"Need, ability, willingness" with bonds yielding <1%

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CFK
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"Need, ability, willingness" with bonds yielding <1%

Post by CFK » Sat Mar 07, 2020 9:08 pm

When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.

To determine risk capacity, the standard advice is to evaluate "need, ability, and willingness". According to the wiki and the standard definitions used on this forum:

1. Need relates to the rate of return an investor must obtain to reach their goal.
2. Ability relates to the investor's circumstances, such as the amount of time until they need the money and their income stability.
3. Willingness relates to an investor's temperament, and their willingness to accept market volatility with equanimity.

A proper asset allocation must balance these three principles, like an object suspended between three magnets.

As I understand the above principles, treasury yields <1% increase an investor's need to take risk. An investor who set their asset allocation in 2000 could buy high grade bonds with a nominal 7% rate of return. If the investor needed a real rate of return of 4%, they could invest a significant portion of their portfolio in bonds and still be likely to obtain their desired rate of return. Today, we can buy ten year treasuries with a nominal yield of .7%. To obtain that same 4% real rate of return, the investor will need to assume more risk.

There are two points to this post. First, for those investors who: 1) have a specific real rate of return that they need to obtain their financial objectives; 2) have a high ability to take risk; and 3) have a high willingness to take risk, that investor should consider changing their asset allocation to be heavier in stocks due to the low interest rates on bonds.

Second, negative real interests rates on bonds present a greater tradeoff for investors who have a high ability to take risk but a low willingness to take risk. For the investor of yesteryear, who could buy treasuries yielding 7%, the long term price that they paid for "sleeping well at night" was probably low. They could enjoy the safety of bonds and get a real rate of return on that portion of their portfolio. Today, with negative real treasury yields, investors with a high ability but low willingness to take risk are likely paying a high long term cost to guard against short-term volatility.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sat Mar 07, 2020 9:11 pm

CFK wrote:
Sat Mar 07, 2020 9:08 pm

As I understand the above principles, treasury yields <1% increase an investor's need to take risk.
Not necessarily.

It depends on what kind of withdrawal rate you need and what you think inflation will be.

If you have 50x living expenses, retire at age 50, and inflation is low, you don't care about nominal yields all that much.

You can just put it all in TIPS and probably be fine.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Triple digit golfer » Sat Mar 07, 2020 9:21 pm

If a low bond yield means you need to take additional risk, then you're holding bonds for the wrong reason.

I believe that expected returns of any asset are speculative and should never cause one to change AA and take additional risk. It's no different than people who said stocks were over valued five years ago and got out. That didn't work out well.

Expected returns on bonds are low. Expected returns on equities are also low. What should an investor do?

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by stan1 » Sat Mar 07, 2020 9:22 pm

Triple digit golfer wrote:
Sat Mar 07, 2020 9:21 pm
Expected returns on bonds are low. Expected returns on equities are also low. What should an investor do?
And fortunately inflation is also low.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sat Mar 07, 2020 9:23 pm

Triple digit golfer wrote:
Sat Mar 07, 2020 9:21 pm

Expected returns on bonds are low. Expected returns on equities are also low. What should an investor do?
Leverage!

Just kidding...

Maybe.

It's more exciting than saying "save more, work longer".
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by AerialWombat » Sat Mar 07, 2020 9:23 pm

Bond yields have absolutely zero bearing on my need or willingness to take risk. The primary objective of my overall 30/70 portfolio is to merely beat inflation — that’s all. Bond yields can go negative, and as long as equities hold up their end, I’m good.

Will I perhaps start looking at CD’s instead of muni’s in taxable? Sure. Already bought one 6-month CD, will probably buy more. But I would have started doing that anyway.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by AerialWombat » Sat Mar 07, 2020 9:24 pm

watchnerd wrote:
Sat Mar 07, 2020 9:23 pm
Leverage!
Sure... In real estate. :)

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by CFK » Sat Mar 07, 2020 9:30 pm

watchnerd wrote:
Sat Mar 07, 2020 9:11 pm
CFK wrote:
Sat Mar 07, 2020 9:08 pm

As I understand the above principles, treasury yields <1% increase an investor's need to take risk.
Not necessarily.

It depends on what kind of withdrawal rate you need and what you think inflation will be.

If you have 50x living expenses, retire at age 50, and inflation is low, you don't care about nominal yields all that much.

You can just put it all in TIPS and probably be fine.
I shouldn't have been so categorical. The investor you describe would have a low need and high ability for risk. So their willingness to take risk would likely be the overriding factor in their asset allocation.

I was thinking more specifically for people like myself who need a 4% real rate of return to meet our goals. If TIPS yielded a 2-3% real return, as they have in the past, then an investor going through the "need, willingness, ability" exercise could put a significant portion of their money in TIPS, and still have a good chance at hitting their goals. That isn't the case today.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by CFK » Sat Mar 07, 2020 9:35 pm

Triple digit golfer wrote:
Sat Mar 07, 2020 9:21 pm
If a low bond yield means you need to take additional risk, then you're holding bonds for the wrong reason.

I believe that expected returns of any asset are speculative and should never cause one to change AA and take additional risk. It's no different than people who said stocks were over valued five years ago and got out. That didn't work out well.
I'm not sure I agree with either point. Why shouldn't a bond's return factor into an investor's need to take risk? If TIPS yielded 2% real return, and all I needed was a 2% real return, then I wouldn't have any need to take risk (though I still might).

