The logical fallacy behind "Bonds Are For Safety"

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vineviz
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Sun Jun 09, 2019 6:22 pm

stlutz wrote:
Sun Jun 09, 2019 5:34 pm
Now, on that point I disagree with you that inflation is a minimal risk, which makes me think you are on track duration-wisse if we are talking about long-term TIPS. (I'll save the "why" in my disagreement for a future discussion).

But of course you don't really like LT TIPS as much because of that whole correlation thing.
I like long term TIPS just fine, for investors whose portfolio would otherwise have significant exposure to inflation risk.

There are other ways to deal with that risk, but TIPS are a good tool.

stlutz wrote:
Sun Jun 09, 2019 5:34 pm
Problem, for this person their investment horizon for their bonds is no longer for the rest of their life but it's until the next rebalance point.
Yeah, that’s NOT their investment horizon. Rebalancing plays no role in calculating the investment horizon: investment horizon is the weighted average time to expenditure (or withdrawal).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by WoodSpinner » Sun Jun 09, 2019 8:58 pm

Vineviz,

Interesting thread — I think I have some grasp on the concepts.

Perhaps an an example will help me better understand.

I am building a Liability Matching Portfolio of bonds, say a rolling 10 years of expenses. The remaining portion of the portfolio will be in Equities.

My assumption is that my bond investment horizon will be correctly matched to a bond ladder which provides me the cash flows of my expected expenses. The chief risks are inflation related rather than term related.

Why would long term treasuries be superior to a bond ladder that marches anticipated cash flow needs?


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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 6:57 am

WoodSpinner wrote:
Sun Jun 09, 2019 8:58 pm
I am building a Liability Matching Portfolio of bonds, say a rolling 10 years of expenses. The remaining portion of the portfolio will be in Equities.

My assumption is that my bond investment horizon will be correctly matched to a bond ladder which provides me the cash flows of my expected expenses. The chief risks are inflation related rather than term related.
Can I ask you to clarify what you mean by "a rolling 10 years of expenses"? That sounds like maybe you're talking about a rolling bond ladder, which would not be a liability matching portfolio. But maybe you mean something else?

In general, I'll say there are two related concepts in bond portfolio management. One is cash flow matching (aka liability matching) and the other is immunization. I was essentially referring to an immunization strategy, rather than a cash flow matching strategy. In theory cash flow matching is considered to be preferable, but it can be challenging to implement in real life (especially for investors who don't know their real spending needs up front) so I tend to prefer immunization approaches as being easier to undertake successfully.

For most individual investors, neither approach is likely to be more than a rough approximation. But either approach is probably better than a "intermediate-term for everyone" approach.

Investopedia explains the difference in more details reasonably well: https://www.investopedia.com/articles/i ... tching.asp
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by skeptic42 » Mon Jun 10, 2019 7:12 am

Isn't the immunization concept a similar "fallacy of composition"?
Immunization makes sense for a bond portfolio, but not so much for a stock/bond portfolio, or what is the duration of a stock/bond portfolio?

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Jmh04j » Mon Jun 10, 2019 7:32 am

Which Long term treasury fund is best? EDV? TLT?

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by rkhusky » Mon Jun 10, 2019 7:48 am

abc132 wrote:
Sun Jun 09, 2019 12:08 pm
HEDGEFUNDIE wrote:
Sun Jun 09, 2019 11:30 am
I find it interesting how some Bogleheads’ first instinct when confronted with a behavioral anomaly is not to correct the behavior, but rather to build one’s portfolio around it.
Bogleheads:
"The forum's members discuss financial news and theory, while also helping less experienced investors develop their portfolios."

I think it's OK to do whatever one wants individually, but if/when there becomes a support group for poor behavior, the site is no longer serving the interests of less experienced investors. Minimizing regret for an inexperienced investor is a recipe for financial disaster - when fear replaces knowledge and understanding, many things can go wrong.
Choosing Total Bond over Long Term Treasury is hardly a recipe for disaster (market timing bitcoin is a recipe for disaster).

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 7:49 am

skeptic42 wrote:
Mon Jun 10, 2019 7:12 am
Isn't the immunization concept a similar "fallacy of composition"?
Immunization makes sense for a bond portfolio, but not so much for a stock/bond portfolio, or what is the duration of a stock/bond portfolio?
That's a really good question, and I don't know that there is a clearcut answer.

I tend to think the answer is "no" to the first question, unless someone is assuming that immunizing the bond portfolio against interest rate risk also immunizes the overall portfolio against interest rate risk.

Most investors don't tend to think of stock or overall stock/bond portfolios in terms of duration (and the academic literature is fairly inconclusive on whether "equity duration" is even a meaningful or useful concept). However I view the incorporation of investment horizon into the process of setting the overall asset allocation as implicitly accounting for this.

No doubt there is room for diverse views on this, though.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by WoodSpinner » Mon Jun 10, 2019 8:59 am

vineviz wrote:
Mon Jun 10, 2019 6:57 am
WoodSpinner wrote:
Sun Jun 09, 2019 8:58 pm
I am building a Liability Matching Portfolio of bonds, say a rolling 10 years of expenses. The remaining portion of the portfolio will be in Equities.

