To put it another way: during 2008-2009, which was a better anchor to windward for "regular" stocks (VTSMX, yellow)? Or corporate bonds (VFICX, mostly corporates), which, darn it, look, they didn't go up, they went down? Are you going to say "well, forget that, I don't want any bonds if they went down, I think I'll try some other kind of stocks instead... like dividend stocks, because people say they 'offer downside protection,' like VHDYX (orange) or VEIPX (green)."

Image
Last edited by nisiprius on Fri Feb 23, 2018 10:54 am, edited 1 time in total.
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sjwoo
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Re: When Stocks and Bonds Fall

Post by sjwoo » Fri Feb 23, 2018 10:50 am

dbr wrote:
Fri Feb 23, 2018 10:42 am
sjwoo wrote:
Fri Feb 23, 2018 9:45 am

Seems like what we have now (and perhaps for the near future, say, a couple of years) with bonds is lower downside than stocks
This presumption is absurd. Where did you get it?
Ummm...okay, you got me, no excuses, you caught me red handed in the "timing" jar. :wink:

I don't think it's unreasonable to say that we have this now -- but yeah, couple of years is totally my feel/projection, for whatever that's worth (not much!). Equities overvalued, inflation ticking up, yield curve flattening...it just feels like we're headed for a down year on both stocks and bonds front.

dbr
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Re: When Stocks and Bonds Fall

Post by dbr » Fri Feb 23, 2018 10:52 am

sjwoo wrote:
Fri Feb 23, 2018 10:50 am
dbr wrote:
Fri Feb 23, 2018 10:42 am
sjwoo wrote:
Fri Feb 23, 2018 9:45 am

Seems like what we have now (and perhaps for the near future, say, a couple of years) with bonds is lower downside than stocks
This presumption is absurd. Where did you get it?
Ummm...okay, you got me, no excuses, you caught me red handed in the "timing" jar. :wink:

I don't think it's unreasonable to say that we have this now -- but yeah, couple of years is totally my feel/projection, for whatever that's worth (not much!). Equities overvalued, inflation ticking up, yield curve flattening...it just feels like we're headed for a down year on both stocks and bonds front.
Yes, but what would ever make you think that bonds have the magnitude of downside that stocks have when such an idea is absurd. It is not the timing but the fact that stocks can fall by tens of percents when bonds can fall by percents.

sjwoo
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Re: When Stocks and Bonds Fall

Post by sjwoo » Fri Feb 23, 2018 10:54 am

nisiprius wrote:
Fri Feb 23, 2018 10:42 am
They couldn't have prevented a crushing loss unless you were holding five times as much Treasuries as stocks, i.e. your stock allocation was lower than 17/83.
Holy crap -- this I did not know. 17/83...that's a ratio I can't imagine many people have.

OK -- I'll just buckle my seatbelt and turn off CNBC. :sharebeer Thank you, nisiprius.

SimplicityNow
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Re: When Stocks and Bonds Fall

Post by SimplicityNow » Fri Feb 23, 2018 10:54 am

If your horizon is long term then, in my opinion, there is no reason to avoid Total Bond Index or Intermediate Bond Index.

We are fortunate in that we have access to several good stable value funds that compose a good percentage of our fixed income assets.

PS I enjoy Nisiprius' graphs, charts, explanations and insights. Thanks for adding to every thread you post to.

sjwoo
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Re: When Stocks and Bonds Fall

Post by sjwoo » Fri Feb 23, 2018 10:57 am

dbr wrote:
Fri Feb 23, 2018 10:52 am
Yes, but what would ever make you think that bonds have the magnitude of downside that stocks have when such an idea is absurd. It is not the timing but the fact that stocks can fall by tens of percents when bonds can fall by percents.
I didn't think I was suggesting that bonds have similar downside magnitude risk as stocks? If so, my bad. Basically I was trying to see if it's worth breaking up a total bond fund into less risky components, but it looks like it's really not worth doing, so I'll just stay pat.