Expected returns for stocks are obviously speculative. No argument on that point here. It is my understanding that you can estimate with decent accuracy the nominal return of bonds based on their yield to maturity rate.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Enzo IX » Sat Mar 07, 2020 9:35 pm

That's the way I'm seeing it in this current environment. If you have a good safety buffer, holding excess cash or bonds is not a good idea at current levels.

As Warren Buffett keeps repeating, Take a 10 year Treasury bond at .71 (could be off a few hundredth a percent) with a P/E ratio of 140 with no chance of increasing earnings and the total stock market, there is a good chance the market is gonna outperform substantially. Substitute 30 year Treasuries as needed.

However, if you are financially or physically unable to hang on for the ride, then it's probably good to stay more conservative.

The biggest detriment to achieving your goals is the hidden inflation factor, it's the biggest tax we have. take a compound interest calculator and input your estimations in the proper fields. Then take the ending number the calculator gives you, sounds pretty impressive I hope. Now take that ending number and use a present value calculator using 2-3% as the discount value for future inflation and it should give you sobering view, not as impressive as it was.

As always, nobody knows what was best until after the it plays out in real time.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by TheLaughingCow » Sat Mar 07, 2020 9:36 pm

I don't understand how bonds can have negative real return. The risk of default, while low, is not negative. Isn't it obvious that financial markets are distorted?

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sat Mar 07, 2020 9:48 pm

CFK wrote:
Sat Mar 07, 2020 9:30 pm

I was thinking more specifically for people like myself who need a 4% real rate of return to meet our goals. If TIPS yielded a 2-3% real return, as they have in the past, then an investor going through the "need, willingness, ability" exercise could put a significant portion of their money in TIPS, and still have a good chance at hitting their goals. That isn't the case today.
I think the TIPS yields of the past were a historical fluke.

My forecasting assumes TIPS earning a guaranteed 0% real, keeping up with inflation, and not losing principal during deflation.

I hold nominal long Treasuries for very different reasons: for risk parity matching (allowing me to hold more equities) and deflation protection.

I expect my real returns in excess of inflation to come from equities.



Maybe someday I'll dabble in emerging market bonds, which split the difference between equity and bond attributes.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sat Mar 07, 2020 9:52 pm

TheLaughingCow wrote:
Sat Mar 07, 2020 9:36 pm
I don't understand how bonds can have negative real return. The risk of default, while low, is not negative. Isn't it obvious that financial markets are distorted?
Are you saying that bond holders are not being fairly compensated for potential default risk of the Federal government vs....what? cash?
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by CFK » Sat Mar 07, 2020 10:10 pm

watchnerd wrote:
Sat Mar 07, 2020 9:48 pm
CFK wrote:
Sat Mar 07, 2020 9:30 pm

I was thinking more specifically for people like myself who need a 4% real rate of return to meet our goals. If TIPS yielded a 2-3% real return, as they have in the past, then an investor going through the "need, willingness, ability" exercise could put a significant portion of their money in TIPS, and still have a good chance at hitting their goals. That isn't the case today.
I think the TIPS yields of the past were a historical fluke.

My forecasting assumes TIPS earning a guaranteed 0% real, keeping up with inflation, and not losing principal during deflation.

I hold nominal long Treasuries for very different reasons: for risk parity matching (allowing me to hold more equities) and deflation protection.

I expect my real returns in excess of inflation to come from equities.
This is how I was thinking about things a month ago. But with 10 year treasuries now yielding .7%, I'm not sure it is still reasonable to expect bonds to earn 0% after inflation. Seems more likely they will earn -1% or so, which is why I'm considering increasing my stock allocation. Bonds are low risk and low reward in the short term. But in the long term, a bond with a .7% yield is high risk (it's purchasing power will almost certainly erode over time) and low reward. I'm worried I'm paying an extraordinarily high long term price to mitigate short term volatility.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sun Mar 08, 2020 12:09 am

CFK wrote:
Sat Mar 07, 2020 10:10 pm

This is how I was thinking about things a month ago. But with 10 year treasuries now yielding .7%, I'm not sure it is still reasonable to expect bonds to earn 0% after inflation. Seems more likely they will earn -1% or so, which is why I'm considering increasing my stock allocation. Bonds are low risk and low reward in the short term. But in the long term, a bond with a .7% yield is high risk (it's purchasing power will almost certainly erode over time) and low reward. I'm worried I'm paying an extraordinarily high long term price to mitigate short term volatility.

If you're concerned about inflation, do you hold TIPS or I-bonds?
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Noobvestor » Sun Mar 08, 2020 12:11 am

TheLaughingCow wrote:
Sat Mar 07, 2020 9:36 pm
I don't understand how bonds can have negative real return. The risk of default, while low, is not negative. Isn't it obvious that financial markets are distorted?
Real yield != nominal yield.

The yield on intermediate-term TIPS right now is around negative 0.5%

However, they get an inflation adjustment factor - that's the 'bonus' of TIPS, not reflected in the base yield.

The current inflation rate according to my quick Google search is around 2.5%

So TIPS are getting something like -0.5% + 2.5% = 2% nominal (normal dollar) yield. That's not a bad deal in this low-nominal-rate environment

For comparison, intermediate-term Treasuries right now are yielding less than 0.5%, so around a quarter as much as TIPS of the same duration.

