"Bonds as a way to generate cash if the stock market is in the toilet"

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"Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

The title is a quote is from today's piece by Jonathan Clements:
https://humbledollar.com/2020/10/game-o ... ses-test_7
He argues that given low yields, bonds won't act as a source of yield (since real returns are expected to be negative) nor as a diversifier (because you would need long durations to have significant increases in bond prices when interest rates decrease in a bear market, but this would imply large decreases in bond prices when interest rates increase).

The situation in Europe has been worse and for this reason I never invested in bonds (I think my first post on BH was a question about bonds) since cash and structured products work better for me.

I am wondering whether BH in the US have now come to agree with Mr Clements that the idea of bonds as a diversifer is no longer applicable in practice. To quote the title of the article:
Game over
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by whodidntante »

I agree that bonds are unattractive and there are better alternatives for me.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by skime »

whodidntante wrote: Sat Oct 10, 2020 5:22 am I agree that bonds are unattractive and there are better alternatives for me.
What would some of those alternatives be?
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by whodidntante »

skime wrote: Sat Oct 10, 2020 5:26 am
whodidntante wrote: Sat Oct 10, 2020 5:22 am I agree that bonds are unattractive and there are better alternatives for me.
What would some of those alternatives be?
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

The main role of bonds in my portfolio is to not drop by 50% when the market does. The secondary role of bonds is to allow me to buy stocks through rebalancing when the market drops. The tertiary role of bonds is to provide income.

I use a mix of bonds, with a portion that will not lose principal and a portion in corporate bonds. The combo provides sufficient income, without taking a lot of risk.
Last edited by rkhusky on Sat Oct 10, 2020 5:50 am, edited 1 time in total.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

rkhusky wrote: Sat Oct 10, 2020 5:46 am The secondary role of bonds is to allow me to buy stocks through rebalancing when the market drops.
Do you consider this market timing?
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

Lauretta wrote: Sat Oct 10, 2020 5:49 am
rkhusky wrote: Sat Oct 10, 2020 5:46 am The secondary role of bonds is to allow me to buy stocks through rebalancing when the market drops.
Do you consider this market timing?
No. Rebalancing depends on the state of my portfolio, not on forecasts of what the market might do. Rebalacing has to do with what the market has already done, without any prognostication of the future.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Pushkin »

I’m new. What’s this mean for my shares of BND? Do I sell them and buy QQQ? Please help!!!!
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by hackingdragon »

I think the US is unique as they offer two types of bonds to individual investors that are good diversifiers in the current investing climate. These are I bonds and EE bonds. We can compare them to Clements two points from the article:
Let's start with the obvious: If you buy high-quality bonds today, you’ll collect very little yield—and there’s an excellent chance you’ll lose money once inflation and taxes are figured in.
Let's see how I bonds and EE bonds fare to these two points:

1. Very little yield
  • I bonds: Tracked to inflation so they offer a 1% yield currently. The Fed is trying to push inflation over 2%, and if successful then I bonds will yield more.
  • EE bonds: If held for 20 years return a compound interest of 3.5%. That's really good for now.

2. Losing money
  • I bonds: Can't lose money to inflation because it tracks inflation. It also can't go lower than what you initially paid.
  • EE bonds: Inflation would have have to rise by more than 3.5% over the next 20 years. That is possible but not probable. You also cannot lose money.
It seems that I bonds and EE bonds are good deals. Together, they provide both an inflation hedge and a real return. They are limited by the amount that can be purchased, $10,000, and that you have to hold EE bonds for 20 years.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by livesoft »

Pushkin wrote: Sat Oct 10, 2020 5:53 am I’m new. What’s this mean for my shares of BND? Do I sell them and buy QQQ? Please help!!!!
It means nothing.

You keep them and spend less money and save more money.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

rkhusky wrote: Sat Oct 10, 2020 5:51 am
Lauretta wrote: Sat Oct 10, 2020 5:49 am
rkhusky wrote: Sat Oct 10, 2020 5:46 am The secondary role of bonds is to allow me to buy stocks through rebalancing when the market drops.
Do you consider this market timing?
No. Rebalancing depends on the state of my portfolio, not on forecasts of what the market might do. Rebalacing has to do with what the market has already done, without any prognostication of the future.
I'm not sure I understand your reasoning. You seem to want to keep a given percentage allocation to stocks and one to bonds, even though the latter have negative yields going forward. What's the point in keeping a percentage allocation to them? (except for having a steady bleed?).
Mr Clements suggests keeping say 5 years expenses in bonds.
What's the point of starting with a larger allocation to bonds and then buy stocks if they drop, unless you are market timing?
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

hackingdragon wrote: Sat Oct 10, 2020 5:56 am EE bonds: Inflation would have have to rise by more than 3.5% over the next 20 years. That is possible but not probable. You also cannot lose money.


