Hey, we finally got on the same page. I absolutely mean you know your upside in nominal terms from the YTM of a long bond.vineviz wrote: ↑Thu Oct 08, 2020 6:28 pmNo, you don’t “know your upside” unless you know something the market doesn’t know about whether that yield is going to increase or decrease.
And if by “know your upside” you mean you know your return if you hold to maturity, then yea but that’s trivially self-evident: that’s always true with fixed income investments. It’s right there in the name.
But what you DON’T know is the return of buying short term bonds and rolling them over for 20 years. The expected return is lower than just buying the 20-year bond but your upside and downside from this strategy are both uncertain.
And if you have a view on which of those is greater, you are a market timer. If you have no such view, it’s irrational to buy short term bonds if you have a long term investment horizon.
Maybe explaining, from a different perspective, how I'm comparing downside risk. Imagine a scenario in which interest rates jump by 2% at the same time the equity markets sell-off. A 20 year treasury will likely have lost more than 25% of market value, and let's say equities lost the same -25% for simplicity. Now I have no way to rebalance into my suddenly much more attractive equities without locking in the losses in the long bonds.... With 2-3 yr bonds (let alone shorter-term which I prefer right now), I've lost less than 5%, and I can more easily sell bonds and buy stocks.
If that scenario is one you don't care about, then that's fine, and I'm not arguing your preference at all. All I'm saying is that I disagree that when yields change the relative attractiveness between short term bonds and long term bonds absolutely shifts. At lower yields, bonds tend to be more sensitive to jumps in rates, and also lose their reliability of negative correlation to equity markets.
To clarify, I am in no way saying I know where rates will go, inflation/deflation. I dont know if fixed income will be positive (or negatively) correlated to equities over any given situation. However, if I probability weight all these binary scenarios at 50% each, the picture becomes clear to me that I don't want to be on the long bond side of that coin flip.