Of course, all of this can and will change as inflation and rates go up and down, but TIPS aren't the worst option at the moment.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Noobvestor » Sun Mar 08, 2020 12:13 am

watchnerd wrote:
Sun Mar 08, 2020 12:09 am
CFK wrote:
Sat Mar 07, 2020 10:10 pm

This is how I was thinking about things a month ago. But with 10 year treasuries now yielding .7%, I'm not sure it is still reasonable to expect bonds to earn 0% after inflation. Seems more likely they will earn -1% or so, which is why I'm considering increasing my stock allocation. Bonds are low risk and low reward in the short term. But in the long term, a bond with a .7% yield is high risk (it's purchasing power will almost certainly erode over time) and low reward. I'm worried I'm paying an extraordinarily high long term price to mitigate short term volatility.

If you're concerned about inflation, do you hold TIPS or I-bonds?
Up to the annual purchase limit, I Bonds are definitively the better deal right now. I've been buying them for years, even when TIPS rates were positive and higher than I Bond rates (for various reasons). I'm glad I kept buying and will continue to buy.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Nestegg_User » Sun Mar 08, 2020 12:17 am

CFK wrote:
Sat Mar 07, 2020 10:10 pm
watchnerd wrote:
Sat Mar 07, 2020 9:48 pm
CFK wrote:
Sat Mar 07, 2020 9:30 pm

I was thinking more specifically for people like myself who need a 4% real rate of return to meet our goals. If TIPS yielded a 2-3% real return, as they have in the past, then an investor going through the "need, willingness, ability" exercise could put a significant portion of their money in TIPS, and still have a good chance at hitting their goals. That isn't the case today.
I think the TIPS yields of the past were a historical fluke.

My forecasting assumes TIPS earning a guaranteed 0% real, keeping up with inflation, and not losing principal during deflation.

I hold nominal long Treasuries for very different reasons: for risk parity matching (allowing me to hold more equities) and deflation protection.

I expect my real returns in excess of inflation to come from equities.
This is how I was thinking about things a month ago. But with 10 year treasuries now yielding .7%, I'm not sure it is still reasonable to expect bonds to earn 0% after inflation. Seems more likely they will earn -1% or so, which is why I'm considering increasing my stock allocation. Bonds are low risk and low reward in the short term. But in the long term, a bond with a .7% yield is high risk (it's purchasing power will almost certainly erode over time) and low reward. I'm worried I'm paying an extraordinarily high long term price to mitigate short term volatility.
I just responded in the same manner to another thread...
with treasuries having that low a yield, I would be guaranteed to loose to inflation (as I know my personal inflation rate, which includes medical, will be higher)
I also said I see CD's (15 month up to three years, but currently at least to two) having higher TEY than comparable treasuries...so that's what I'm using (didn't reinvest recently matured treasuries; they'll go into CD's)

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Sun Mar 08, 2020 12:34 am

Nestegg_User wrote:
Sun Mar 08, 2020 12:17 am


I just responded in the same manner to another thread...
with treasuries having that low a yield, I would be guaranteed to loose to inflation (as I know my personal inflation rate, which includes medical, will be higher)
I also said I see CD's (15 month up to three years, but currently at least to two) having higher TEY than comparable treasuries...so that's what I'm using (didn't reinvest recently matured treasuries; they'll go into CD's)
So then why not ignore nominal bonds and buy inflation-protected bonds of whatever flavor you like ?

TIPS, I-bonds, etc.

Even CDs are a gamble vs inflation.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Bluce » Sun Mar 08, 2020 12:35 am

CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.

To determine risk capacity, the standard advice is to evaluate "need, ability, and willingness". According to the wiki and the standard definitions used on this forum:

1. Need relates to the rate of return an investor must obtain to reach their goal.
2. Ability relates to the investor's circumstances, such as the amount of time until they need the money and their income stability.
3. Willingness relates to an investor's temperament, and their willingness to accept market volatility with equanimity.

A proper asset allocation must balance these three principles, like an object suspended between three magnets.

As I understand the above principles, treasury yields <1% increase an investor's need to take risk. An investor who set their asset allocation in 2000 could buy high grade bonds with a nominal 7% rate of return. If the investor needed a real rate of return of 4%, they could invest a significant portion of their portfolio in bonds and still be likely to obtain their desired rate of return. Today, we can buy ten year treasuries with a nominal yield of .7%. To obtain that same 4% real rate of return, the investor will need to assume more risk.

There are two points to this post. First, for those investors who: 1) have a specific real rate of return that they need to obtain their financial objectives; 2) have a high ability to take risk; and 3) have a high willingness to take risk, that investor should consider changing their asset allocation to be heavier in stocks due to the low interest rates on bonds.

Second, negative real interests rates on bonds present a greater tradeoff for investors who have a high ability to take risk but a low willingness to take risk. For the investor of yesteryear, who could buy treasuries yielding 7%, the long term price that they paid for "sleeping well at night" was probably low. They could enjoy the safety of bonds and get a real rate of return on that portion of their portfolio. Today, with negative real treasury yields, investors with a high ability but low willingness to take risk are likely paying a high long term cost to guard against short-term volatility.
There are all kinds of bonds besides Treasuries. I hold a good chunk of Treasuries -- certainly not for the puny yield, but for price appreciation. They've been through the roof YTD.

If one needs the income, there are all kinds of non-Treasury bonds, and their funds, that yield a lot more than Treasuries. One can limit risk by fund duration and by the types and ratings of the various bonds held.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Scooter57 » Sun Mar 08, 2020 8:50 am

CDs with a six month early withdrawal penalty at today's low rates protect very well against unexpected inflation as they can be cheaply exchanged for CDs with higher rates should inflation rise.

