Your thoughts on negative interest rates

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Tejfyy
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Your thoughts on negative interest rates

Post by Tejfyy »

I’m curious what others think about negative interest rates and their impact on the average investor/middle class person. For savers and non-borrowers they’re another slap in the face. Or maybe a wake up call? We can't rule them out. So if they arrive what are you going to do and not do?
superinvestor
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Re: Your thoughts on negative interest rates

Post by superinvestor »

Nothing, real rates are already negative.
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Re: Your thoughts on negative interest rates

Post by Grt2bOutdoors »

Tejfyy wrote: Wed Jul 22, 2020 10:05 pm I’m curious what others think about negative interest rates and their impact on the average investor/middle class person. For savers and non-borrowers they’re another slap in the face. Or maybe a wake up call? We can't rule them out. So if they arrive what are you going to do and not do?
Why must it be a slap? You have a choice - accept it or deflect it by taking action now. You can go out and lock in positive nominal rates for 30 years if you like. If you don’t like it, you can choose to not accept it and select another alternative. Your asset allocation is your liaison but you must take positive action in advance to reduce your risks of negative nominal rates.

What are your thoughts on where to allocate the funds?
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TheDDC
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Re: Your thoughts on negative interest rates

Post by TheDDC »

There is an alternative. Invest more in stocks, or at the very least in a 20/80 fund. A 20/80 fund will quickly become the new “fixed income” fund in such an interest rate environment.

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000
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Re: Your thoughts on negative interest rates

Post by 000 »

I don't see myself investing in something with less than -0.25% real return. A slight negative real return might be OK in some circumstances (cash for transactional purposes, gold as a hedge).

I'd rather invest more in other asset classes or just spend the money than accept much of a negative return.
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Re: Your thoughts on negative interest rates

Post by Dandy »

Not happy about the prospect especially in retirement with an allocation of 45/55. I try not to do anything rash e.g. up my equity allocation significantly. I'll probably allocate a bit more to intermediate vs short term bond funds and use a bit more "high" yield savings and CDs vs money markets and short term Treasury funds and keep my equity allocation near the high end of my target.

I think some of the rise in the stock market is due to the historic low rates. Is that a bubble? I don't see what will elevate rates in the near future. I try to focus on the idea that my fixed income is mostly for safety and risk modification vs income or growth. Even slight negativity is better than having it subject to losses of 50% or more.

I am lucky that my retirement income almost equals my expenses but who knows how secure pensions and SS really will be given the current pandemic and the effects on business and employment.
Chicken Little
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Re: Your thoughts on negative interest rates

Post by Chicken Little »

Negative rates set up kind of a false paradigm where you can now take on more risk - change your risk tolerance - to match the same expected return.

I think we're in an era of big, regular, moves in stock prices. You can do the mental gymnastics; why did stocks have that value in February, why did they decline to the low in March, why did they stop declining, why are they where they are now? Once that's done, you can slide back to GFC and repeat. Then I slide forward for next one (not asking you to join in on that).

Anyway, I seemingly can go 100% equity or have some bonds to prepare for Marches. In the modern investing landscape, say 1990 forward, I like to capitalize on major drops in stocks. If I'm going to do that, I need to have money somewhere else that is liquid.

Beyond that, if I was really worried about rates decreasing further, I should be holding 30-yr, right?

https://portfoliocharts.com/2019/05/27/ ... convexity/

I'm short on duration because I'm more worried about inflation. I don't think the fed has fine control over unexpected inflation with interest rates. Eventually, if they increase rates high enough they will turn the tables, but I'm not sure they get to decide what that point is, or have the capacity to execute if they do (I doubt there would ever be a single 5% raise, even if it was warranted).
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Re: Your thoughts on negative interest rates

Post by Valuethinker »

Chicken Little wrote: Thu Jul 23, 2020 7:15 am Negative rates set up kind of a false paradigm where you can now take on more risk - change your risk tolerance - to match the same expected return.

I think we're in an era of big, regular, moves in stock prices. You can do the mental gymnastics; why did stocks have that value in February, why did they decline to the low in March, why did they stop declining, why are they where they are now? Once that's done, you can slide back to GFC and repeat. Then I slide forward for next one (not asking you to join in on that).
The February-March decline was your classic "exogenous shock". In all the states of the world, stock markets had assigned a low probability to an epidemic and the subsequent economic consequences - which hit the profits of large parts of the corporate sector. So when the probability went to 1.0, ie it happened, the markets reacted.
Anyway, I seemingly can go 100% equity or have some bonds to prepare for Marches. In the modern investing landscape, say 1990 forward, I like to capitalize on major drops in stocks. If I'm going to do that, I need to have money somewhere else that is liquid.
It is an open question whether Central Banks and governments can rescue markets -- again. CBs have done things that weren't supposed to be possible in terms of expansion of balance sheet and reductions in interest rates. Governments have taken on deficits and command over large parts of the economy in a fashion unprecedented in peacetime.
Beyond that, if I was really worried about rates decreasing further, I should be holding 30-yr, right?

https://portfoliocharts.com/2019/05/27/ ... convexity/

I'm short on duration because I'm more worried about inflation. I don't think the fed has fine control over unexpected inflation with interest rates. Eventually, if they increase rates high enough they will turn the tables, but I'm not sure they get to decide what that point is, or have the capacity to execute if they do (I doubt there would ever be a single 5% raise, even if it was warranted).
It is certainly the case that the Board of the Fed has a more inflationist bias than it has in a generation. But Central Bankers are central bankers - there's a DNA they share about the 1970s and letting inflation get out of control. Depends how politicised the Board becomes, in large part. I would note that Alice Shelton (Skelton?) has called for the restoration of the Gold Standard - definitely not an inflationist perspective.
Robot Monster
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Re: Your thoughts on negative interest rates

Post by Robot Monster »

Long-term bonds could serve as a potential hedge.