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Re: When Stocks and Bonds Fall

Post by willthrill81 » Fri Feb 23, 2018 10:59 am

Sandtrap wrote:
Fri Feb 23, 2018 9:57 am
This is a good case for diversification of income streams. IE: SPIA's, Rental Income, etc etc.
mahalo,
j :D
Adding to that list, crowdfunded real estate (e.g. RealtyShares, RealtyMogul), peer-to-peer lending, and 'hard money' loans (e.g. FundThatFlip, PeerStreet) are unlikely to be correlated with stocks except perhaps in a recession, when it matters most. :annoyed

At least during 'normal' times, alternatives like these can earn decent returns that don't move in lockstep with stocks. My P2P returns (>7%) didn't budge during the recent stock correction. And even during 2008/2009, credit card defaults (seemingly strongly correlated with P2P defaults) were low enough that issuers were still in the black. Yes, loans of any kind are subject to interest rate risk, but the yields are much higher with alternative lending in the first place, so the risk is lower.
Last edited by willthrill81 on Fri Feb 23, 2018 11:01 am, edited 1 time in total.
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nisiprius
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Re: When Stocks and Bonds Fall

Post by nisiprius » Fri Feb 23, 2018 10:59 am

sjwoo wrote:
Fri Feb 23, 2018 10:54 am
nisiprius wrote:
Fri Feb 23, 2018 10:42 am
They couldn't have prevented a crushing loss unless you were holding five times as much Treasuries as stocks, i.e. your stock allocation was lower than 17/83.
Holy crap -- this I did not know. 17/83...that's a ratio I can't imagine many people have.

OK -- I'll just buckle my seatbelt and turn off CNBC. :sharebeer Thank you, nisiprius.
Just to be clear: I did say "intermediate-term Treasuries." In theory you could invest long-term Treasuries, which have shown a more powerful "flight to safety," but that comes along with other things I wouldn't want: more interest risk (and thus more volatility) and serious inflation risk). And you can in theory leverage up those Treasuries (i.e. "risk parity"--which hasn't always worked so well). But your ordinary run-of-the-mill "core" bond funds haven't done much either day during a stock market crash. Use 50% bonds and your personal drawdown will be 50% that of stocks... more or less.

Also, sorry about the false precision of 17/83. I mean, stocks fell about 50%, intermediate-term Treasuries rose about 10%, not at the same time... and in order to balance, you need to have about 5X as much in the Treasuries as in stocks, and that turns out to be 16.6666667%. Well, at least I rounded to the nearest whole percent!
Last edited by nisiprius on Fri Feb 23, 2018 11:06 am, edited 1 time in total.
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nisiprius
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Re: When Stocks and Bonds Fall

Post by nisiprius » Fri Feb 23, 2018 11:04 am

SimplicityNow wrote:
Fri Feb 23, 2018 10:54 am
...PS I enjoy Nisiprius' graphs, charts, explanations and insights. Thanks for adding to every thread you post to...
Thank you. One reason I do it is to encourage people to do it themselves. It's easy. It isn't the answer to life, the universe, and everything, but IMHO it is much better than reading somebody's words about what some kind of investment "tends to do," and also much better than scanning down a 1-3-5-10-year return chart looking for the biggest numbers.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

dbr
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Re: When Stocks and Bonds Fall

Post by dbr » Fri Feb 23, 2018 11:12 am

sjwoo wrote:
Fri Feb 23, 2018 10:57 am
dbr wrote:
Fri Feb 23, 2018 10:52 am
Yes, but what would ever make you think that bonds have the magnitude of downside that stocks have when such an idea is absurd. It is not the timing but the fact that stocks can fall by tens of percents when bonds can fall by percents.
I didn't think I was suggesting that bonds have similar downside magnitude risk as stocks? If so, my bad. Basically I was trying to see if it's worth breaking up a total bond fund into less risky components, but it looks like it's really not worth doing, so I'll just stay pat.
I misread what you meant by lower downside. You have my apologies.