I did that with some low rate CDs during the brief window when rates rose in 2018 with no difficulty

If you can't afford to lose the money you have already saved, you would be ill advised to buy riskier investments.Academics may define "risk" anyway they want. They have tenure, high salaries, and pensions. The rest of us should define risk as the probability of damaging loss.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by dbr » Sun Mar 08, 2020 9:31 am

I would say in principle that if conditions change expectations then one should reevaluate the asset allocation. But I would also say that low yields on bonds were supposed to have been considered among the possible outcomes and in that sense already anticipated. When it comes to estimating returns to meet a goal the problem is supposed to be done statistically where future return is a random variable with some mean and some distribution around the mean. The fact that one is actually getting low yields at this time doesn't change anything that one thought beforehand. For present knowledge to affect the decision one would have to use forecasting models that assume conditional probabilities given current conditions or one would have to apply perhaps Bayesian methods. I think that generally there is not enough independent data to make those kinds of judgments, but there are plenty of blogs and articles where people run out things of the nature of "3% is the new 4%" for example.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by willthrill81 » Sun Mar 08, 2020 9:40 am

CFK wrote:
Sat Mar 07, 2020 9:30 pm
I was thinking more specifically for people like myself who need a 4% real rate of return to meet our goals.
If you believe all of the 'experts' forecasting real returns for stocks in the 3-4% range over the next decade, then you probably need a heavy stock allocation if you need 4% real over the 10 years.

FWIW, Treasuries have lost to inflation at many points in the past, and their long-term real return has only been around 1%. So a real return of 0% is well within the range of their historic norm.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by dbr » Sun Mar 08, 2020 9:52 am

TheLaughingCow wrote:
Sat Mar 07, 2020 9:36 pm
I don't understand how bonds can have negative real return. The risk of default, while low, is not negative. Isn't it obvious that financial markets are distorted?
Bonds can easily have negative real returns when inflation is high -- or even when it is not. A 1.5% CD with 2% inflation has a real return of -.5%. Five year TIPS have a real yield of -0.56% as of March 6. This has nothing to do with defaults.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Bluce » Sun Mar 08, 2020 10:19 am

When negative-yield bonds are brought up, I think they are usually referring to any bond that is sold on the secondary market, for which it was bought at a premium beyond which the yield will cover.

Just pulling numbers out of the air: Take a $1,000 face value bond with one year to maturity, with a coupon of 2%. So the holder would get $1,020 back.

But with rates dropping, that 2% yielding bond becomes more valuable, so let's say someone bought it for $1,030. Because interest is always paid on face value, the return is still $20. So he bought a bond for $1,030 that only yields $20, so he is in negative territory if he holds it to maturity. But if rates continue to drop, he can always sell it for more than he paid for it, the negative yield not even a factor.

I think this is what is going on around the world -- people and institutions betting that bond prices will continue to rise. Of course this is all pretty silly and will someday come to an end. I hope it isn't ugly, and instead tapers off gradually then slowly gets back to somewhat normal rates. I doubt I will live long enough to see that, but we shall see.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by dbr » Sun Mar 08, 2020 10:28 am

Bluce wrote:
Sun Mar 08, 2020 10:19 am
When negative-yield bonds are brought up, I think they are usually referring to any bond that is sold on the secondary market, for which it was bought at a premium beyond which the yield will cover.
Or, even at issue. TIPS have a negative real yield with a positive coupon because they will auction at a premium over face value.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Bluce » Sun Mar 08, 2020 11:02 am

dbr wrote:
Sun Mar 08, 2020 10:28 am
Bluce wrote:
Sun Mar 08, 2020 10:19 am
When negative-yield bonds are brought up, I think they are usually referring to any bond that is sold on the secondary market, for which it was bought at a premium beyond which the yield will cover.
Or, even at issue. TIPS have a negative real yield with a positive coupon because they will auction at a premium over face value.
Yes, now that you mention it, I believe I read somewhere that in 2008, institutional investors desperate for a safe parking spot for $millions at a shot, bid the price of T-Bills above their face value at auction.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Nestegg_User » Mon Mar 09, 2020 9:33 am

watchnerd wrote:
Sun Mar 08, 2020 12:34 am
Nestegg_User wrote:
Sun Mar 08, 2020 12:17 am


I just responded in the same manner to another thread...
with treasuries having that low a yield, I would be guaranteed to loose to inflation (as I know my personal inflation rate, which includes medical, will be higher)
I also said I see CD's (15 month up to three years, but currently at least to two) having higher TEY than comparable treasuries...so that's what I'm using (didn't reinvest recently matured treasuries; they'll go into CD's)
So then why not ignore nominal bonds and buy inflation-protected bonds of whatever flavor you like ?

TIPS, I-bonds, etc.

Even CDs are a gamble vs inflation.
as you can see today, bonds will be taking a hit as they follow the treasuries... and at this point I want individual CD's or bonds that I hold to maturity and that have a short duration.... with current yields (including TIPs) that means CD's

I currently see deflation versus inflation... with inflation showing up in the more distant future (within five years, after the economy stabilizes and demand starts up from an almost standstill)

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Almond » Mon Mar 09, 2020 9:45 am

Bluce wrote:
Sun Mar 08, 2020 12:35 am
CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.

To determine risk capacity, the standard advice is to evaluate "need, ability, and willingness". According to the wiki and the standard definitions used on this forum:

1. Need relates to the rate of return an investor must obtain to reach their goal.
2. Ability relates to the investor's circumstances, such as the amount of time until they need the money and their income stability.
3. Willingness relates to an investor's temperament, and their willingness to accept market volatility with equanimity.