If interest rates go negative, presumably inflation will be fairly muted. Certainly, it's difficult to think the Fed would keep interest rates negative if inflation heats significantly above their 2% inflation target. The countries that do have negative interest rates all have muted inflation (Switzerland has outright deflation). This is all good news for long term nominal bonds, which will rally if interest rates go down, and can therefore serve as a good hedge if you've got a lot in money market funds.

If, on the other hand, we have an inflation surprise and inflation begins to bubble up like the inflation hawks predict, your long term bonds will suffer, but if it causes the Fed to hike up rates in order to combat this inflation, money market funds will be happy.

But...if we had stagflation, with high unemployment and high inflation, might the Fed still keep rates low to combat unemployment at the risk of letting inflation get out of hand? Who knows? It's impossible to predict everything.
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rockstar
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Re: Your thoughts on negative interest rates

Post by rockstar »

They exist to push you into more risky investments. They force you to spend or take on more risk. It's why I've accelerated paying down my home. There is a finite amount of risk I want to take.
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Re: Your thoughts on negative interest rates

Post by jeffyscott »

Just as I can avoid short-intermediate treasury rates of about 0.1% to 0.5% right now by using high yield savings accounts and/or CDs, I think that will continue to be an option that will have positive nominal returns should those treasury rates become -0.5% to -0.1%.

I would also prefer to take some risk in bonds over accepting negative rates, should they arrive.
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nisiprius
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Re: Your thoughts on negative interest rates

Post by nisiprius »

Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return. I think it's a big mistake to suppose that there just must be some easy way out, some magic secret that insiders know; searching for the unobtainable makes you vulnerable to the deceptive pitches from people offering things too good to be true.

If you had good reason to believe that the difference between the long-term total return of stocks and bonds had permanently and irrevocably widened, i.e. the equity risk premium had just undergone a robust, durable increase, then that would be a rational reason to change stock/bond allocation. If you think their relative return has not changed, but that both stocks and bonds have poorer long-term expected returns, then low or negative bond returns are not a justification for changing. There isn't any step-function or corner when bond returns cross zero.

(The relation between bonds and virtually-risk-free investments like FDIC-insured bank accounts does matter, though, and because of the $250,000 per.. entity... limit on FDIC insurance, and other regulatory anomalies, you can have situations that would justify shifting from bonds into bank accounts).

Another reason for increasing stock allocation would be a good, strong reason for believing that your personal risk tolerance had increased a lot. That could be the effect that bad times and chaos have on some people. Just be sure that it is the case for you. Personally, my own risk tolerance decreases under stress, but I hope I have that already baked into my own (conservative) asset allocation choice.

Flailing around and taking more risk than you would have been willing to take two years ago is, at least, a suspect choice. And, if you can will yourself to become more risk-tolerant, you could alternatively will yourself to accept a less wealthy retirement.

The reason why staying the course is "simple but not easy" is that it is not an intuitive thing to do. It is easy to stay the course when it looks right. It is difficult to stay the course when it looks crazy. The Boglehead premise is that there is decent evidence that staying the course is a good strategy. But that includes staying the course when it looks crazy. "Staying the course when it looks sensible and abandoning it when it looks crazy" is not "staying the course."
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Re: Your thoughts on negative interest rates

Post by Robot Monster »

nisiprius wrote: Thu Jul 23, 2020 10:26 am Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return.
I wholeheartedly agree with you, I expect neither a reasonable return nor even a return at all, but a negative return feels like a horse of a different color if only because it means cash scattered haphazardly on the floor of my bedroom amongst the dirty laundry will perform better than cash in a money market fund, but also maybe because I'm now paying to lend, which is ugh.
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dodecahedron
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Re: Your thoughts on negative interest rates

Post by dodecahedron »

Robot Monster wrote: Thu Jul 23, 2020 10:46 am
nisiprius wrote: Thu Jul 23, 2020 10:26 am Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return.
I wholeheartedly agree with you, I expect neither a reasonable return nor even a return at all, but a negative return feels like a horse of a different color if only because it means cash scattered haphazardly on the floor of my bedroom amongst the dirty laundry will perform better than cash in a money market fund, but also maybe because I'm now paying to lend, which is ugh.
You might think about it as I do, philosophically.

Interest rates are simply exchange rates for moving purchasing power across time rather than space. Whether talking about moving purchasing power across time vs across space, there is no inherent reason why that exchange rate should always be more favorable in one direction vs. another, particularly after the friction of taxes, transaction costs, etc.