My assumption is that my bond investment horizon will be correctly matched to a bond ladder which provides me the cash flows of my expected expenses. The chief risks are inflation related rather than term related.
Can I ask you to clarify what you mean by "a rolling 10 years of expenses"? That sounds like maybe you're talking about a rolling bond ladder, which would not be a liability matching portfolio. But maybe you mean something else?

In general, I'll say there are two related concepts in bond portfolio management. One is cash flow matching (aka liability matching) and the other is immunization. I was essentially referring to an immunization strategy, rather than a cash flow matching strategy. In theory cash flow matching is considered to be preferable, but it can be challenging to implement in real life (especially for investors who don't know their real spending needs up front) so I tend to prefer immunization approaches as being easier to undertake successfully.

For most individual investors, neither approach is likely to be more than a rough approximation. But either approach is probably better than a "intermediate-term for everyone" approach.

Investopedia explains the difference in more details reasonably well: https://www.investopedia.com/articles/i ... tching.asp
I am referring to a rolling 10 year bond ladder that is planned to match my anticipated expenses. It’s a variation of the LMP strategy.

Your differentiation of immunization is an important point for those of us struggling to understand these concepts.

Thanks,

WoodSpinner

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 9:10 am

WoodSpinner wrote:
Mon Jun 10, 2019 8:59 am
I am referring to a rolling 10 year bond ladder that is planned to match my anticipated expenses. It’s a variation of the LMP strategy.
I'm still confused: a rolling bond ladder can not, by definition, be a cash flow matching (LMP) strategy. Do you mean a non-rolling 10 year bond ladder?

https://www.bogleheads.org/wiki/Rolling ... bond_funds
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by WoodSpinner » Mon Jun 10, 2019 9:47 am

vineviz wrote:
Mon Jun 10, 2019 9:10 am
WoodSpinner wrote:
Mon Jun 10, 2019 8:59 am
I am referring to a rolling 10 year bond ladder that is planned to match my anticipated expenses. It’s a variation of the LMP strategy.
I'm still confused: a rolling bond ladder can not, by definition, be a cash flow matching (LMP) strategy. Do you mean a non-rolling 10 year bond ladder?

https://www.bogleheads.org/wiki/Rolling ... bond_funds
No, I mean a Rolling Ladder of Bonds.

I project my nominal cash needs (expenses - Income) on a yearly basis out to 10 years. Then purchase bonds (or bond funds) to match. Bond ladder is maintained yearly as part of rebalancing.

Not exactly Bernstein’s LMP approach but a workable variation. Especially since my projected cash needs are pretty low after age 70.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by gips » Mon Jun 10, 2019 9:47 am

HEDGEFUNDIE wrote:
Sat Jun 08, 2019 3:30 pm
gips wrote:
Sat Jun 08, 2019 2:22 pm
are you sure intermediate or long term bonds have higher expected returns than CDs? Those of us who invest in CDs typically do so because a) the after-tax returns are higher than intermediate and long term treasuries and b) we look for low EWPs which allow us to break the CD if rates move sharply higher.

anecdotally, over the last two years, I've opened several CDs where the rate > 4.0% with low EWPs (one has a zero EWP).
https://www.portfoliovisualizer.com/fun ... F07%2F2019

If you had invested in VGLT in Jan 2017, your CAGR would be 6.7%. If you invested in Jan 2018, your CAGR would be 5.4%

If you had invested in EDV in Jan 2017, your CAGR would be 9.3%. If you invested in Jan 2018, your CAGR would be 6.1%

And as Treasury bonds, these are both exempt from state income tax.

Show me a CD that did better.
HEDGEFUNDIE, at the time we invest in bonds, what are our choices? yield, duration and credit risk. at the time I made my cd investments, the yield was higher than 10-year treasuries. It was impossible to predict where rates would go.

Still, I'd guess the 4.2% cd outperformed both those investments since 2018. I suppose I should do the math but It seems to me you're comparing cd rates to total return. When rates drop, the value of my cd increases just like a bond. no?

best,
jd

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by HEDGEFUNDIE » Mon Jun 10, 2019 9:55 am

gips wrote:
Mon Jun 10, 2019 9:47 am
HEDGEFUNDIE wrote:
Sat Jun 08, 2019 3:30 pm
gips wrote:
Sat Jun 08, 2019 2:22 pm
are you sure intermediate or long term bonds have higher expected returns than CDs? Those of us who invest in CDs typically do so because a) the after-tax returns are higher than intermediate and long term treasuries and b) we look for low EWPs which allow us to break the CD if rates move sharply higher.

anecdotally, over the last two years, I've opened several CDs where the rate > 4.0% with low EWPs (one has a zero EWP).
https://www.portfoliovisualizer.com/fun ... F07%2F2019

If you had invested in VGLT in Jan 2017, your CAGR would be 6.7%. If you invested in Jan 2018, your CAGR would be 5.4%

If you had invested in EDV in Jan 2017, your CAGR would be 9.3%. If you invested in Jan 2018, your CAGR would be 6.1%

And as Treasury bonds, these are both exempt from state income tax.