It seems that I bonds and EE bonds are good deals. Together, they provide both an inflation hedge and a real return. They are limited by the amount that can be purchased, $10,000, and that you have to hold EE bonds for 20 years.
How can you predict inflaiton over the next 20 years?
If you can only buy $10,000 that's really not a significant amount for many investors!
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by whereskyle »

Pushkin wrote: Sat Oct 10, 2020 5:53 am I’m new. What’s this mean for my shares of BND? Do I sell them and buy QQQ? Please help!!!!
Keep them. Nobody knows nothing.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

Lauretta wrote: Sat Oct 10, 2020 5:59 am
rkhusky wrote: Sat Oct 10, 2020 5:51 am
Lauretta wrote: Sat Oct 10, 2020 5:49 am
rkhusky wrote: Sat Oct 10, 2020 5:46 am The secondary role of bonds is to allow me to buy stocks through rebalancing when the market drops.
Do you consider this market timing?
No. Rebalancing depends on the state of my portfolio, not on forecasts of what the market might do. Rebalacing has to do with what the market has already done, without any prognostication of the future.
I'm not sure I understand your reasoning. You seem to want to keep a given percentage allocation to stocks and one to bonds, even though the latter have negative yields going forward. What's the point in keeping a percentage allocation to them? (except for having a steady bleed?).
Mr Clements suggests keeping say 5 years expenses in bonds.
What's the point of starting with a larger allocation to bonds and then buy stocks if they drop, unless you are market timing?
My bonds don't have negative yields and I don't focus on short term fluctuations, nor take prognostications into account. I keep a fixed ratio of stocks/bonds, such that if the stocks drop a sufficient amount, I naturally sell bonds to buy stocks. If stocks rise, I sell stocks and buy more bonds. So, perhaps I have a larger allocation to stocks in order to buy more bonds in the future?

Basing your investing strategy on "negative yields going forward" is market timing.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

rkhusky wrote: Sat Oct 10, 2020 6:07 am

Basing your investing strategy on "negative yields going forward" is market timing.
yes, sorry, I did not explain myself properly. I am not talking of "negative yields going forward"; I am saying that it is mathematically certain that if you buy a bond it will have a negative yield, after taxes and inflation. The Clements article confirms this.
A bond fund might go up in value in the short term if interest rates decrease (that's also maths) but in the long run it will have negative returns.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

Lauretta wrote: Sat Oct 10, 2020 6:14 am
rkhusky wrote: Sat Oct 10, 2020 6:07 am

Basing your investing strategy on "negative yields going forward" is market timing.
yes, sorry, I did not explain myself properly. I am not talking of "negative yields going forward"; I am saying that it is mathematically certain that if you buy a bond it will have a negative yield, after taxes and inflation. The Clements article confirms this.
A bond fund might go up in value in the short term if interest rates decrease (that's also maths) but in the long run it will have negative returns.
I don't know what inflation will be in the future.
I disagree that it is certain that bond funds will have negative returns in the future, even accounting for taxes and inflation.

People have been predicting a bond fund catastrophe for the last 10+ years. I have not seen it yet.
Last edited by rkhusky on Sat Oct 10, 2020 6:35 am, edited 1 time in total.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by hackingdragon »

Lauretta wrote: Sat Oct 10, 2020 6:03 am How can you predict inflaiton over the next 20 years?
You can't. That's why it's best to pair I and EE bonds together. I was just stating that given our deflationary concerns, and low natural interest rate, it's less probable to see higher inflation. In other words, EE bonds provide good diversification for the scenario of long term low inflation and low rates. I bonds are good diversification for higher inflation.
Lauretta wrote: Sat Oct 10, 2020 6:03 am If you can only buy $10,000 that's really not a significant amount for many investors!
I agree. That's way over my budget, but sometimes when EE bonds or I bonds are mentioned people respond that they can only buy so many a year.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