That said, just as with foreign exchange rates, there are better and worse deals from various alternate intermediation vehicles for exchanging across time. I don´t use money market funds OR cash scattered with my dirty laundry. I use FDIC-insured savings accounts and CDs and TIAA Trad (liquid variety) and TIPS in an effort to get the best possible terms of trade for safely moving purchasing power into the future.

Real after tax interest rates have frequently been negative over the course of my lifetime. They may well continue to be so in the future. It is what it is. I deal with it.
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Re: Your thoughts on negative interest rates

Post by KlangFool »

Robot Monster wrote: Thu Jul 23, 2020 10:46 am
nisiprius wrote: Thu Jul 23, 2020 10:26 am Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return.
I wholeheartedly agree with you, I expect neither a reasonable return nor even a return at all, but a negative return feels like a horse of a different color if only because it means cash scattered haphazardly on the floor of my bedroom amongst the dirty laundry will perform better than cash in a money market fund, but also maybe because I'm now paying to lend, which is ugh.
Robot Monster,

And, why is that a problem if you are properly diversified with a fair amount of CASH?

CASH is a separate asset class.

CASH, Bond, and the STOCK are 3 separate asset classes. Diversification is a good thing. If you have to bet on the interest rate, you are not properly diversified.

KlangFool
RomeoMustDie
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Re: Your thoughts on negative interest rates

Post by RomeoMustDie »

Tejfyy wrote: Wed Jul 22, 2020 10:05 pm I’m curious what others think about negative interest rates and their impact on the average investor/middle class person. For savers and non-borrowers they’re another slap in the face. Or maybe a wake up call? We can't rule them out. So if they arrive what are you going to do and not do?
Buy international bonds with greater yield, REIT's with superior yield, or dividend yield stocks.

I will play the cards that are given not try to force a round peg into a square hole if one asset class is not supporting my portfolio goals.

No, I will not hold rate sensitive bonds through a rising rates or negative yield environment.
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unclescrooge
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Re: Your thoughts on negative interest rates

Post by unclescrooge »

Tejfyy wrote: Wed Jul 22, 2020 10:05 pm I’m curious what others think about negative interest rates and their impact on the average investor/middle class person.... So if they arrive what are you going to do and not do?
In a negative interest rate environment, gold becomes more popular.
I've always had a small allocation to gold. Now it is slightly less small, and invest also added gold miners.

For my cash, it's mostly in checking accounts...í haven't really bothered to get any return on it for a decade.
petulant
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Re: Your thoughts on negative interest rates

Post by petulant »

nisiprius wrote: Thu Jul 23, 2020 10:26 am Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return. I think it's a big mistake to suppose that there just must be some easy way out, some magic secret that insiders know; searching for the unobtainable makes you vulnerable to the deceptive pitches from people offering things too good to be true.

If you had good reason to believe that the difference between the long-term total return of stocks and bonds had permanently and irrevocably widened, i.e. the equity risk premium had just undergone a robust, durable increase, then that would be a rational reason to change stock/bond allocation. If you think their relative return has not changed, but that both stocks and bonds have poorer long-term expected returns, then low or negative bond returns are not a justification for changing. There isn't any step-function or corner when bond returns cross zero.

(The relation between bonds and virtually-risk-free investments like FDIC-insured bank accounts does matter, though, and because of the $250,000 per.. entity... limit on FDIC insurance, and other regulatory anomalies, you can have situations that would justify shifting from bonds into bank accounts).

Another reason for increasing stock allocation would be a good, strong reason for believing that your personal risk tolerance had increased a lot. That could be the effect that bad times and chaos have on some people. Just be sure that it is the case for you. Personally, my own risk tolerance decreases under stress, but I hope I have that already baked into my own (conservative) asset allocation choice.

Flailing around and taking more risk than you would have been willing to take two years ago is, at least, a suspect choice. And, if you can will yourself to become more risk-tolerant, you could alternatively will yourself to accept a less wealthy retirement.

The reason why staying the course is "simple but not easy" is that it is not an intuitive thing to do. It is easy to stay the course when it looks right. It is difficult to stay the course when it looks crazy. The Boglehead premise is that there is decent evidence that staying the course is a good strategy. But that includes staying the course when it looks crazy. "Staying the course when it looks sensible and abandoning it when it looks crazy" is not "staying the course."
Wouldn't we expect the equity risk premium to widen, though? The lower bonds go, the less of their return is taxable, which can do funny things to the risk/reward curve if you measure the reward as net of taxes. If expected returns from bonds are 5% taxable coupons and equity risk premium is a pretax 6%, then the expected return from stocks is 11% taxed as, say QD+LTCG. If we postulate that the marginal capital allocators are taxable accounts in the 37% bracket and putting to the side state taxes, the actual expected return on bonds is 3.15%, and the actual return on stocks is 8.38% (using 20% LTCG+2.3% NIIT). The net equity risk premium for this investors would be 5.23%. If bonds drop to 1% taxable coupons and equity risk premium stays at 6%, the net would be 0.63% for bonds and 5.33% for stocks, resulting in a net equity risk premium of 4.7%. So these investors would actually take it on the chin a bit or ask for a large pretax equity risk premium. To completely restore their "net" equity risk premium of 5.23%, they would demand a pretax risk premium of 6.69%. They would probably take it a bit on the chin though since they don't want to accept 1% returns on bonds, so the number might actually end up between 6% and 6.69%. So while you're right that equity risk premium shouldn't be expected to double, there might be a variety of strange effects that move it around, possibly widening it.
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McGilicutty
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Re: Your thoughts on negative interest rates

Post by McGilicutty »

I think negative interest rates are a good thing. They should help goose the stock market and hopefully help the economy.