But, I agree there is no real point to messing around with your bonds.

aristotelian
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Re: When Stocks and Bonds Fall

Post by aristotelian » Fri Feb 23, 2018 11:20 am

nisiprius wrote:
Fri Feb 23, 2018 10:42 am
Non-correlation isn't negative correlation. I think stocks and bonds will continue to exhibit non-correlation, i.e. move independently. Hoping that they will always move in opposite directions is the investing equivalent of perpetual motion.
But it's not that important, anyway. The dream that any ordinary bond fund, suitable as a core holding, is going to offset stock losses in any important way, is just a dream.
Agreed to an extent, but don't Treasuries generally have negative correlation? Of course you are right that noncorrelation or weak negative correlation does not guarantee positive returns during a random short term 5% correction, but I think it is fair to assume that Treasuries by their nature will give you some positive return during an extended bear market.

The current situation (low interest rates/high bond prices combined with tail end of a bull market/economic recovery) does appear to be a perfect storm of conditions where both might have negative returns as both stocks and interest rates normalize.

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Re: When Stocks and Bonds Fall

Post by dcabler » Fri Feb 23, 2018 11:42 am

nisiprius wrote:
Fri Feb 23, 2018 10:59 am
sjwoo wrote:
Fri Feb 23, 2018 10:54 am
nisiprius wrote:
Fri Feb 23, 2018 10:42 am
They couldn't have prevented a crushing loss unless you were holding five times as much Treasuries as stocks, i.e. your stock allocation was lower than 17/83.
Holy crap -- this I did not know. 17/83...that's a ratio I can't imagine many people have.

OK -- I'll just buckle my seatbelt and turn off CNBC. :sharebeer Thank you, nisiprius.
Just to be clear: I did say "intermediate-term Treasuries." In theory you could invest long-term Treasuries, which have shown a more powerful "flight to safety," but that comes along with other things I wouldn't want: more interest risk (and thus more volatility) and serious inflation risk). And you can in theory leverage up those Treasuries (i.e. "risk parity"--which hasn't always worked so well). But your ordinary run-of-the-mill "core" bond funds haven't done much either day during a stock market crash. Use 50% bonds and your personal drawdown will be 50% that of stocks... more or less.

Also, sorry about the false precision of 17/83. I mean, stocks fell about 50%, intermediate-term Treasuries rose about 10%, not at the same time... and in order to balance, you need to have about 5X as much in the Treasuries as in stocks, and that turns out to be 16.6666667%. Well, at least I rounded to the nearest whole percent!
While not exactly 17/83 and, depending on which article you read you might find different assets in the stock & bond categories, but isn't this same idea that's behind the Larry Portfolio? Now I've done it - here comes the posts on the LP, PP, Golden Butterfly, etc. Shields up, Mr. Sulu! :D

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nisiprius
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Re: When Stocks and Bonds Fall

Post by nisiprius » Fri Feb 23, 2018 11:46 am

aristotelian wrote:
Fri Feb 23, 2018 11:20 am
nisiprius wrote:
Fri Feb 23, 2018 10:42 am
Non-correlation isn't negative correlation. I think stocks and bonds will continue to exhibit non-correlation, i.e. move independently. Hoping that they will always move in opposite directions is the investing equivalent of perpetual motion.
But it's not that important, anyway. The dream that any ordinary bond fund, suitable as a core holding, is going to offset stock losses in any important way, is just a dream.
Agreed to an extent, but don't Treasuries generally have negative correlation?
They have not.
Look for yourself and you tell me. If you prefer a number, the particular scatter chart over this particular range of years is showing a very small positive correlation of +0.07 between intermediate-term Treasuries and large-company stocks. (That's negligibly different from zero in my opinion). You can find other ranges of years when the correlation was negative. (The reason I limited the range to 2014 is that the Ibbotson 2015 SBBI Classic Yearbook is the latest copy I own, i.e. for me it is "all available data.") The plot for long-term Treasuries is quite similar, and the correlation for that range of years was +0.08.
Note: values are inflation-corrected.
Image
And a personal observation. I have come to distrust all statements about what financial assets "tend to do" or "usually do" or "generally do" or "typically do," because, when I've checked them out it has so often been the case that they didn't. (And if anything, it is worse when the statement is followed a "because investors do...")
Last edited by nisiprius on Fri Feb 23, 2018 1:49 pm, edited 1 time in total.
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aristotelian
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Re: When Stocks and Bonds Fall