Lauretta wrote: Sat Oct 10, 2020 6:03 am If you can only buy $10,000 that's really not a significant amount for many investors!
I don't buy these, but I imagine that they are part of a long term strategy. If you buy $10K/year over 40 years, that is a significant amount. They are not for those that want to jump in and out of investments based on short term forecasting.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

rkhusky wrote: Sat Oct 10, 2020 6:37 am
Lauretta wrote: Sat Oct 10, 2020 6:03 am If you can only buy $10,000 that's really not a significant amount for many investors!
I don't buy these, but I imagine that they are part of a long term strategy. If you buy $10K/year over 40 years, that is a significant amount. They are not for those that want to jump in and out of investments based on short term forecasting.
Well even 400K$ is a relatively small amount for a retiree. Also, it wasn't stated that it's $10,000 a year so I did not know when I commented.
As for myself, I never jumped in or out of bonds; I simply never jumped in as in Europe I thought one has to be pretty stupid to buy bonds with negative returns.
But no doubt your situation is different. Sure, besides me - and I can only do the maths, knowing little about finance - there are many people saying that it's certain that one will lose money with bonds, from Dalio to o'Shaughnessy to Clements in this article etc But then who know? It's worked in the past, so it might work going forward, right? :wink: :sharebeer
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by UpperNwGuy »

If you read the second part of the article, after all the doom and gloom of the first part, Clements admits that he still holds bonds in his own porftolio and that bonds still work for many purposes. All he's saying is not to rely on them for income in an era of low rates and to keep an eye on inflation.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by rkhusky »

Lauretta wrote: Sat Oct 10, 2020 6:44 am Well even 400K$ is a relatively small amount for a retiree.
That's just $400K in contributions, the total is likely much more. And that's not your entire portfolio. You might have another $500K in a Total Bond Fund and $1M in stocks.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

UpperNwGuy wrote: Sat Oct 10, 2020 6:46 am If you read the second part of the article, after all the doom and gloom of the first part, Clements admits that he still holds bonds in his own porftolio and that bonds still work for many purposes. All he's saying is not to rely on them for income in an era of low rates and to keep an eye on inflation.
he's saying not to rely on them for income nor as an asset that compensates for losses in bear markets.
He's saying their use is for money you need in the short term (up to 5 yrs). Unless you can't stomach having all the rest in stocks because of the possible drawdowns, in which case hold more bonds, even though you'll lose money.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

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rkhusky wrote: Sat Oct 10, 2020 6:52 am
Lauretta wrote: Sat Oct 10, 2020 6:44 am Well even 400K$ is a relatively small amount for a retiree.
That's just $400K in contributions, the total is likely much more. And that's not your entire portfolio. You might have another $500K in a Total Bond Fund and $1M in stocks.
^^ Agreed.

Lauretta, would you agree that $400K is a huge amount of money for the majority of people? Sure there are lots of millionaires in the world but they're a relatively small percentage of the population. For a person with a smaller nest egg, whether EE or I Bonds are not worthwhile for wealthier investors is not a relevant fact for deciding whether such bonds are good for me.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

sycamore wrote: Sat Oct 10, 2020 7:10 am
rkhusky wrote: Sat Oct 10, 2020 6:52 am
Lauretta wrote: Sat Oct 10, 2020 6:44 am Well even 400K$ is a relatively small amount for a retiree.
That's just $400K in contributions, the total is likely much more. And that's not your entire portfolio. You might have another $500K in a Total Bond Fund and $1M in stocks.
^^ Agreed.

Lauretta, would you agree that $400K is a huge amount of money for the majority of people? Sure there are lots of millionaires in the world but they're a relatively small percentage of the population. For a person with a smaller nest egg, whether EE or I Bonds are not worthwhile for wealthier investors is not a relevant fact for deciding whether such bonds are good for me.
sycamore yes I agree. In Europe too there are products which give higher interests but you're limited in the amount you can invest.
With EE bonds I think the issue would be that if inflation rises significantly they'll have negative real returns, but it's the first time I hear of them so I don't really know how they work.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