Show me a CD that did better.
HEDGEFUNDIE, at the time we invest in bonds, what are our choices? yield, duration and credit risk. at the time I made my cd investments, the yield was higher than 10-year treasuries. It was impossible to predict where rates would go.
This is exactly my point! The yield-chasing investor would have picked the CD as you did, but you should have matched your duration with your time horizon. And if you did you would have been rewarded for it (in the long run at least, although in this case you would have won in the short run as well). Chasing yield is market timing.

To be more specific, picking the highest yield is to assume interest rates don’t move during your holding period. The non-timing strategy, as described in length here, is to rely on the long run behavior of the term premium, which is almost always positive, and therefore to match your bonds’ term with your investment horizon.

This is the same kind of thing as relying on the equity risk premium for stocks (i.e. in the long run stocks should beat bonds because stocks are inherently riskier). If stocks performed worse than bonds last year (or if stocks are projected to perform worse than bonds next year), is that a reason to change your AA to load up on bonds?

Still, I'd guess the 4.2% cd outperformed both those investments since 2018. I suppose I should do the math but It seems to me you're comparing cd rates to total return. When rates drop, the value of my cd increases just like a bond. no?
No, the total return on a CD is the same as its rate. You can’t trade CDs like you can a bond or bond fund, so the “market value” of a CD is meaningless. If CDs were tradable then its rate would not have been 4.2% to begin with, it would have been lower due to liquidity discount.
Last edited by HEDGEFUNDIE on Mon Jun 10, 2019 10:16 am, edited 2 times in total.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 10:13 am

WoodSpinner wrote:
Mon Jun 10, 2019 9:47 am
vineviz wrote:
Mon Jun 10, 2019 9:10 am
WoodSpinner wrote:
Mon Jun 10, 2019 8:59 am
I am referring to a rolling 10 year bond ladder that is planned to match my anticipated expenses. It’s a variation of the LMP strategy.
I'm still confused: a rolling bond ladder can not, by definition, be a cash flow matching (LMP) strategy. Do you mean a non-rolling 10 year bond ladder?

https://www.bogleheads.org/wiki/Rolling ... bond_funds
No, I mean a Rolling Ladder of Bonds.

I project my nominal cash needs (expenses - Income) on a yearly basis out to 10 years. Then purchase bonds (or bond funds) to match. Bond ladder is maintained yearly as part of rebalancing.
What you are describing, if I understand you correctly, is maintaining a non-rolling bond ladder.

For example, in 2019 you buy a 10-year bond with the intention of spending the par value when it matures in 2029: that's a non-rolling ladder.

On the other hand, in 2019 you buy a 10-year bond with the intention of reinvesting the par value in another 10-year bond in 2029: that's a rolling ladder.

It sounds like you are doing the former, but when one rung matures (and you spend the par value) you pull money from elsewhere (stock fund, bond, fund, etc.) to establish a new rung. In this case, the appropriate duration for the bond fund you are using to rebuild the ladder each year would be the weighted average time for the expenses from year 11 until the last year you plan on the portfolio existing.

This is an interesting hybrid approach between cash flow matching and immunization, though perhaps more complicated to manage than it could be.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Jmh04j » Mon Jun 10, 2019 10:31 am

No, the total return on a CD is the same as its rate. You can’t trade CDs like you can a bond or bond fund, so the “market value” of a CD is meaningless. If CDs were tradable then its rate would not have been 4.2% to begin with, it would have been lower due to liquidity discount.
My thoughts exactly

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by HomerJ » Mon Jun 10, 2019 10:41 am

vineviz wrote:
Sat Jun 08, 2019 11:22 am
An investor who expresses a preference for stable bonds REGARDLESS of how those bonds affect the total return of the portfolio is, without question, behaving irrationally.
This is, of course, incorrect. A person is not irrational because they are not focused on total return.

I think the real logical fallacy here is thinking investing or economics is an actual science.

It's not.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by HomerJ » Mon Jun 10, 2019 10:51 am

willthrill81 wrote:
Sun Jun 09, 2019 10:06 am
fennewaldaj wrote:
Sun Jun 09, 2019 12:08 am
I think for many some degree of mental accounting give them a lot of peace of mind. So it maximizes their utility (and I think it is often logical to maximize utility). For example emergency funds are commonly used even by people with large taxable accounts. This is clearly mental accounting but I think it would be a stretch to call it illogical.
I'm inclined to agree. Everyone is seeking to maximize something, but exactly what they're trying to maximize can be hard to pin down. It's certainly true that maximizing one's returns is not the goal of many investors, nor is the maximization of risk-adjusted returns. Many investors could be well served by attempting to minimize their maximum regret.

Like it or not, humans aren't robots, and we don't have universal goals, much less universal means of achieving any one particular goal.
This. Good post.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Doc » Mon Jun 10, 2019 10:57 am

WoodSpinner wrote:
Mon Jun 10, 2019 9:47 am
No, I mean a Rolling Ladder of Bonds.

I project my nominal cash needs (expenses - Income) on a yearly basis out to 10 years. Then purchase bonds (or bond funds) to match. Bond ladder is maintained yearly as part of rebalancing.
vineviz wrote:
Mon Jun 10, 2019 10:13 am
What you are describing, if I understand you correctly, is maintaining a non-rolling bond ladder.
Before we started getting our pensions and SS I put together a ten year TIPS ladder with each rung being one year's anticipated expenses. The idea was to spend it only if needed in a down market and replace the missing rung(s) when the market recovered.