One thing I won't be doing is buying any bonds or bond funds.
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vineviz
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Re: Your thoughts on negative interest rates

Post by vineviz »

Through all this, remember that the closest thing that long-term investors have to a risk-free investment a some combination of long-term nominal Treasury bonds and long-term TIPS (or the savings bond equivalents).

Some combination of those and a globally diversified equity portfolio may not look inspiring in nominal terms but it’s the best today’s investors can do.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Chicken Little
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Re: Your thoughts on negative interest rates

Post by Chicken Little »

McGilicutty wrote: Thu Jul 23, 2020 11:43 am I think negative interest rates are a good thing. They should help goose the stock market and hopefully help the economy.

One thing I won't be doing is buying any bonds or bond funds.
Exactly.

So let’s quit playing around and target fed funds rate at -4.0 to -5.0, and drop $5 trillion on next round of stimulus.

Stock market goes BOOM and we all retire.

What’s not to like?
KlangFool
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Re: Your thoughts on negative interest rates

Post by KlangFool »

Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
Chicken Little
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Re: Your thoughts on negative interest rates

Post by Chicken Little »

KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
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000
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Re: Your thoughts on negative interest rates

Post by 000 »

nisiprius wrote: Thu Jul 23, 2020 10:26 am It is a mistake to think that the markets owe you some "reasonable" return.
The markets don't owe you anything, but you owe something to yourself (e.g. not buying an unreasonable investment).
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Re: Your thoughts on negative interest rates

Post by 000 »

KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
Chicken Little
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Re: Your thoughts on negative interest rates

Post by Chicken Little »

000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
You are describing a bond bull market.
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Re: Your thoughts on negative interest rates

Post by 000 »

Chicken Little wrote: Thu Jul 23, 2020 12:33 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
You are describing a bond bull market.
For existing issues, not necessarily newly purchased ones.
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Re: Your thoughts on negative interest rates

Post by Tom_T »

Chicken Little wrote: Thu Jul 23, 2020 12:33 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
You are describing a bond bull market.
Correct me if I am wrong, but the oft-cited formula of how a bond fund NAV would fall in reaction to a one-point rise in rates also works when rates fall. And rates are not all zero. The 10-year is .60%. What if that dropped to zero? That's more than a half-point goose for an intermediate-term Treasury fund, no?
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Re: Your thoughts on negative interest rates

Post by KlangFool »

000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
000,

Why should that matter to you? It does not matter to me with an AA of 60/40. Unless you are 0/100, it does not matter to you either.

I invest in VBTLX (Total Bond Index) and VFIUX (Inter-mediate Term Treasury).

The bond fund will reinvest in the new bond automatically. And, I would rebalance based on my AA.

Please think this through. Unless you are 0/100, it does not matter.

KlangFool
KlangFool
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Re: Your thoughts on negative interest rates

Post by KlangFool »

oft-cited formula of how a bond fund NAV would fall in reaction to a one-point rise in rates also works when rates fall. wrote: Thu Jul 23, 2020 12:38 pm
Chicken Little wrote: Thu Jul 23, 2020 12:33 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
You are describing a bond bull market.
Correct me if I am wrong, but the oft-cited formula of how a bond fund NAV would fall in reaction to a one-point rise in rates also works when rates fall. And rates are not all zero. The 10-year is .60%. What if that dropped to zero? That's more than a half-point goose for an intermediate-term Treasury fund, no?
Tom_T,

<<oft-cited formula of how a bond fund NAV would fall in reaction to a one-point unexpected rise in rates also works when rates fall. >>

If the rise is expected, it would have been priced into the previously issued bond.

I know enough to know that I know nothing. It is not that simple.

KlangFool
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FIREchief
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Re: Your thoughts on negative interest rates

Post by FIREchief »

I have a ten year TIPS ladder (98.7% complete) that I've built over the past several years. The vast majority of those TIPS were purchased with a positive real YTM. The fact that they're all currently negative real YTM in the secondary market hasn't changed anything. It just means I could show a lot of "profit" if I sold them today in the secondary market. Sure, if we have ten years worth of negative real return auction rates, than I'll be losing a predetermined amount of future purchasing power each year, but if my plans allow for that (they do), than my only thoughts are "stay the course." Could I make an extra 0.5% - 1.0% real return with corporate bonds? Maybe. It largely depends upon future inflation (which is totally unknowable). Do I need that miniscule growth? No. That's what my RP is for. 8-)
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Re: Your thoughts on negative interest rates

Post by Robot Monster »

FIREchief wrote: Thu Jul 23, 2020 1:05 pm Sure, if we have ten years worth of negative real return auction rates, than I'll be losing a predetermined amount of future purchasing power each year, but if my plans allow for that (they do),
What is your worst case scenario you're using in your planning as far as how negative interest rates could go and for how long? And also what is inflation during that? I was thinking along the lines of 40 years -1% interest with average inflation at 1.75%. Is that too pessimistic? Not pessimistic enough?
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FIREchief
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Re: Your thoughts on negative interest rates