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Lauretta wrote: Sat Oct 10, 2020 4:57 am I am wondering whether BH in the US have now come to agree with Mr Clements that the idea of bonds as a diversifer is no longer applicable in practice.
Lauretta: You initial post asked a question about whether US investors have now come to agree with Mr Clements. You've gotten a lot of answers, and it's pretty clear that most of us have not given up on bonds. The tone of your recent comments is that we should give up on bonds. Unfortunately, most of your examples come from your personal experience as a European investor and don't apply here in the US.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by jimkinny »

rkhusky wrote: Sat Oct 10, 2020 6:37 am
Lauretta wrote: Sat Oct 10, 2020 6:03 am If you can only buy $10,000 that's really not a significant amount for many investors!
I don't buy these, but I imagine that they are part of a long term strategy. If you buy $10K/year over 40 years, that is a significant amount. They are not for those that want to jump in and out of investments based on short term forecasting.
+1
And if you a spouse you can add another 10K, plus at least 5k if purchased with a tax refund on I bonds (EE?)
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by jimkinny »

UpperNwGuy wrote: Sat Oct 10, 2020 7:43 am
Lauretta wrote: Sat Oct 10, 2020 4:57 am I am wondering whether BH in the US have now come to agree with Mr Clements that the idea of bonds as a diversifer is no longer applicable in practice.
Lauretta: You initial post asked a question about whether US investors have now come to agree with Mr Clements. You've gotten a lot of answers, and it's pretty clear that most of us have not given up on bonds. The tone of your recent comments is that we should give up on bonds. Unfortunately, most of your examples come from your personal experience as a European investor and don't apply here in the US.
I agree with Clements, especially if one considers his earlier article in which he wrote that he was going to use some SPIAs because his work status and age. I think a lot depends on the readers age and goals. I am going to gradually increase my equity exposure because of my status and soon will start buying SPIAs, because of my age, goals, tolerance for risk etc....
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

UpperNwGuy wrote: Sat Oct 10, 2020 7:43 am
Lauretta wrote: Sat Oct 10, 2020 4:57 am I am wondering whether BH in the US have now come to agree with Mr Clements that the idea of bonds as a diversifer is no longer applicable in practice.
Lauretta: You initial post asked a question about whether US investors have now come to agree with Mr Clements. You've gotten a lot of answers, and it's pretty clear that most of us have not given up on bonds. The tone of your recent comments is that we should give up on bonds. Unfortunately, most of your examples come from your personal experience as a European investor and don't apply here in the US.
yes you are right, that's a valid point. :happy And I am sorry that I used the wrong tone.
I guess I wanted to understand why people carry on holding bonds. I mean what I wanted to express is this: have you not given up because you disagree with Mr Clements (and if you do, where do you think he's wrong?), or because you have been used to a portfolio of X% stocks and (100-X)% bonds where X is perhaps 60, and you carry on with that portfolio even though now rates have gone down so much? I mean I can see mathematically why such a portfolio has made a lot of sense since 1980; I don't see how it makes sense now.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Whakamole »

hackingdragon wrote: Sat Oct 10, 2020 5:56 am 2. Losing money
  • I bonds: Can't lose money to inflation because it tracks inflation. It also can't go lower than what you initially paid.
If they track inflation perfectly, then unless you are in a zero percent tax bracket when you cash in the bond, taxes will eat up a portion of the return. In an inflation-adjusted sense, you are getting less than what you paid in.

I'm not sure how well they track inflation, considering the cost of goods at the grocery store.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Nowizard »

So many threads, and so much bond confusion. The frequent comments about major changes for many with bond allocations suggests the belief that an enduring shift in recommended portfolio construction is occurring. What happened to "Stay the Course?" What says this is not "Noise?" Why little suggestion that this is talking about market timing related to short term changes? The point of agreement appears to be that there is considerable confusion regarding how to invest in ways that provide diversification and reduce risk. That is the current situation, but is it reflective of a systematic change?

Tim
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

Nowizard wrote: Sat Oct 10, 2020 8:37 am That is the current situation, but is it reflective of a systematic change?

Tim
I believe it is.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by JackoC »

rkhusky wrote: Sat Oct 10, 2020 6:33 am
Lauretta wrote: Sat Oct 10, 2020 6:14 am
rkhusky wrote: Sat Oct 10, 2020 6:07 am

Basing your investing strategy on "negative yields going forward" is market timing.
yes, sorry, I did not explain myself properly. I am not talking of "negative yields going forward"; I am saying that it is mathematically certain that if you buy a bond it will have a negative yield, after taxes and inflation. The Clements article confirms this.
A bond fund might go up in value in the short term if interest rates decrease (that's also maths) but in the long run it will have negative returns.
I don't know what inflation will be in the future.
I disagree that it is certain that bond funds will have negative returns in the future, even accounting for taxes and inflation.