This I think is what WoodSpinner was trying to accomplish.

Unfortunately I "spent" all ten rungs in '08 to rebalance. I eventually replaced most of it with a "wobbly" nominal Treasury ladder.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by 2pedals » Mon Jun 10, 2019 11:09 am

"Bonds are for Resoluteness"

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Phineas J. Whoopee » Mon Jun 10, 2019 11:12 am

willthrill81 wrote:
Sun Jun 09, 2019 1:10 pm
...
Loss aversion is one of them. Further, loss aversion has some mathematical basis (i.e. a 50% loss requires a 100% gain to break-even).
What precisely is the distinction between: 50% of $100; and 100% of $50?

PJW

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by rbaldini » Mon Jun 10, 2019 11:19 am

In a Boglehead-esque investment strategy (i.e. investing in a few cheap, passive index funds; non-real-estate assets mostly divided between stocks and bonds; not timing the market), the role of bonds funds is indeed to lower risk relative to stock funds (recognizing, of course, the ambiguity of the term "risk"). So at a very basic level, yes, "bonds are for safety": a portfolio with more bonds is generally expected to have less chance of losing lots of money than one with less bonds. Of course it's not always that simple: historically, a portfolio with about 90% bond and 10% stock is less volatile than 100% bonds. This is because the two are not really positively correlated, so the variance in returns turns out to be reduced. So, technically, there are cases where fewer bonds (relative to stocks) is expected to be "safer", broadly speaking. (I'm solely talking about nominal returns btw.)

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by rbaldini » Mon Jun 10, 2019 11:20 am

Phineas J. Whoopee wrote:
Mon Jun 10, 2019 11:12 am
willthrill81 wrote:
Sun Jun 09, 2019 1:10 pm
...
Loss aversion is one of them. Further, loss aversion has some mathematical basis (i.e. a 50% loss requires a 100% gain to break-even).
What precisely is the distinction between: 50% of $100; and 100% of $50?

PJW
Say you lose 50% of $100. You now have $50. Now let's say the market immediately has a +50% return. 50% of $50 is $25, so you now have $75. <$100.

EDIT: that doesn't exactly answer your question but hopefully it clarifies willthrill81's point, if it wasn't clear already.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Phineas J. Whoopee » Mon Jun 10, 2019 11:34 am

rbaldini wrote:
Mon Jun 10, 2019 11:20 am
Phineas J. Whoopee wrote:
Mon Jun 10, 2019 11:12 am
willthrill81 wrote:
Sun Jun 09, 2019 1:10 pm
...
Loss aversion is one of them. Further, loss aversion has some mathematical basis (i.e. a 50% loss requires a 100% gain to break-even).
What precisely is the distinction between: 50% of $100; and 100% of $50?

PJW
Say you lose 50% of $100. You now have $50. Now let's say the market immediately has a +50% return. 50% of $50 is $25, so you now have $75. <$100.
A percentage is a ratio between two numbers: the numerator; and the denominator. Change the denominator and the percentage that results loses relative meaning. To use your example: 50% of $100 is greater than 50% of $50; as $50 is more than $25; but the two 50% ratios are relative to different denominators and therefore aren't directly comparable.

Readers may want to look at our wiki article Percentage gain and loss.

PJW

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by rbaldini » Mon Jun 10, 2019 11:38 am

The comparison is usually meant to highlight the somewhat nonintuitive (especially to new investors) fact that losing 1% in the market one day and gaining 1% in the market the next day means you have lost money. I'm sure you're aware of this. That's all I mean, and I think it's what willthrill meant.

Of course, if people thought in terms of factors, then we'd say "getting a return factor of 0.99 and then a return factor of 1.01 does not equal a return of 1.0, because you multiply them". But we don't say that.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by willthrill81 » Mon Jun 10, 2019 11:51 am

rbaldini wrote:
Mon Jun 10, 2019 11:38 am
The comparison is usually meant to highlight the somewhat nonintuitive (especially to new investors) fact that losing 1% in the market one day and gaining 1% in the market the next day means you have lost money. I'm sure you're aware of this. That's all I mean, and I think it's what willthrill meant.

Of course, if people thought in terms of factors, then we'd say "getting a return factor of 0.99 and then a return factor of 1.01 does not equal a return of 1.0, because you multiply them". But we don't say that.
Correct. Thank you.

The concept of loss aversion refers to equivalent losses or gains. In terms of actual dollars, losses and gains should logically be viewed as equivalent. But in terms of percentages, gains should be preferred to losses.
Last edited by willthrill81 on Mon Jun 10, 2019 12:08 pm, edited 1 time in total.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by WoodSpinner » Mon Jun 10, 2019 12:02 pm

Doc wrote:
Mon Jun 10, 2019 10:57 am
WoodSpinner wrote:
Mon Jun 10, 2019 9:47 am
No, I mean a Rolling Ladder of Bonds.

I project my nominal cash needs (expenses - Income) on a yearly basis out to 10 years. Then purchase bonds (or bond funds) to match. Bond ladder is maintained yearly as part of rebalancing.
vineviz wrote:
Mon Jun 10, 2019 10:13 am
What you are describing, if I understand you correctly, is maintaining a non-rolling bond ladder.
Before we started getting our pensions and SS I put together a ten year TIPS ladder with each rung being one year's anticipated expenses. The idea was to spend it only if needed in a down market and replace the missing rung(s) when the market recovered.