A proper asset allocation must balance these three principles, like an object suspended between three magnets.

As I understand the above principles, treasury yields <1% increase an investor's need to take risk. An investor who set their asset allocation in 2000 could buy high grade bonds with a nominal 7% rate of return. If the investor needed a real rate of return of 4%, they could invest a significant portion of their portfolio in bonds and still be likely to obtain their desired rate of return. Today, we can buy ten year treasuries with a nominal yield of .7%. To obtain that same 4% real rate of return, the investor will need to assume more risk.

There are two points to this post. First, for those investors who: 1) have a specific real rate of return that they need to obtain their financial objectives; 2) have a high ability to take risk; and 3) have a high willingness to take risk, that investor should consider changing their asset allocation to be heavier in stocks due to the low interest rates on bonds.

Second, negative real interests rates on bonds present a greater tradeoff for investors who have a high ability to take risk but a low willingness to take risk. For the investor of yesteryear, who could buy treasuries yielding 7%, the long term price that they paid for "sleeping well at night" was probably low. They could enjoy the safety of bonds and get a real rate of return on that portion of their portfolio. Today, with negative real treasury yields, investors with a high ability but low willingness to take risk are likely paying a high long term cost to guard against short-term volatility.
There are all kinds of bonds besides Treasuries. I hold a good chunk of Treasuries -- certainly not for the puny yield, but for price appreciation. They've been through the roof YTD.

If one needs the income, there are all kinds of non-Treasury bonds, and their funds, that yield a lot more than Treasuries. One can limit risk by fund duration and by the types and ratings of the various bonds held.

I was using the same reasoning but have to admit I am now confused with everyone focused on yields and the chance they go lower or negative. Are people thinking if yields go lower the price will collapse?

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by HEDGEFUNDIE » Mon Mar 09, 2020 9:54 am

Almond wrote:
Mon Mar 09, 2020 9:45 am
Bluce wrote:
Sun Mar 08, 2020 12:35 am
CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.

To determine risk capacity, the standard advice is to evaluate "need, ability, and willingness". According to the wiki and the standard definitions used on this forum:

1. Need relates to the rate of return an investor must obtain to reach their goal.
2. Ability relates to the investor's circumstances, such as the amount of time until they need the money and their income stability.
3. Willingness relates to an investor's temperament, and their willingness to accept market volatility with equanimity.

A proper asset allocation must balance these three principles, like an object suspended between three magnets.

As I understand the above principles, treasury yields <1% increase an investor's need to take risk. An investor who set their asset allocation in 2000 could buy high grade bonds with a nominal 7% rate of return. If the investor needed a real rate of return of 4%, they could invest a significant portion of their portfolio in bonds and still be likely to obtain their desired rate of return. Today, we can buy ten year treasuries with a nominal yield of .7%. To obtain that same 4% real rate of return, the investor will need to assume more risk.

There are two points to this post. First, for those investors who: 1) have a specific real rate of return that they need to obtain their financial objectives; 2) have a high ability to take risk; and 3) have a high willingness to take risk, that investor should consider changing their asset allocation to be heavier in stocks due to the low interest rates on bonds.

Second, negative real interests rates on bonds present a greater tradeoff for investors who have a high ability to take risk but a low willingness to take risk. For the investor of yesteryear, who could buy treasuries yielding 7%, the long term price that they paid for "sleeping well at night" was probably low. They could enjoy the safety of bonds and get a real rate of return on that portion of their portfolio. Today, with negative real treasury yields, investors with a high ability but low willingness to take risk are likely paying a high long term cost to guard against short-term volatility.
There are all kinds of bonds besides Treasuries. I hold a good chunk of Treasuries -- certainly not for the puny yield, but for price appreciation. They've been through the roof YTD.

If one needs the income, there are all kinds of non-Treasury bonds, and their funds, that yield a lot more than Treasuries. One can limit risk by fund duration and by the types and ratings of the various bonds held.

I was using the same reasoning but have to admit I am now confused with everyone focused on yields and the chance they go lower or negative. Are people thinking if yields go lower the price will collapse?
Ignore them.

No one focuses on yield alone for stocks.

No one should focus on yield alone for bonds.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Mon Mar 09, 2020 9:59 am

Nestegg_User wrote:
Mon Mar 09, 2020 9:33 am


as you can see today, bonds will be taking a hit as they follow the treasuries...
I'm not sure what you mean by taking a hit.

My long Treasuries are up +5% so far today.

Or by hit do you mean yields are down?
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Nestegg_User » Mon Mar 09, 2020 10:13 am

watchnerd

New bond yields will be priced lower ( I'm more into individual bonds, with hold until maturity, but I didn't reinvest my recently matured treasuries as TEY wasn't high relative to CD's. We're retired and no longer in the 33% marginal)

I see from another thread that you were at 35% equities... my AA was for 45% but I had done some "harvesting" of gains and was down at 42% before the recent drop

So I've got some "dry powder", but I still need a little more drop.... when we get the quarterly results out should really see the final tallies. probably waiting for that and can then redeploy funds

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Mon Mar 09, 2020 10:15 am

Nestegg_User wrote:
Mon Mar 09, 2020 10:13 am

I see from another thread that you were at 35% equities...
No, my portfolio is 70% equities (see sig).