Post by aristotelian » Fri Feb 23, 2018 12:23 pm

nisiprius wrote:
Fri Feb 23, 2018 11:46 am
aristotelian wrote:
Fri Feb 23, 2018 11:20 am
Agreed to an extent, but don't Treasuries generally have negative correlation?
They have not.
Look for yourself and you tell me. If you prefer a number, the particular scatter chart over this particular range of years is showing a very small positive correlation of +0.07 between intermediate-term Treasuries and large-company stocks. (That's negligibly different from zero in my opinion). You can find other ranges of years when the correlation was negative. (The reason I limited the range to 2014 is that the Ibbotson 2015 SBBI Classic Yearbook is the latest copy I own, i.e. for me it is "all available data.") The plot for long-term Treasuries is quite similar, and the correlation for that range of years was +0.08.
Image
And a personal observation. I have come to distrust all statements about what financial assets "tend to do" or "usually do" or "generally do" or "typically do," because, when I've checked them out it has so often been the case that they didn't. (And if anything, it is worse when the statement is followed a "because investors do...")
Interesting, thanks for that. I have definitely seen stronger negative numbers in some reports but no doubt covering different timeframes, as you suspect. I would be curious to see what the numbers look like if you screen for bear markets, since most of us hold majority stocks and are looking to bonds for diversification especially when stocks are down. It is clear from the chart that there are times when both are negative, although it looks like bonds generally did at least OK (if not positive) during the worst bear years. I would be curious to know what happened that one year on the scatter chart that bonds were -12% and stocks were -21%.

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Re: When Stocks and Bonds Fall

Post by Toons » Fri Feb 23, 2018 12:26 pm

I would consider the Vanguard Balanced Index Fund or,
Lifestrategy Funds.

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Re: When Stocks and Bonds Fall

Post by 1nv35t » Fri Feb 23, 2018 1:19 pm

The 4% SWR suggests that historic peak to trough still produced a reasonable outcome in the worst case. Yes on average rewards were better, and trough to peak rewards were great. Assuming the next x years fall within those limits and are not a outlier compared to history then just accept that given low yields/inflation/interest rates rewards might be more around that lower figure than the historic upper figure (when yields/inflation/interest rates were much much higher).

Buy the haystack and just accept what's given.

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Re: When Stocks and Bonds Fall

Post by nisiprius » Fri Feb 23, 2018 1:47 pm

aristotelian wrote:
Fri Feb 23, 2018 11:20 am
...I would be curious to know what happened that one year on the scatter chart that bonds were -12% and stocks were -21%...
It was 1946. I should have mentioned that my data values are inflation-adjusted, so those numbers reflect the 18.2% inflation of that year. Without inflation correction, the numbers would be -8.07% for stocks and +1.00% for bonds.
Last edited by nisiprius on Fri Feb 23, 2018 2:51 pm, edited 3 times in total.
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Re: When Stocks and Bonds Fall

Post by getrichslowly » Fri Feb 23, 2018 2:00 pm

sjwoo wrote:
Fri Feb 23, 2018 9:45 am
Would you consider breaking up VBTLX into something like:

VBTLX - 50%
VBIRX - 50% (Vanguard Short-Term Bond Index Fund Admiral Shares)
Taylor has always recommended keeping it simple with Total Bond Market.

Is Total Bond risky? I do not think so.

In the long run, bonds return their originally stated yield upon maturity.

In the short run, the maximum possible drawdown depends on current interest rates. At 8.2 years and 2.82%, even a massive doubling in interest rates is merely a 21% drawdown. And you would recover in about 4 years upon the new yield. So depending on your investment horizon, that may or may not be a concern. If this is for retirement, then it is a nonrisk.

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Re: When Stocks and Bonds Fall

Post by Chuck » Fri Feb 23, 2018 3:23 pm

So, I should 5x leverage my bond holdings. Got it.

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