People have been predicting a bond fund catastrophe for the last 10+ years. I have not seen it yet.
If you buy TIPS it's in fact certain (as anything in the real world is) you get a negative real return even pre tax. With nominal bonds of course it's possible that inflation is far enough below market expectation to come up positive real, though a real stretch of the imagination that could happen if the return is taxed at any significant %. Basically by holding low risk bonds you're committing to negative real after tax return on that money. That's nothing to do with 'predicting catastrophe' and what bonds returned from 10 yrs ago to now is entirely irrelevant to that point.

Now, does the fact that bond yields are distinctly negative real after tax imply a different asset allocation? That depends. For me, 'bonds' (mainly CD's, which are so far superior to nominal treasuries it's not funny, but still in the general category 'bond', and even best CD's now at best barely reach expected inflation before tax) are to mainly preserve a certain amount of the already adequate amount of money I have. A modest negative real after tax return, with almost complete safety, still accomplishes that purpose. I also believe it's an illusion if people think bond expected returns have gone down (it seems you may even doubt that, but it's obvious I'm afraid) but stock expected returns haven't also gone down, perhaps more. I don't see risky assets* as more attractive relative to 'bonds' in my situation than they used to be. Nor do I firmly believe there's any basically better solution to risk management than a mix of some riskier assets and some safer assets**.

*some of my risky assets are real estate and risky bonds but I don't believe that 'fixes' low expected return.
**one possibility might be more stocks with tail risk hedging (index puts or VIX calls). I don't 'firmly believe in it', but it's worth exploring I think. Just layering on more and more naked stock risk because fixed income yields are low is...not so wise IMO, I was going to put it more bluntly. :happy
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Sandtrap »

Lauretta wrote: Sat Oct 10, 2020 4:57 am The title is a quote is from today's piece by Jonathan Clements:
https://humbledollar.com/2020/10/game-o ... ses-test_7
He argues that given low yields, bonds won't act as a source of yield (since real returns are expected to be negative) nor as a diversifier (because you would need long durations to have significant increases in bond prices when interest rates decrease in a bear market, but this would imply large decreases in bond prices when interest rates increase).

The situation in Europe has been worse and for this reason I never invested in bonds (I think my first post on BH was a question about bonds) since cash and structured products work better for me.

I am wondering whether BH in the US have now come to agree with Mr Clements that the idea of bonds as a diversifer is no longer applicable in practice. To quote the title of the article:
Game over
What is the specific problem that needs a solution here?

How do bond index funds (per 3-4 fund portfolio) solve or not solve the problem?

What is the solution to the problem?

Sometimes these types of articles, and so many financial articles, have a point of view that is deep in the weeds or forest, rather than looking at a broad and simple overview of things and proposing actionable and "simple" solutions, whether the solution is to do something different, or nothing at all.

There are 3 types of solutions to encountering an obstacle in a path. . .
Go straight through now.
Wait until things change (in the obstacle or conditions or self)
Go around.

So, in this case. . . what are the alternatives and solutions? :?: :?:

j :D
Last edited by Sandtrap on Sat Oct 10, 2020 10:19 am, edited 1 time in total.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

JackoC wrote: Sat Oct 10, 2020 9:20 am
rkhusky wrote: Sat Oct 10, 2020 6:33 am
Lauretta wrote: Sat Oct 10, 2020 6:14 am
rkhusky wrote: Sat Oct 10, 2020 6:07 am

Basing your investing strategy on "negative yields going forward" is market timing.
yes, sorry, I did not explain myself properly. I am not talking of "negative yields going forward"; I am saying that it is mathematically certain that if you buy a bond it will have a negative yield, after taxes and inflation. The Clements article confirms this.
A bond fund might go up in value in the short term if interest rates decrease (that's also maths) but in the long run it will have negative returns.
I don't know what inflation will be in the future.
I disagree that it is certain that bond funds will have negative returns in the future, even accounting for taxes and inflation.