My net worth is 35% equities.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Nestegg_User » Mon Mar 09, 2020 10:25 am

watchnerd wrote:
Mon Mar 09, 2020 10:15 am
Nestegg_User wrote:
Mon Mar 09, 2020 10:13 am

I see from another thread that you were at 35% equities...
No, my portfolio is 70% equities (see sig).

My net worth is 35% equities.
sorry... misread... didn't look at sig


As I said, I have AA for 45% but was down for profit taking (still don't have anything for TLH), but in retirement with pension and CD ladder.....
and unlike another in the other thread, I DO remember that '87 drop, just didn't have a lot in the market then

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Almond » Mon Mar 09, 2020 10:37 am

HEDGEFUNDIE wrote:
Mon Mar 09, 2020 9:54 am
Almond wrote:
Mon Mar 09, 2020 9:45 am
Bluce wrote:
Sun Mar 08, 2020 12:35 am
CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.

To determine risk capacity, the standard advice is to evaluate "need, ability, and willingness". According to the wiki and the standard definitions used on this forum:

1. Need relates to the rate of return an investor must obtain to reach their goal.
2. Ability relates to the investor's circumstances, such as the amount of time until they need the money and their income stability.
3. Willingness relates to an investor's temperament, and their willingness to accept market volatility with equanimity.

A proper asset allocation must balance these three principles, like an object suspended between three magnets.

As I understand the above principles, treasury yields <1% increase an investor's need to take risk. An investor who set their asset allocation in 2000 could buy high grade bonds with a nominal 7% rate of return. If the investor needed a real rate of return of 4%, they could invest a significant portion of their portfolio in bonds and still be likely to obtain their desired rate of return. Today, we can buy ten year treasuries with a nominal yield of .7%. To obtain that same 4% real rate of return, the investor will need to assume more risk.

There are two points to this post. First, for those investors who: 1) have a specific real rate of return that they need to obtain their financial objectives; 2) have a high ability to take risk; and 3) have a high willingness to take risk, that investor should consider changing their asset allocation to be heavier in stocks due to the low interest rates on bonds.

Second, negative real interests rates on bonds present a greater tradeoff for investors who have a high ability to take risk but a low willingness to take risk. For the investor of yesteryear, who could buy treasuries yielding 7%, the long term price that they paid for "sleeping well at night" was probably low. They could enjoy the safety of bonds and get a real rate of return on that portion of their portfolio. Today, with negative real treasury yields, investors with a high ability but low willingness to take risk are likely paying a high long term cost to guard against short-term volatility.
There are all kinds of bonds besides Treasuries. I hold a good chunk of Treasuries -- certainly not for the puny yield, but for price appreciation. They've been through the roof YTD.

If one needs the income, there are all kinds of non-Treasury bonds, and their funds, that yield a lot more than Treasuries. One can limit risk by fund duration and by the types and ratings of the various bonds held.

I was using the same reasoning but have to admit I am now confused with everyone focused on yields and the chance they go lower or negative. Are people thinking if yields go lower the price will collapse?
Ignore them.

No one focuses on yield alone for stocks.

No one should focus on yield alone for bonds.
TY. Having seen thread after thread that only focuses on yield and going to cash/cd’s I was very confused as my portfolio would be a lot worse off right now if I didn’t have bonds and cd’s will not mitigate that much stock losses.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by garlandwhizzer » Mon Mar 09, 2020 11:40 am

I don't like these incredibly low yields. I do not like the current selloff in equities. Nor do I like the fact that many experts whose opinions I respect believe that equities going forward are going to produce substantially lower long term returns. A lot of investing success is blind luck, sequence of returns. If it were 1982 now, we could load up on 10 yr Treasuries yielding 15%, and buy the S&P 500 at a PE of 7.7 and the future would reward us for the next 38 years with decreasing inflation and ever lower rates which pushed up the principal values of our bonds and produced PE ratio inflation of 300%. Back then you could buy risk free bonds and make substantial real gains over time, returns without risk. Those days appear to be over. In addition between 1982 and 1999 economic growth, labor productivity, and both stock and bond markets boomed in the US. We're in a different scenario now--all time low interest rates, stubbornly slow economic growth, inability of maximum monetary policy to create inflation or robust economic growth, and significantly lower than historical expected returns in equities going forward. Unfortunately we cannot choose the markets/economy situation that we want. Based on the current status of markets we cannot expect good long term real returns without taking on significant equity risk. and today the risk of equity is quire clear to all. We have to deal with the situation we have, not the one we want. The good news is that we've had a great bull run for the past 10+ years in both stocks and bonds, and we should have amassed a lot of gains during that time in both risk and safe assets.

Governments all over the world are IMO going to pull out all the stops, both monetary policy and fiscal stimulus, to try to combat the current global situation and reignite economic growth. I certainly hope that they are successful but their track record is mixed. The things that investors can do to make a difference are to choose the right portfolio suited to their needs and circumstances and stick with it through thick and thin with only minor gradual modifications, save more, invest regularly and consistently regardless of market conditions, control spending, and be patient. It is entirely possible that the current selloff before it's over will present us with an equity buying opportunity for those who have sufficient fixed income holdings to deploy and the nerve to accept the risk of it. Picking the bottom is impossible but at some point if prices keep going down substantially more, equity starts selling for less than its worth for long term investors. Having been burned before, I will not market time and do not recommend it, but some aggressive investors in the accumulation phase and people like Warren Buffett are likely to do so at a certain point if markets continue to tank.