Post by FIREchief »

Robot Monster wrote: Thu Jul 23, 2020 1:17 pm
FIREchief wrote: Thu Jul 23, 2020 1:05 pm Sure, if we have ten years worth of negative real return auction rates, than I'll be losing a predetermined amount of future purchasing power each year, but if my plans allow for that (they do),
What is your worst case scenario you're using in your planning as far as how negative interest rates could go and for how long? And also what is inflation during that? I was thinking along the lines of 40 years -1% interest with average inflation at 1.75%. Is that too pessimistic? Not pessimistic enough?
Since my fixed income is 100% TIPS, I don't need to include any inflation predictions. Inflation will be cancelled out in all scenarios. I really don't have a "worst case scenario." I generally have run forecasts assuming 0.0% to 0.25% real return. My overall TIPS portfolio is currently exceeding that if based upon either YTM at purchase or aggregate coupon rates. I use all ten year TIPS, which are approaching (but not yet at) -1.0% real yield. If that were to turn into -2%, I would probably just reevaluate to determine if I might need to shift some funds from my RP to my LMP. I would also have to look at what 10 year nominal treasuries were yielding, to consider if there were a case to deviate from 100% TIPS. I see that scenario as highly unlikely, and therefore not really worth much advanced planning time (would be better spent working on ROTH conversion and tax gain harvesting strategies - see other current thread 8-) ).
Last edited by FIREchief on Thu Jul 23, 2020 2:08 pm, edited 1 time in total.
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Re: Your thoughts on negative interest rates

Post by jeffyscott »

KlangFool wrote: Thu Jul 23, 2020 12:54 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
000,

Why should that matter to you? It does not matter to me with an AA of 60/40. Unless you are 0/100, it does not matter to you either.

I invest in VBTLX (Total Bond Index) and VFIUX (Inter-mediate Term Treasury).

The bond fund will reinvest in the new bond automatically. And, I would rebalance based on my AA.

Please think this through. Unless you are 0/100, it does not matter.

KlangFool
The question was ridiculous, there's not going to be -50% yields. The answer that, "yes, you would accept -50% on 40% of your portfolio" is equally ridiculous.

I wouldn't invest in bonds at even -1%, but at least at that point one could argue that they could go even lower and the cap gains would make up for the negative yield. But at some point probably long before even -10%, let alone -50%, that's just not going to happen.

No one is going to pay $100K to get less than $25,000 in 10 years (-10% compounded).
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Re: Your thoughts on negative interest rates

Post by longinvest »

New investors often think that the weighted-average yield-to-maturity (YTM) of a bond fund predicts its future time-weighted returns. This is a mistake.

It's easy to understand why they would make such a mistake. They often don't even know about the difference between time-weighted and money-weighted returns (see our wiki's Two types of returns for an explanation). Also, the YTM of an individual bond, at the time it is bought, precisely predicts its money-weighted return between two specific dates: the date it was bought and the date it matures, assuming that the bond is held until maturity and that coupons are taken as cash. Note that this isn't the time-weighted of the bond return between these two dates. A total-market bond index fund doesn't work like this. Instead, it constantly buys new bonds which enter the market, and sells bonds which fall outside of its tracking mandate (e.g. when a bond maturity gets as low as one year or when its credit falls out of investment-grade), and it might have to rebalance to keep tracking the capitalization weights of the market.

On the web site of mutual funds, time-weighted returns are used to report performance. Discussions in our forums also assume that time-weighted returns are used when returns are discussed, except when it's explicitly mentioned that money-weighted are being discussed.

To eliminate any doubt about the impossibility to predict the future returns of a bond fund, a few years ago I've developed a very simple bond fund model to help forum members understand how bond funds work and why the average YTM of a fund doesn't predict its returns. Here are two posts about it: Bonds, like stocks, are marketable securities. Their current bid and ask prices (implying two distinct bid and ask YTM) are determined through a continuous auction. There's simply no reason to believe that market participants aren't aware of current prices and haven't already reacted, selling when they think a security (stock or bond) is priced above its fair price, or buying when they think a security is priced below its fair price, leading market prices to naturally adjust towards what market participants consider fair.

In summary:
  • Is it possible for a bond fund to deliver negative returns in a positive average YTM environment? Yes, it's possible.
  • Is it possible for a bond fund to deliver positive returns in a negative average YTM environment? Yes, it's possible.
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
Last edited by longinvest on Thu Jul 23, 2020 2:10 pm, edited 1 time in total.
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Re: Your thoughts on negative interest rates

Post by KlangFool »

jeffyscott wrote: Thu Jul 23, 2020 1:46 pm
The question was ridiculous, there's not going to be -50% yields. The answer that, "yes, you would accept -50% on 40% of your portfolio" is equally ridiculous.

I wouldn't invest in bonds at even -1%, but at least at that point one could argue that they could go even lower and the cap gains would make up for the negative yield. But at some point probably long before even -10%, let alone -50%, that's just not going to happen.

No one is going to pay $100K to get less than $25,000 in 10 years (-10% compounded).
jeffyscott,

I have an AA of 60/40.