This I think is what WoodSpinner was trying to accomplish.

Unfortunately I "spent" all ten rungs in '08 to rebalance. I eventually replaced most of it with a "wobbly" nominal Treasury ladder.
Correct. Not doing TIPs because I think the inflation rate risk is low over the next 10 years. Building a ladder of treasuries instead.

Hope it’s not too wobbly, time will tell.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Steve Reading » Mon Jun 10, 2019 12:18 pm

skeptic42 wrote:
Mon Jun 10, 2019 7:12 am
Isn't the immunization concept a similar "fallacy of composition"?
Immunization makes sense for a bond portfolio, but not so much for a stock/bond portfolio, or what is the duration of a stock/bond portfolio?
Oh I love that. OP recommends immunizing your bonds to decrease their overall risk and assuming that will lead to a better portfolio. But maybe purposefully shortening the duration (exposing you to reinvestment risk), although making the bond part riskier, might turn out to make the entire portfolio safer because of some unknown reason.

OP would be making the same behavioral mistake he is critizing.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by patrick013 » Mon Jun 10, 2019 12:24 pm

willthrill81 wrote:
Sun Jun 09, 2019 10:06 am

I'm inclined to agree. Everyone is seeking to maximize something, but exactly what they're trying to maximize can be hard to pin down. It's certainly true that maximizing one's returns is not the goal of many investors, nor is the maximization of risk-adjusted returns. Many investors could be well served by attempting to minimize their maximum regret.
I think traditional portfolio theory is adequate. Volatility measures aren't excessive. Total returns can be spent but not statistical metrics. MPT is just an academic concept then.

The same with duration. It is so linear it can hardly be used in most situations. Another academic concept then. Some added info about that below.

= http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Duration.aspx?tagName=duration&weburl=http://kfknowledgebank.kaplan.co.uk&listid=1d06790a-eef1-4037-8b41-f862a89ff68e
age in bonds, buy-and-hold, 10 year business cycle

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 12:44 pm

305pelusa wrote:
Mon Jun 10, 2019 12:18 pm
skeptic42 wrote:
Mon Jun 10, 2019 7:12 am
Isn't the immunization concept a similar "fallacy of composition"?
Immunization makes sense for a bond portfolio, but not so much for a stock/bond portfolio, or what is the duration of a stock/bond portfolio?
Oh I love that. OP recommends immunizing your bonds to decrease their overall risk and assuming that will lead to a better portfolio. But maybe purposefully shortening the duration (exposing you to reinvestment risk), although making the bond part riskier, might turn out to make the entire portfolio safer because of some unknown reason.

OP would be making the same behavioral mistake he is critizing.
I'm not sure any of that follows logically from what I've said, though maybe I can clarify a few things.

1) Immunization is a strategy for reducing exposure to interest rate risk, not "overall risk".

2) I have no problem with ANY change to a component of the portfolio (including shortening duration) which is made with a goal of improving the performance of the aggregate portfolio.
My point is NOT that everyone should own a specific kind of bonds. Instead, my point is that NO ONE should create suboptimal portfolios on purpose based on fallacious heuristics or aphorisms.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 12:48 pm

patrick013 wrote:
Mon Jun 10, 2019 12:24 pm
I think traditional portfolio theory is adequate. Volatility measures aren't excessive. Total returns can be spent but not statistical metrics. MPT is just an academic concept then.

The same with duration. It is so linear it can hardly be used in most situations. Another academic concept then. Some added info about that below.
This is akin to saying that gravity is "just an academic concept".

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Ferdinand2014 » Mon Jun 10, 2019 1:00 pm

HomerJ wrote:
Mon Jun 10, 2019 10:41 am
vineviz wrote:
Sat Jun 08, 2019 11:22 am
An investor who expresses a preference for stable bonds REGARDLESS of how those bonds affect the total return of the portfolio is, without question, behaving irrationally.
This is, of course, incorrect. A person is not irrational because they are not focused on total return.

I think the real logical fallacy here is thinking investing or economics is an actual science.

It's not.
Whenever I hear someone say ‘without question’, I most definitely will question what they are saying.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by patrick013 » Mon Jun 10, 2019 1:08 pm

vineviz wrote:
Mon Jun 10, 2019 12:48 pm
patrick013 wrote:
Mon Jun 10, 2019 12:24 pm
I think traditional portfolio theory is adequate. Volatility measures aren't excessive. Total returns can be spent but not statistical metrics. MPT is just an academic concept then.

The same with duration. It is so linear it can hardly be used in most situations. Another academic concept then. Some added info about that below.
This is akin to saying that gravity is "just an academic concept".