People have been predicting a bond fund catastrophe for the last 10+ years. I have not seen it yet.
If you buy TIPS it's in fact certain (as anything in the real world is) you get a negative real return even pre tax. With nominal bonds of course it's possible that inflation is far enough below market expectation to come up positive real, though a real stretch of the imagination that could happen if the return is taxed at any significant %. Basically by holding low risk bonds you're committing to negative real after tax return on that money. That's nothing to do with 'predicting catastrophe' and what bonds returned from 10 yrs ago to now is entirely irrelevant to that point.

Now, does the fact that bond yields are distinctly negative real after tax imply a different asset allocation? That depends. For me, 'bonds' (mainly CD's, which are so far superior to nominal treasuries it's not funny, but still in the general category 'bond', and even best CD's now at best barely reach expected inflation before tax) are to mainly preserve a certain amount of the already adequate amount of money I have. A modest negative real after tax return, with almost complete safety, still accomplishes that purpose. I also believe it's an illusion if people think bond expected returns have gone down (it seems you may even doubt that, but it's obvious I'm afraid) but stock expected returns haven't also gone down, perhaps more. I don't see risky assets* as more attractive relative to 'bonds' in my situation than they used to be. Nor do I firmly believe there's any basically better solution to risk management than a mix of some riskier assets and some safer assets**.

*some of my risky assets are real estate and risky bonds but I don't believe that 'fixes' low expected return.
**one possibility might be more stocks with tail risk hedging (index puts or VIX calls). I don't 'firmly believe in it', but it's worth exploring I think. Just layering on more and more naked stock risk because fixed income yields are low is...not so wise IMO, I was going to put it more bluntly. :happy
these are all very good points, and I agree with basically everything you say.
Re: stocks I would add this: if I am not mistaken as a rule of thumb one compares 10yr Treasuries to stocks dividend yields . In countries like Europe you have negative bond yields whereas stock dividends are quite attractive, so it seems that for some reason stocks are a better deal than bonds.
But I understand your point that the fact the interest rates have gone down should also push down stocks expected returns.
Btw this was asked at the end of the article and Clements agrees that stocks returns should be lower going forward, but he expects them to be positive (unlike bonds).
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by hackingdragon »

Whakamole wrote: Sat Oct 10, 2020 8:23 am If they track inflation perfectly, then unless you are in a zero percent tax bracket when you cash in the bond, taxes will eat up a portion of the return. In an inflation-adjusted sense, you are getting less than what you paid in.

I'm not sure how well they track inflation, considering the cost of goods at the grocery store.
Yes, taxes will eat a portion of return, by definition. You can defer taxes till when you are in lower income (like retirement) and sell then. Also if you sell within the first five years, you lose the last 3 months interest.

However, it is one of the best inflation hedges. Clearly you are not going to get rich from I bonds. I bonds should be considered as real assets since they track the CPI.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by willthrill81 »

Lauretta wrote: Sat Oct 10, 2020 4:57 am The title is a quote is from today's piece by Jonathan Clements:
https://humbledollar.com/2020/10/game-o ... ses-test_7
He argues that given low yields, bonds won't act as a source of yield (since real returns are expected to be negative) nor as a diversifier (because you would need long durations to have significant increases in bond prices when interest rates decrease in a bear market, but this would imply large decreases in bond prices when interest rates increase).
Clements has made a huge error by conflating diversification with hedging.

It's true that bonds are almost certainly going to lag behind inflation for at least the next decade. The only ways that this could not happen is if interest rates fall even further and/or inflation drops to below bond's current yields, neither of which the Fed has said that they were even interested in trying to achieve.

But effective diversification does not require a positive expected return. Even if bonds are losing to inflation, they can still stabilize a portfolio otherwise comprised of mostly stocks (i.e. act as a diversifying asset).

If an investor is looking for an effective asset to hedge stocks, I would suggest that long-term bonds, both nominals and TIPS, are still a good option for long-term investors.