<<The answer that, "yes, you would accept -50% on 40% of your portfolio" is equally ridiculous.>>

If the 40% bond goes -50%, my 60% stock's gain would make go up more than enough to compensate for that. So, why should I care?

You choose to look at the 40% bond separately from your total portfolio. I don't.

<<I wouldn't invest in bonds at even -1%,>>

I am too dumb to know what that actually means for my 60/40 portfolio. So, good luck to you if you know.

KlangFool
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Re: Your thoughts on negative interest rates

Post by vineviz »

longinvest wrote: Thu Jul 23, 2020 2:01 pm
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
In the post above, the false idea that “yield doesn’t predict return” was persistently repeated.

Perhaps the author meant “yield doesn’t PERFECTLY predict returns”. If so, saying so explicitly would have made the post perfectly compatible with the vast quantity of research demonstrating that starting yield is by far the best available indicator of future returns that bond and bond fund investors have.
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Re: Your thoughts on negative interest rates

Post by jtower68 »

I am not going to worry about it. For the bond fund I own (VBTLX), I will keep it and not do anything. Its NAV will continue to increase in a negative interest rate environment. I don't care about what it yields, I care only about its total return.
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Re: Your thoughts on negative interest rates

Post by longinvest »

vineviz wrote: Thu Jul 23, 2020 2:12 pm
longinvest wrote: Thu Jul 23, 2020 2:01 pm
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
In the post above, the false idea that “yield doesn’t predict return” was persistently repeated.

Perhaps the author meant “yield doesn’t PERFECTLY predict returns”. If so, saying so explicitly would have made the post perfectly compatible with the vast quantity of research demonstrating that starting yield is by far the best available indicator of future returns that bond and bond fund investors have.
Dear Vineviz,

You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.

Best regards,

longinvest
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Re: Your thoughts on negative interest rates

Post by nisiprius »

000 wrote: Thu Jul 23, 2020 12:28 pm
nisiprius wrote: Thu Jul 23, 2020 10:26 am It is a mistake to think that the markets owe you some "reasonable" return.
The markets don't owe you anything, but you owe something to yourself (e.g. not buying an unreasonable investment).
But what is "unreasonable?" Everything must be evaluated relative to some alternative, and if the risk is different there is no direct comparison.

All insurance depends on the proposition that we are willing to accept a negative return (the premiums exceed the expected claims) in order to reduce risk.

There is no rational basis to say we should always prefer a positive expected return, with high risk, to a negative expected return, with low risk.

To be sure, we should rationally prefer an investment that has both higher return and lower risk, so if we have available a bond X with negative return, and something that has both lower risk and non-negative return, like a no-fee bank account--then, sure, we owe it to ourselves to put our money in the bank instead of buying the bond.

Meanwhile, as I write this, Vanguard is showing 1.21% for the SEC yield of Total Bond. That's a long way from negative, and for the hypothetical situation in which Total Bond, in mirroring the bond market, is investing in bonds with an average coupon that is negative, I'm willing to say "I'll cross that bridge when I come to it."
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Re: Your thoughts on negative interest rates

Post by Chicken Little »

nisiprius wrote: Thu Jul 23, 2020 2:21 pm
000 wrote: Thu Jul 23, 2020 12:28 pm
nisiprius wrote: Thu Jul 23, 2020 10:26 am It is a mistake to think that the markets owe you some "reasonable" return.
The markets don't owe you anything, but you owe something to yourself (e.g. not buying an unreasonable investment).
But what is "unreasonable?" Everything must be evaluated relative to some alternative, and if the risk is different there is no direct comparison.

All insurance depends on the proposition that we are willing to accept a negative return (the premiums exceed the expected claims) in order to reduce risk.

There is no rational basis to say we should always prefer a positive expected return, with high risk, to a negative expected return, with low risk.

To be sure, we should rationally prefer an investment that has both higher return and lower risk, so if we have available a bond X with negative return, and something that has both lower risk and non-negative return, like a no-fee bank account--then, sure, we owe it to ourselves to put our money in the bank instead of buying the bond.

Meanwhile, as I write this, Vanguard is showing 1.21% for the SEC yield of Total Bond. That's a long way from negative, and for the hypothetical situation in which Total Bond, in mirroring the bond market, is investing in bonds with an average coupon that is negative, I'm willing to say "I'll cross that bridge when I come to it."
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Re: Your thoughts on negative interest rates

Post by qwertyjazz »

longinvest wrote: Thu Jul 23, 2020 2:18 pm
vineviz wrote: Thu Jul 23, 2020 2:12 pm
longinvest wrote: Thu Jul 23, 2020 2:01 pm
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
In the post above, the false idea that “yield doesn’t predict return” was persistently repeated.

Perhaps the author meant “yield doesn’t PERFECTLY predict returns”. If so, saying so explicitly would have made the post perfectly compatible with the vast quantity of research demonstrating that starting yield is by far the best available indicator of future returns that bond and bond fund investors have.
Dear Vineviz,

You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.

Best regards,

longinvest
I think you arguing to not choose a bond fund based on matching a duration as bond funds make continuous purchases over years so the current rates and duration might not be the correct way of looking at them (versus individual bonds you might purchase). In that case, what factor should be used to optimize bond fund choices?
Thank you
Bonds Are Confusing
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Re: Your thoughts on negative interest rates

Post by vineviz »

longinvest wrote: Thu Jul 23, 2020 2:18 pm You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.
Ie as trying to be polite, but so as to avoid being accused of “playing with words” I’ll be blunt instead: you’re wrong.