Garland Whizzer

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by hudson » Mon Mar 09, 2020 11:56 am

HEDGEFUNDIE wrote:
Mon Mar 09, 2020 9:54 am
No one should focus on yield alone for bonds.
I make buying decisions on fixed income products on the payout yield or distribution yield.
I also want an intermediate duration product that is very high in US/AAA/AA/A bonds or the equivalent.
I don't focus on yield alone; but I go for the best payout...after taxes.
Is there a better way?

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by SimpleGift » Mon Mar 09, 2020 12:05 pm

garlandwhizzer wrote:
Mon Mar 09, 2020 11:40 am
I don't like these incredibly low yields. I do not like the current selloff in equities. Nor do I like the fact that many experts whose opinions I respect believe that equities going forward are going to produce substantially lower long term returns. A lot of investing success is blind luck, sequence of returns.
...(snip)...
The things that investors can do to make a difference are to choose the right portfolio suited to their needs and circumstances and stick with it through thick and thin with only minor gradual modifications, save more, invest regularly and consistently regardless of market conditions, control spending, and be patient.
Thank you, Garland, this in full was one of your better posts, among many fine ones. You have a nice way of putting into context the broad sweep of financial history, then bringing it down into sensible recommendations for passive investors. Well done!

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Mon Mar 09, 2020 1:02 pm

garlandwhizzer wrote:
Mon Mar 09, 2020 11:40 am
I don't like these incredibly low yields. I do not like the current selloff in equities. Nor do I like the fact that many experts whose opinions I respect believe that equities going forward are going to produce substantially lower long term returns. A lot of investing success is blind luck, sequence of returns. If it were 1982 now, we could load up on 10 yr Treasuries yielding 15%, and buy the S&P 500 at a PE of 7.7 and the future would reward us for the next 38 years with decreasing inflation and ever lower rates which pushed up the principal values of our bonds and produced PE ratio inflation of 300%. Back then you could buy risk free bonds and make substantial real gains over time, returns without risk. Those days appear to be over. In addition between 1982 and 1999 economic growth, labor productivity, and both stock and bond markets boomed in the US. We're in a different scenario now--all time low interest rates, stubbornly slow economic growth, inability of maximum monetary policy to create inflation or robust economic growth, and significantly lower than historical expected returns in equities going forward. Unfortunately we cannot choose the markets/economy situation that we want. Based on the current status of markets we cannot expect good long term real returns without taking on significant equity risk. and today the risk of equity is quire clear to all. We have to deal with the situation we have, not the one we want. The good news is that we've had a great bull run for the past 10+ years in both stocks and bonds, and we should have amassed a lot of gains during that time in both risk and safe assets.

Governments all over the world are IMO going to pull out all the stops, both monetary policy and fiscal stimulus, to try to combat the current global situation and reignite economic growth. I certainly hope that they are successful but their track record is mixed. The things that investors can do to make a difference are to choose the right portfolio suited to their needs and circumstances and stick with it through thick and thin with only minor gradual modifications, save more, invest regularly and consistently regardless of market conditions, control spending, and be patient. It is entirely possible that the current selloff before it's over will present us with an equity buying opportunity for those who have sufficient fixed income holdings to deploy and the nerve to accept the risk of it. Picking the bottom is impossible but at some point if prices keep going down substantially more, equity starts selling for less than its worth for long term investors. Having been burned before, I will not market time and do not recommend it, but some aggressive investors in the accumulation phase and people like Warren Buffett are likely to do so at a certain point if markets continue to tank.

Garland Whizzer
Give it 10-20 years when the generation Y population boom starts entering the work force and the youthful economies of India and Africa start flexing their muscles and all will be fine.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by garlandwhizzer » Mon Mar 09, 2020 2:22 pm

Over the long term, those of us who stay invested and constantly invest more on a regular basis from their paychecks, will do just fine as they always have done in the US. It may take today's investors a bit more time to reach their goals, but they will get there if they stick to it. Eventually the market rewards patience, persistence, and a sound investment plan. I believe it wise to pay as little attention as possible to short term market fluctuations either up or down and focus instead on the distant long term view, following through with a sound diversified low-cost investment plan. No reason to panic now.

Garland Whizzer

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Noobvestor » Mon Mar 09, 2020 2:26 pm

garlandwhizzer wrote:
Mon Mar 09, 2020 2:22 pm
Over the long term, those of us who stay invested and constantly invest more on a regular basis from their paychecks, will do just fine as they always have done in the US. It may take today's investors a bit more time to reach their goals, but they will get there if they stick to it. Eventually the market rewards patience, persistence, and a sound investment plan. I believe it wise to pay as little attention as possible to short term market fluctuations either up or down and focus instead on the distant long term view, following through with a sound diversified low-cost investment plan. No reason to panic now.