All the finance texts are so concerned with return volatility and so little concerned for price volatility. They should be concerned with both concepts I'd say.
age in bonds, buy-and-hold, 10 year business cycle

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Northern Flicker » Mon Jun 10, 2019 1:32 pm

I like long term TIPS just fine, for investors whose portfolio would otherwise have significant exposure to inflation risk.
Inflation risk is hard to quantify for growth assets. Int’l stocks, small value tilts, real estate, commodity producers, and commodities all protect against inflation risk probabilistically to varying degrees, but there is no guarantee that they will perform as hoped. They all have other drivers of return as well, and the dislocations caused by robust inflation can affect the supply and demand balances fundamentally relevant to each investment in unpredictable ways.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Steve Reading » Mon Jun 10, 2019 1:41 pm

vineviz wrote:
Mon Jun 10, 2019 12:44 pm
305pelusa wrote:
Mon Jun 10, 2019 12:18 pm
skeptic42 wrote:
Mon Jun 10, 2019 7:12 am
Isn't the immunization concept a similar "fallacy of composition"?
Immunization makes sense for a bond portfolio, but not so much for a stock/bond portfolio, or what is the duration of a stock/bond portfolio?
Oh I love that. OP recommends immunizing your bonds to decrease their overall risk and assuming that will lead to a better portfolio. But maybe purposefully shortening the duration (exposing you to reinvestment risk), although making the bond part riskier, might turn out to make the entire portfolio safer because of some unknown reason.

OP would be making the same behavioral mistake he is critizing.
I'm not sure any of that follows logically from what I've said, though maybe I can clarify a few things.

1) Immunization is a strategy for reducing exposure to interest rate risk, not "overall risk".

2) I have no problem with ANY change to a component of the portfolio (including shortening duration) which is made with a goal of improving the performance of the aggregate portfolio.
My point is NOT that everyone should own a specific kind of bonds. Instead, my point is that NO ONE should create suboptimal portfolios on purpose based on fallacious heuristics or aphorisms.
Matching duration to investment horizon ensures that price risk cancels out reinvestment risk, effectively minimizing interest rate risk.

If you use a shorter duration than your horizon, reinvestment risk increases while price risk decreases.

Immunizing the bond holding might make for the lowest interest rate risk of the bond holding, but what matters is the portfolio no? So who knows, maybe if you purposefully de-immunized the portfolio and decreased the price risk further while increasing reinvestment risk would actually turn out to make a safer portfolio even though the bond holding now has higher interest rate risk.

You have to appreciate the poetic justice that if reinvestment risk was negatively correlated with stocks somehow, then that might be exactly what you should do by the same logic you critize here yes?

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by willthrill81 » Mon Jun 10, 2019 1:42 pm

WoodSpinner wrote:
Mon Jun 10, 2019 12:02 pm
Doc wrote:
Mon Jun 10, 2019 10:57 am
WoodSpinner wrote:
Mon Jun 10, 2019 9:47 am
No, I mean a Rolling Ladder of Bonds.

I project my nominal cash needs (expenses - Income) on a yearly basis out to 10 years. Then purchase bonds (or bond funds) to match. Bond ladder is maintained yearly as part of rebalancing.
vineviz wrote:
Mon Jun 10, 2019 10:13 am
What you are describing, if I understand you correctly, is maintaining a non-rolling bond ladder.
Before we started getting our pensions and SS I put together a ten year TIPS ladder with each rung being one year's anticipated expenses. The idea was to spend it only if needed in a down market and replace the missing rung(s) when the market recovered.

This I think is what WoodSpinner was trying to accomplish.

Unfortunately I "spent" all ten rungs in '08 to rebalance. I eventually replaced most of it with a "wobbly" nominal Treasury ladder.
Correct. Not doing TIPs because I think the inflation rate risk is low over the next 10 years. Building a ladder of treasuries instead.

Hope it’s not too wobbly, time will tell.
However, the 10 year breakeven inflation rate is currently just 1.73%, so the cost of TIPS' 'insurance' seems very small right now.
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 2:07 pm

305pelusa wrote:
Mon Jun 10, 2019 1:41 pm
Immunizing the bond holding might make for the lowest interest rate risk of the bond holding, but what matters is the portfolio no?
Yes, and this doesn't present the contradiction you suggest.

For one thing, the the relationship between the price change of a bond and the yield change of a bond is not just merely a correlation. It's a mathematical certainty.

Also, we know empirically that the relationship between stock price change and bond yield change is very weak (that's what makes the concept of equity duration so questionable, as I mentioned earlier)

Furthermore, to the extent that there is a relationship between stock prices and bond yields, the covariance matrix of the portfolio captures it. This is precisely the reason that paying attention to the aggregate portfolio, and not just the component pieces, is so critical.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Doc » Mon Jun 10, 2019 2:53 pm

vineviz wrote:
Mon Jun 10, 2019 2:07 pm
Furthermore, to the extent that there is a relationship between stock prices and bond yields, the covariance matrix of the portfolio captures it. This is precisely the reason that paying attention to the aggregate portfolio, and not just the component pieces, is so critical.
The problem that I have is that I don't know how to measure what the relationship is between stock prices and bond yields during a market crash.

Look at TIPS, nominal Treasures and the S&P 500 around '08. Here is a 3 month rolling return chart at that time.