Starting yield is highly predictive of future returns, and by “highly predictive” I specifically mean that the relationship is statistically significant and not by a thin margin.

The only mathematical support you could possibly offer for your blanket “yields don’t predict returns” would - likewise - be some sort of test for statistical significance. If you had that data you’d have provided it.

Switching back to being charitable in my interpretation what you wrote does make some sense if you think a predictive relationship must mean a confidence interval of +/- 0.00. If so, that’s a highly non-consensus meaning.
"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: Your thoughts on negative interest rates

Post by The Man with the Axe »

In response to low/zero/negative rates on fixed income, we have shifted a portion of our fixed income allocation into cash and gold.
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Re: Your thoughts on negative interest rates

Post by JackoC »

petulant wrote: Thu Jul 23, 2020 11:16 am
nisiprius wrote: Thu Jul 23, 2020 10:26 am Hard times happen. It is a mistake to think that the markets owe you some "reasonable" return.
Wouldn't we expect the equity risk premium to widen, though? ... So while you're right that equity risk premium shouldn't be expected to double, there might be a variety of strange effects that move it around, possibly widening it.
You'd generally expect low/negative rates forced by central banks trying to gin the economy to narrow the equity risk premium. A big part of the idea of a policy to not only keep short rates zero but actively push down long rates as various central banks having doing, is to skew non-central bank investment toward riskier assets including stocks, making stocks more expensive and hoping to increase aggregate demand through the wealth effect of more propensity for investors to spend those gains. But more expensive stock valuations mean lower expected returns, even a lower premium in expected return over riskless assets. If you look at credit spreads especially for poor credits those have tended to narrow over the general period of very easy money, and are a more directly visible cousin to the equity risk premium. Seems to me your argument based on taxes (a lot of investment money is in tax deferred individual accounts or pooled non-taxed accounts like pension fund and insurance co investments) is at most some limited offset to that.

Long term past long term US bond realized return was ballpark 2%, stocks near 7%. Now 1/CAPE of the S&P is around 3.3% (an indicator of real expected return), the 30yr TIPS -.30%. Many people here are more optimistic than that about stock returns (maybe not *because* their investment/retirement plans would look a lot better if so, but I think it's usually the case that they would) but you have to be pretty optimistic about stock expected return to think the equity risk premium now is even as high as the historical average.
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Re: Your thoughts on negative interest rates

Post by longinvest »

vineviz wrote: Thu Jul 23, 2020 2:37 pm
longinvest wrote: Thu Jul 23, 2020 2:18 pm You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.
Ie as trying to be polite, but so as to avoid being accused of “playing with words” I’ll be blunt instead: you’re wrong.

Starting yield is highly predictive of future returns, and by “highly predictive” I specifically mean that the relationship is statistically significant and not by a thin margin.

The only mathematical support you could possibly offer for your blanket “yields don’t predict returns” would - likewise - be some sort of test for statistical significance. If you had that data you’d have provided it.

Switching back to being charitable in my interpretation what you wrote does make some sense if you think a predictive relationship must mean a confidence interval of +/- 0.00. If so, that’s a highly non-consensus meaning.
Dear Vineviz,

The mathematics are what they are. You can play all day long with backtests, collecting statistics, and try to build your own "expectations" about the future, it won't change the basic mathematical fact.

I've provided two complete examples which show that the starting yield isn't predictive of future returns, despite an unchanging yield curve. That's two counterexamples for the price of one, and it's sufficient to prove my statement. Q.E.D.

The real world is so much more complex than this simple bond fund, but the human brain craves certainty. So, it's easy to fall into the trap of looking at the past and expect the future to be almost identical. That could be a mistake. I much prefer to use robust mathematics, with proofs, to guide my investing decisions while accepting the uncertainty of what hasn't been proven, instead of using statistics about the past. Unfortunately, there are very few mathematical proofs, in investing. My preferred one is William Sharpe's brilliant The Arithmetic of Active Management.

It's tough to make predictions, especially about the future.” ― Yogi Berra

Best regards,

longinvest
Last edited by longinvest on Thu Jul 23, 2020 4:18 pm, edited 6 times in total.
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Re: Your thoughts on negative interest rates

Post by longinvest »

qwertyjazz wrote: Thu Jul 23, 2020 2:31 pm
longinvest wrote: Thu Jul 23, 2020 2:18 pm
vineviz wrote: Thu Jul 23, 2020 2:12 pm
longinvest wrote: Thu Jul 23, 2020 2:01 pm
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
In the post above, the false idea that “yield doesn’t predict return” was persistently repeated.

Perhaps the author meant “yield doesn’t PERFECTLY predict returns”. If so, saying so explicitly would have made the post perfectly compatible with the vast quantity of research demonstrating that starting yield is by far the best available indicator of future returns that bond and bond fund investors have.
Dear Vineviz,

You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.