Garland Whizzer
No need to panic, I agree. Even before this Vanguard was projecting this coming decade to be a low-growth one for equitis. They also note that a US-only portfolio is likely to underperform a global one. That whitepaper came out before the virus, but I suspect their estimates haven't improved - I continue to expect low growth this decade and a globally diversified portfolio to do better than a US-only one.
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by InvestingGeek » Mon Mar 09, 2020 3:06 pm

CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.
Interesting that this is how risk is defined. Short term variation is what I'd call volatility. Risk of an investment is the probability of falling behind inflation, which if your time horizon is far enough, is higher with bonds.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by InvestingGeek » Mon Mar 09, 2020 3:11 pm

watchnerd wrote:
Mon Mar 09, 2020 1:02 pm
Give it 10-20 years when the generation Y population boom starts entering the work force and the youthful economies of India and Africa start flexing their muscles and all will be fine.
India's population isn't going to be very youthful in 20 years. Their growth is at replacement level now and dropping steadily afaik - education and increasing prosperity will do that to a country 🤷.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by aristotelian » Mon Mar 09, 2020 3:16 pm

InvestingGeek wrote:
Mon Mar 09, 2020 3:06 pm
CFK wrote:
Sat Mar 07, 2020 9:08 pm
When evaluating our asset allocation, one foundational question is what is our capacity for risk, which is defined in the wiki as the short term variation of an investment's return. Another common definition for risk is what is the maximum drawdown.
Interesting that this is how risk is defined. Short term variation is what I'd call volatility. Risk of an investment is the probability of falling behind inflation, which if your time horizon is far enough, is higher with bonds.
There are multiple kinds of risk, including market risk and inflation risk. The big one that includes all the others is the risk of running out of money in retirement. Generally stock-heavy portfolios have higher success rates for longer retirements and higher withdrawal rates but more vulnerable to short-term market risk.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by tmcc » Mon Mar 09, 2020 8:39 pm

What is interesting is that mortgages are not following the long bond yield.

ie you cant find a mortgage at 1.75 which is market + 100bps. rates are holding at 3% +/-

I wonder how long the market makers can prop up that market

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by SemiRetire » Tue Mar 10, 2020 3:36 am

Over past two hundred days per

https://stockcharts.com/freecharts/perf.php?AGG

Aggregate bonds AGG have returned about 10 percent in total return.

Right now, rebalancing bonds enables you to buy stocks cheap. If stocks continue to drop, you will sell more bonds to buy stocks even cheaper....... I am not going to be a bond buyer as long as stocks are tanking...I will have to sell them, or at minimum put new money into stocks not bonds to keep allocation intact.


See we buy bonds cheap, sell them high, buy stocks cheap, sell them high, buy bonds.

The Return a boglehead rebalancer experiences is not going to be <1 percent expectantly from holding bonds and rebalancing. We are able to buy stocks cheap with bond gains, then those bond gains get compounded upwards at the rate of stock gains in the future.

Hope that makes sense, helps

“Cheap” is of course relative.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by HEDGEFUNDIE » Tue Mar 10, 2020 9:32 am

hudson wrote:
Mon Mar 09, 2020 11:56 am
HEDGEFUNDIE wrote:
Mon Mar 09, 2020 9:54 am
No one should focus on yield alone for bonds.
I make buying decisions on fixed income products on the payout yield or distribution yield.
I also want an intermediate duration product that is very high in US/AAA/AA/A bonds or the equivalent.
I don't focus on yield alone; but I go for the best payout...after taxes.
Is there a better way?
Why yes there is.

Bogleheads generally hold bonds for safety, relative to the stock portion of they’re portfolio. Well, what is more safe, bond that do nothing while stocks crash, or bonds that jump up when that happens?

My bonds are 100% long term for this reason. Yield has nothing to do with it.

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by hudson » Tue Mar 10, 2020 9:46 am

HEDGEFUNDIE wrote:
Tue Mar 10, 2020 9:32 am
hudson wrote:
Mon Mar 09, 2020 11:56 am
HEDGEFUNDIE wrote:
Mon Mar 09, 2020 9:54 am
No one should focus on yield alone for bonds.
I make buying decisions on fixed income products on the payout yield or distribution yield.
I also want an intermediate duration product that is very high in US/AAA/AA/A bonds or the equivalent.
I don't focus on yield alone; but I go for the best payout...after taxes.
Is there a better way?
Why yes there is.

Bogleheads generally hold bonds for safety, relative to the stock portion of they’re portfolio. Well, what is more safe, bond that do nothing while stocks crash, or bonds that jump up when that happens?

My bonds are 100% long term for this reason.
I think that I remember from Larry Swedroe's Bond Book, that long term bonds were the correct choice for someone with a large percentage of equities. So, long bonds is a match for you. If I were in your position, I would likely do the same.

I think Larry also said that for many investors, intermediate bonds were the sweet spot. I think that fits me because I'm 100% fixed, so I go for the "sweet spot."

For fixed income products, I only consider intermediate funds/CDs of the highest quality. I focus on the products holdings not past performance. With that in mind, I pick the product with the highest payout, interest, or distribution yield. Is there a better way?

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Re: "Need, ability, willingness" with bonds yielding <1%

Post by watchnerd » Tue Mar 10, 2020 9:54 am

hudson wrote:
Tue Mar 10, 2020 9:46 am

I think that I remember from Larry Swedroe's Bond Book, that long term bonds were the correct choice for someone with a large percentage of equities. So, long bonds is a match for you. If I were in your position, I would likely do the same.
I hold long Treasuries for similar reasons (see sig).

I wouldn't hold them, though, in either large amounts or at all if one doesn't have a reasonably high equity allocation. They're far from calm.
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Re: "Need, ability, willingness" with bonds yielding <1%

Post by Pikel » Tue Mar 10, 2020 10:06 am

A little tangential but it's borderline we will be getting 4% real from equity over the next 10-20 years.

My mentality is to make up for yield with frugality.

We are locked into CDs earning 2.35-2.9% (sad to be happy with that, less than inflation when tax drag is included). We will roll as much as possible into I and EE bonds as they mature.

I have looked into cash covered puts but that's something I need to think on for at least a year.

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