Image

http://quotes.morningstar.com/chart/fun ... A%5B%5D%7D

VIPSX: TIPS, IEI: Treasuries, SPY: Equities

Are your statistics going to be able to quantify that behaviour?
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"Bonds Are For Safety"

Post by Taylor Larimore » Mon Jun 10, 2019 2:56 pm

Bogleheads:

Vanguard reports these Historical Risk/Return Results (1926–2017):

Worst annual return for a 100% Stock Portfolio was -43.1%

Worst annual return for a 100% Bond Portfolio was -8.1%

https://www.vanguard.com/us/insights/sa ... llocations

Best wishes.
Taylor
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Re: "Bonds Are For Safety"

Post by Dialectical Investor » Mon Jun 10, 2019 3:03 pm

Taylor Larimore wrote:
Mon Jun 10, 2019 2:56 pm
Bogleheads:

Vanguard reports these Historical Risk/Return Results (1926–2017):

Worst annual return for a 100% Stock Portfolio was -43.1%

Worst annual return for a 100% Bond Portfolio was -8.1%

https://www.vanguard.com/us/insights/sa ... llocations

Best wishes.
Taylor
This might be relevant if you care about nominal annual returns and hold a 100% stock or 100% bond portfolio. That is not the case for most investors.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Angst » Mon Jun 10, 2019 3:23 pm

I'm sorry, but you lost me with your original post. No, I haven't read the entire thread yet, but for someone as quick to criticize others for inaccuracy or a lack of precision as you can occasionally be, you don't appear to me to have started out very strong here:
vineviz wrote:
Fri Jun 07, 2019 10:33 am
Before presenting the actual definitions, let me present an example.
You are not really presenting your "example" here, unless you meant an "example of an analogy". Only afterwards do you actually present your "example". You use the following as an analogy to help demonstrate the fallacy of your later example.
vineviz wrote:
Fri Jun 07, 2019 10:33 am
1) Fruit is tasty
2) Cake is tasty
3) Therefore, fruitcake must also be tasty. <h/t to Jim Gaffigan>
Fallacy of Composition: (also known as: composition fallacy, exception fallacy, faulty induction)

Description: Inferring that something is true of the whole from the fact that it is true of some part of the whole.
This fallacy, which I think manifests among investors as a behavioral bias towards short-term bonds, manifests when people erroneously extrapolate the characteristics of the component (e.g. the riskiness of the bond fund) up to the level of the aggregate (e.g. the riskiness of the portfolio) without taking into account how the components are arranged within the aggregate.
Ok, now you're getting around to the "example":
vineviz wrote:
Fri Jun 07, 2019 10:33 am
Example of the fallacy: bond fund A is less volatile than bond fund B, therefore a portfolio containing bond fund A must be less volatile than a portfolio containing bond fund B.
Alright, but you're quickly getting us into the weeds here. In your discussion beginning with "This fallacy..." above, you focused on "the riskiness" of both bond funds and of a portfolio (my bold/underlines), but in your example where you might have been more consistent by saying "bond fund A is less risky", you chose instead to say "less volatile". Why change horses all of a sudden? It's distracting, to say the least. Furthermore, you've chosen a rather mediocre example as far as following through from the analogy you started off with; it does not nicely follow through from the analogy. A more elegant, logically consistent example to follow the analogy you lead with would have been something like this:
A more logically consistent example one might have wrote: Example of the fallacy: bond fund A is less volatile than an equity fund C and bond fund B is less volatile than an equity fund C, therefore an equity/bond portfolio containing both bond fund A and bond fund B must also be less volatile than an equity fund C.
Unfortunately though, this fairly un-contentious example would probably have done little to further your discussion. Even more unfortunately though, from my standpoint at least, is that the distraction provided by the aforementioned shortcomings of your original post has consumed so much of my time that at this point that I no longer am able to pursue the remainder of your thread. It does sound interesting though and I hope to remember to get back to it.
:D

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Taylor Larimore » Mon Jun 10, 2019 3:24 pm

Dialectical Investor wrote:This might be relevant if you care about nominal annual returns and hold a 100% stock or 100% bond portfolio. That is not the case for most investors.
Dialectical Investor:

Our stock/bond allocation is arguably the most important decision we must make. The link I provided offers nine different stock/bond portfolios with maximum gains and loses which should be helpful to most investors..

Best wishes.
Taylor
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by pdavi21 » Mon Jun 10, 2019 3:43 pm

There are many logical fallacies going around these days.
"Bonds are for safety" is one of the less harmful ones.
"We spend a great deal of time studying history, which, let's face it, is mostly the history of stupidity." -Stephen Hawking

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 3:49 pm

Angst wrote:
Mon Jun 10, 2019 3:23 pm
I'm sorry, but you lost me with your original post.
And you lost me at this sentence ;)
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 4:01 pm

Doc wrote:
Mon Jun 10, 2019 2:53 pm
vineviz wrote:
Mon Jun 10, 2019 2:07 pm
Furthermore, to the extent that there is a relationship between stock prices and bond yields, the covariance matrix of the portfolio captures it. This is precisely the reason that paying attention to the aggregate portfolio, and not just the component pieces, is so critical.
The problem that I have is that I don't know how to measure what the relationship is between stock prices and bond yields during a market crash.
That relationship can be entirely summarized by the covariance (the volatility of each asset and the correlation of the two assets)

If the covariance as well as the relative weights of the two assets are known, that's all you need in order to calculate the portfolio's variance.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Angst » Mon Jun 10, 2019 4:03 pm

vineviz wrote:
Mon Jun 10, 2019 3:49 pm
Angst wrote:
Mon Jun 10, 2019 3:23 pm
I'm sorry, but you lost me with your original post.
And you lost me at this sentence ;)
Ha! It appears then we're both lost, in good company.
:sharebeer

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Dialectical Investor » Mon Jun 10, 2019 4:27 pm

Taylor Larimore wrote:
Mon Jun 10, 2019 3:24 pm
Dialectical Investor wrote:This might be relevant if you care about nominal annual returns and hold a 100% stock or 100% bond portfolio. That is not the case for most investors.
Dialectical Investor:

Our stock/bond allocation is arguably the most important decision we must make. The link I provided offers nine different stock/bond portfolios with maximum gains and loses which should be helpful to most investors..