Best regards,

longinvest
I think you arguing to not choose a bond fund based on matching a duration as bond funds make continuous purchases over years so the current rates and duration might not be the correct way of looking at them (versus individual bonds you might purchase). In that case, what factor should be used to optimize bond fund choices?
Thank you
Bonds Are Confusing
Qwertyjazz, to paraphrase Jack Bogle I don't look for the needle in the haystack, I just buy the haystack. All of my portfolio is invested into a low-cost globally-diversified all-in-one balanced ETF with a 60/40 stock/bond allocation, close enough to the overall allocation of the Market Portfolio (the global stock-and-bond market). My portfolio contains 12,676 global stocks and 16,941 global bonds for a total of 29,617 global securities allocated at market weight, except for a moderate home bias (and its small difference to the Market Portfolio's current 54/46 stock/bond allocation). It's a One-Fund Portfolio.
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Re: Your thoughts on negative interest rates

Post by 000 »

KlangFool wrote: Thu Jul 23, 2020 12:54 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
000,

Why should that matter to you? It does not matter to me with an AA of 60/40. Unless you are 0/100, it does not matter to you either.

I invest in VBTLX (Total Bond Index) and VFIUX (Inter-mediate Term Treasury).

The bond fund will reinvest in the new bond automatically. And, I would rebalance based on my AA.

Please think this through. Unless you are 0/100, it does not matter.

KlangFool
KlangFool,

I appreciate your response. It matters to me because valuations matter to me and I struggle to see a situation where accepting -XX% per year would be better than spending the money now. Of course, I think it is unlikely rates will get that negative. IMO, expecting gains in stocks to counterbalance negative yield bonds and/or further interest rate reductions seems like a speculation I do not want to take. The asset class has to make sense on a fundamental basis to attract my investment.
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Re: Your thoughts on negative interest rates

Post by qwertyjazz »

longinvest wrote: Thu Jul 23, 2020 3:05 pm
qwertyjazz wrote: Thu Jul 23, 2020 2:31 pm
longinvest wrote: Thu Jul 23, 2020 2:18 pm
vineviz wrote: Thu Jul 23, 2020 2:12 pm
longinvest wrote: Thu Jul 23, 2020 2:01 pm
The average YTM of a bond fund doesn't predict its future returns. I invite anyone who doubts this to look at my examples (linked above) and repeat the complete calculations to convince themselves of this fact.
In the post above, the false idea that “yield doesn’t predict return” was persistently repeated.

Perhaps the author meant “yield doesn’t PERFECTLY predict returns”. If so, saying so explicitly would have made the post perfectly compatible with the vast quantity of research demonstrating that starting yield is by far the best available indicator of future returns that bond and bond fund investors have.
Dear Vineviz,

You're playing with words. I've provided clear counter-examples which act as mathematical proof of my statement.

Best regards,

longinvest
I think you arguing to not choose a bond fund based on matching a duration as bond funds make continuous purchases over years so the current rates and duration might not be the correct way of looking at them (versus individual bonds you might purchase). In that case, what factor should be used to optimize bond fund choices?
Thank you
Bonds Are Confusing
Qwertyjazz, to paraphrase Jack Bogle I don't look for the needle in the haystack, I just buy the haystack. All of my portfolio is invested into a low-cost globally-diversified all-in-one balanced ETF with a 60/40 stock/bond allocation, close enough to the overall allocation of the Market Portfolio (the global stock-and-bond market). My portfolio contains 12,676 global stocks and 16,941 global bonds for a total of 29,617 global securities allocated at market weight, except for a moderate home bias (and its small difference to the Market Portfolio's current 54/46 stock/bond allocation). It's a One-Fund Portfolio.

Thank you
G.E. Box "All models are wrong, but some are useful."
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Re: Your thoughts on negative interest rates

Post by 000 »

jeffyscott wrote: Thu Jul 23, 2020 1:46 pm
KlangFool wrote: Thu Jul 23, 2020 12:54 pm
000 wrote: Thu Jul 23, 2020 12:29 pm
KlangFool wrote: Thu Jul 23, 2020 12:13 pm Folks,

I know that I know nothing. I am diversified. As for others that think they know something like "Negative interest rate = no bond or bond fund", I wish them the best of luck.

KlangFool
The question for me is: how low should one go while staying the course? -5%? -10%? -50%? Is there a lower limit where you would abandon bonds and reinvest maturing bonds elsewise?
000,

Why should that matter to you? It does not matter to me with an AA of 60/40. Unless you are 0/100, it does not matter to you either.

I invest in VBTLX (Total Bond Index) and VFIUX (Inter-mediate Term Treasury).

The bond fund will reinvest in the new bond automatically. And, I would rebalance based on my AA.

Please think this through. Unless you are 0/100, it does not matter.

KlangFool
The question was ridiculous, there's not going to be -50% yields. The answer that, "yes, you would accept -50% on 40% of your portfolio" is equally ridiculous.

I wouldn't invest in bonds at even -1%, but at least at that point one could argue that they could go even lower and the cap gains would make up for the negative yield. But at some point probably long before even -10%, let alone -50%, that's just not going to happen.

No one is going to pay $100K to get less than $25,000 in 10 years (-10% compounded).
I did not intend for the question to be ridiculous; rather, I am trying to understand at what point passive bond investors would make an (active, valuation-based decision) to eschew bonds. I appreciate your thoughts about -1% and -10%. I too think it is quite unlikely the investing public would accept negative double digits in real terms.
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