Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

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willthrill81
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by willthrill81 » Sat Jul 14, 2018 11:01 pm

siamond wrote:
Sat Jul 14, 2018 10:44 pm
willthrill81 wrote:
Sat Jul 14, 2018 10:14 pm
Has this couple 'won the game'? It depends on your perspective, but I'd say that most Bogleheads wouldn't be too pleased with this position. [...] My point is that if one is truly confident that they have indeed 'won the game', there's usually little reason to 'quit playing'.
Yes, of course, you're right. But much more importantly, there are all the people in-between your two examples. For whom the point is NOT capital preservation, it's getting a decent spending budget every year, make the best of decades of retirement to come, and optionally hope for some level of bequest/charities. Those are the people who can really benefit from keeping a decent engine of growth in their portfolio for decades to come, something like the good old 60/40 advice of Peter Bernstein. They'll probably be happy to benefit from rosy outcomes (while managing if the future is dire-ish), but this isn't playing either.

This concept of 'quit playing' never made much sense to me. It's not a game. It's financial planning depending on your specific circumstances. Only very wealthy people may have this mind shift of viewing it as a game. And then yeah, most will probably keep playing, and there is nothing wrong with that.
Good point. I was purposefully demonstrating the extremes, but most Bogleheads will probably be somewhere between them, probably leaning toward the latter. I too believe that most of the 'middle' will do well to maintain a reasonably balanced portfolio throughout their retirement. Most could probably not maintain their desired standard of living in addition to satisfying bequest motives without 'reasonable' exposure to equities.

You're right that only the really wealthy view this as a game; none of those that I personally know in that category want to 'quit playing' though. They like the 'game', and dollars are merely 'points'. Even if they lost 90% of what they had, they'd still be fine and live well.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

digit8
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by digit8 » Mon Jul 16, 2018 8:14 am

No such thing as "always" safe. You allocate assets recognizing that on any given day some investments will do poorly but can be offset by others that do well in the same conditions. This one protects your principal, that one matches inflation, the other does well during some markets trends but drops terribly in others.
"You can't latte yourself to bankruptcy. The bladder won't allow it." | -Katherine Porter

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willthrill81
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by willthrill81 » Mon Jul 16, 2018 9:45 am

digit8 wrote:
Mon Jul 16, 2018 8:14 am
No such thing as "always" safe. You allocate assets recognizing that on any given day some investments will do poorly but can be offset by others that do well in the same conditions. This one protects your principal, that one matches inflation, the other does well during some markets trends but drops terribly in others.
There are no guarantees in life save two.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

afan
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by afan » Mon Jul 16, 2018 4:30 pm

The logic of bonds is not that they are always safe. It is that
1. They are much less volatile than stocks. This means that mixing in bonds reduces the volatility of the overall portfolio.
2. They have low correlation with stocks. This means that, on average, drops in stocks are not accompanied by similar drops in bonds.

Both effects mean that a portfolio of stocks and bonds will be less volatile than a portfolio of stocks alone.

Are there times when bonds drop along with stock? Yes.
Are there times when bonds fall by a lot? Yes.

Bonds are not perfectly safe.

Very short term high quality debt- T bills, for example, are believe to have no risk of nominal loss. So they are "safe" in that sense. But long term they are pretty much assured of trailing inflation. Mixing in some short term debt can also reduce the volatility of the portfolio.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by Nate79 » Mon Jul 16, 2018 4:41 pm

It is not a risk that bonds may or may not have returns less than the inflation rate. It is only a risk if something is designed to do something and it may fail to do so at some point in time. Bonds are not designed to beat inflation and unless someone is relying on them to do so that is not a risk. As afan pointed out and I agree that the logic of bonds is for lower volatility - i.e. safety a principle where stocks which have no safety of principle.