Best wishes.
Taylor
Right, however, they are all of the same type of bond. (Well, over time they are different, due to index availability, but, oh well.) The question in this thread is what type of bond should be held, or more generally, what mix of assets produces the least volatile portfolio, if more than two assets are available. If you think bonds are for safety, the answer to that question depends on the specific mix of portfolio assets and cannot be generalized to the bond fund with the least credit risk and the least term risk (here defining term risk generally, as lower coupon, longer time-to-maturity equals more term risk.) So by the link you provided, one can see that adding more bonds has reduced worst-year loss. One might think, then, that adding a specific class of bonds that has the smallest worst-year loss would produce a set of portfolios with the smallest worst-year loss across the entire spectrum of stock-bond mixes, compared to alternative bond options that individually have larger worst-year losses. But it turns out, that is not what happens. In other words, the phrase "bonds are for safety" does not always mean "choose the bond that if held individually would exhibit the smallest volatility or smallest worst-year loss."

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Doc » Mon Jun 10, 2019 4:39 pm

vineviz wrote:
Mon Jun 10, 2019 4:01 pm
Doc wrote:
Mon Jun 10, 2019 2:53 pm
vineviz wrote:
Mon Jun 10, 2019 2:07 pm
Furthermore, to the extent that there is a relationship between stock prices and bond yields, the covariance matrix of the portfolio captures it. This is precisely the reason that paying attention to the aggregate portfolio, and not just the component pieces, is so critical.
The problem that I have is that I don't know how to measure what the relationship is between stock prices and bond yields during a market crash.
That relationship can be entirely summarized by the covariance (the volatility of each asset and the correlation of the two assets)

If the covariance as well as the relative weights of the two assets are known, that's all you need in order to calculate the portfolio's variance.
If the high variance only occurs over a few months but your metrics use a period of say 60 months the high variance may get lost in the inherent averaging of the calculation. :?:
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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 4:48 pm

Doc wrote:
Mon Jun 10, 2019 4:39 pm
If the high variance only occurs over a few months but your metrics use a period of say 60 months the high variance may get lost in the inherent averaging of the calculation. :?:
Perhaps we can agree that the investor's investment horizon should influence which portfolio characteristics matter most to them?

If we can agree on that, then we can probably agree that most investors should care much more about the general nature of those characteristics over the life of the investment and not as much about what might happen in any particular month.

I'm not saying that what happens during a market crash is completely irrelevant, but there is a clear and present danger in focusing too heavily on it to the exclusion of keeping the big picture in perspective.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Northern Flicker » Mon Jun 10, 2019 5:06 pm

If we can agree on that, then we can probably agree that most investors should care much more about the general nature of those characteristics over the life of the investment and not as much about what might happen in any particular month.
Investment horizon is not a deterministic future property of your life course. Job losses, business insolvencies, health issues and/or disabilities, and family matters, can all change one’s horizon drastically. The length of time one’s expenses are covered by an emergency fund is another potential investment horizon in cases where unemployment exhausts one’s liquid assets. Also note that a larger emergency fund to cover portfolio volatility is equivalent to a shorter portfolio bond duration.

If you do not experience career disruptions, then the income stream from your employment has a long duration that will match your investment horizon. Use of intermediate term fixed income durations can protect against unexpectedly shorter investment horizons associated with loss of employment. That is the basis of the statement that bonds are for safety.

The above may even suggest that retirees should be more concerned about matching fixed income duration to time horizon than working stiffs, as retirees no longer have an expected employment-based income stream with duration matched to time horizon.

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by vineviz » Mon Jun 10, 2019 5:24 pm

Northern Flicker wrote:
Mon Jun 10, 2019 5:06 pm
Investment horizon is not a deterministic future property of your life course.
Obviously true, but not contradictory with anything I've said I think.

A careful investment horizon estimation can include weights to account for both the timing and probability of various expenses. Not every possible cash flow needs to be weighted as if it has 100% certainty.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: The logical fallacy behind "Bonds Are For Safety"

Post by Doc » Tue Jun 11, 2019 6:53 am

One way to include both time frames in one's Investment portfolio is to not use TBM as their only FI asset. Sorry for all you three funders but while easy it ignores the short term concerns. Just break that TBM into it's components and both short and lifetime concerns can be addressed.

If you get laid off the short term components can serve as your emergency fund. When you get a new job start replacing what you spent. Same idea applies to rebalancing in a stock market crash but it's the longer term Treasuries that likely get spent.
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