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willthrill81
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by willthrill81 » Mon Jul 16, 2018 5:34 pm

afan wrote:
Mon Jul 16, 2018 4:30 pm
But long term they are pretty much assured of trailing inflation. Mixing in some short term debt can also reduce the volatility of the portfolio.
I agree with all of your post with the exception of this statement. It is not at all assured that T-bills will lag inflation. Portfolio Charts had a great post on this last year. Below is an excerpt from it.
As you can see, while there are certainly a few times when cash lost money to inflation it actually provided a small return above inflation the vast majority of the time. And lest you think this is an isolated phenomenon, it works this way in every country and currency and even holds up in times of very high inflation. Believe it or not, even as inflation in the US spiked well into double digits in the late 70s and early 80s, Tbills lagged inflation by more than 1% only once in that period! Completely counter to common belief, properly invested cash is perhaps the single most consistent inflation hedge available.
emphasis added
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

afan
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by afan » Mon Jul 16, 2018 5:58 pm

Real returns to cash have been less than 1%, more like 0.5% over long term.
But that is pretax. Although the return only serves to match or very slightly beat inflation, those returns are taxable. After tax, one is behind.
I could not find information on long term real returns to muni money market funds. I don't think they existed 50 of 100 years ago.

From SBBI, as of 2013. Real returns to T bills from the start date indicated to 2013. All pretax
1926 0.5%
1940 0.0%
1960 1.0%
1980 1.6%
1990 0.6%
2000 -0.4%
2003 -0.6%
2008 -1.5%
2009 -1.2%
2010 -1.2%
2011 -0.5%
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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willthrill81
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by willthrill81 » Mon Jul 16, 2018 6:08 pm

afan wrote:
Mon Jul 16, 2018 5:58 pm
Real returns to cash have been less than 1%, more like 0.5% over long term.
But that is pretax. Although the return only serves to match or very slightly beat inflation, those returns are taxable. After tax, one is behind.
I could not find information on long term real returns to muni money market funds. I don't think they existed 50 of 100 years ago.

From SBBI, as of 2013. Real returns to T bills from the start date indicated to 2013. All pretax
1926 0.5%
1940 0.0%
1960 1.0%
1980 1.6%
1990 0.6%
2000 -0.4%
2003 -0.6%
2008 -1.5%
2009 -1.2%
2010 -1.2%
2011 -0.5%
A positive real return does not "trail inflation." According to Portfolio Visualizer, since 1978 tax-exempt short-term bonds have had an annualized real return of .33%. I'd say that's been a good inflation hedge over the last 40 years, and declining interest rates over most of that period didn't offer much of a boost to short-term bonds. You didn't mention taxes in your initial statement, so you're moving the goal post. Taxation is a separate issue but certainly a relevant one, although it's not at all unreasonable for much of a taxable bond's yield to never be taxed at all if held inside a tax-deferred account and subsequently used to fill up the standard deduction in retirement or just held in a Roth account. If we shift the discussion to consistently beating inflation on an after tax basis in general, however, then we must leave bonds and move to more volatile asset classes.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

afan
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Re: Are Bonds Always Safe? — A Second Look at U.S. Portfolio Disasters

Post by afan » Tue Jul 17, 2018 5:12 am

willthrill81 wrote:
Mon Jul 16, 2018 6:08 pm


A positive real return does not "trail inflation." According to Portfolio Visualizer, since 1978 tax-exempt short-term bonds have had an annualized real return of .33%. I'd say that's been a good inflation hedge over the last 40 years, and declining interest rates over most of that period didn't offer much of a boost to short-term bonds. You didn't mention taxes in your initial statement, so you're moving the goal post. Taxation is a separate issue but certainly a relevant one, although it's not at all unreasonable for much of a taxable bond's yield to never be taxed at all if held inside a tax-deferred account and subsequently used to fill up the standard deduction in retirement or just held in a Roth account. If we shift the discussion to consistently beating inflation on an after tax basis in general, however, then we must leave bonds and move to more volatile asset classes.
I said "long term".
Never moved the goal posts, just did not include every detail. For example, many investments have transaction costs associated with them. Short term T bills have long been available direct from the treasury with no costs. Not true for short term munis. Short term munis are not cash.

All investments are meaningful only after all costs, fees, expenses and taxes. When the real return before these approaches is near zero the return after is almost always negative.

Someone holding T bills in a Roth could get the entire return with no transaction costs and no taxes. Someone with a low enough income could have a tax rate of zero and not care what the rate would have been if they had more income. For the rest of us, taxes matter.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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