P.S. Clements is apparently not aware of the history of U.S. bonds. He says that their 'traditional' role was to generate income, but there have been long periods of time when bonds didn't even keep pace with inflation, such as from 1941-1981, when intermediate-term Treasuries lost -1.6% annually to inflation. Over the long-term, Treasuries have only had a real return of about 1%, only serving as a means of storing wealth, not generating it. The bull market in bonds from 1982-2020 has created very strong recency bias in many investors, leading them to believe that bonds have always performed as they did during this period and that they will continue to do so, both of which are dead wrong.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

willthrill81 wrote: Sat Oct 10, 2020 10:13 am
If an investor is looking for an effective asset to hedge stocks, I would suggest that long-term bonds, both nominals and TIPS, are still a good option for long-term investors.
The trouble is that long term bonds are very risky now because of the low interest rates and high duration. A small increase in interest rates will cause a pretty large decrease in value.
I do see your point about diversification in that at least in the US goverment bonds seem to be negatively correlated to stocks in a bear market.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by willthrill81 »

Lauretta wrote: Sat Oct 10, 2020 10:19 am
willthrill81 wrote: Sat Oct 10, 2020 10:13 am If an investor is looking for an effective asset to hedge stocks, I would suggest that long-term bonds, both nominals and TIPS, are still a good option for long-term investors.
The trouble is that long term bonds are very risky now because of the low interest rates and high duration. A small increase in interest rates will cause a pretty large decrease in value.
I do see your point about diversification in that at least in the US goverment bonds seem to be negatively correlated to stocks in a bear market.
Due to the strong convexity of long-term bonds, they are indeed set up for potentially high volatility, but that could go in either direction. Since the Volcker era, the Fed has largely combatted economic issues by lowering interest rates. They don't have much room to do so now without having negative interest rates, which they have said that they will not pursue, but that does not mean that that will always be the case.

Further, I would suggest that a relatively small allocation to gold (i.e. 5-20%) has been a good diversifying asset in portfolios otherwise dominated by stocks and bonds.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

willthrill81 wrote: Sat Oct 10, 2020 10:25 am
Lauretta wrote: Sat Oct 10, 2020 10:19 am
willthrill81 wrote: Sat Oct 10, 2020 10:13 am If an investor is looking for an effective asset to hedge stocks, I would suggest that long-term bonds, both nominals and TIPS, are still a good option for long-term investors.
The trouble is that long term bonds are very risky now because of the low interest rates and high duration. A small increase in interest rates will cause a pretty large decrease in value.
I do see your point about diversification in that at least in the US goverment bonds seem to be negatively correlated to stocks in a bear market.
Due to the strong convexity of long-term bonds, they are indeed set up for potentially high volatility, but that could go in either direction. Since the Volcker era, the Fed has largely combatted economic issues by lowering interest rates. They don't have much room to do so now without having negative interest rates, which they have said that they will not pursue, but that does not mean that that will always be the case.

Further, I would suggest that a relatively small allocation to gold (i.e. 5-20%) has been a good diversifying asset in portfolios otherwise dominated by stocks and bonds.
yep, totally agree on gold. I had a small allocation when I first started investing (as I wrote in the first post I wrote on BH) and I have been increasing it. I am aiming to reach 10% even though it's already gone up it might not be too late to buy more.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by finite_difference »

Bonds are for ballast, not yield.

Stocks are the sails, providing yields.

A good ship has both sails and ballast.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by JoMoney »

I've been pretty cyncial of the "diversifier" alchemy stories.
I'm in agreement with them that some amount of diversification is helpful, holding 30 large stocks with similar expected returns clearly decreases the portfolio volatility relative to holding 5 stocks with similar expected returns.
If you were comparing stock-picker portfolios, and couldn't otherwise distinguish between the stock characteristics, I do think looking at the standard-deviation/volatility "risk adjusted return" has some basis to it.
I don't think bonds have the same expected returns (or risks) as stocks. The value of bonds is that they're an explicit promise of what they'll return and when, stocks don't have that. The lack of 'risk' in bonds has a benefit even if they're not returning anything.
I keep enough in cash and bonds that I sleep ok, knowing that my well being isn't reliant on the short-term variations in stocks, but making my long-term investment in stocks.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by zie »

you have to pay for safety, with rare occasional exceptions(on a real basis, after tax, etc).

Roughly in order of safety:
  • FDIC insured accounts (HYSA, CD's, etc)
  • Treasuries(to include I/EE bonds, tips, etc)
  • Money Market funds(MMF) (SIPC insured)
  • MYGA's (SPIC insured)
  • Bank Accounts not FDIC insured, i.e. you went over the FDIC limits.
  • Stable Value Funds (SVF)
  • Short term bonds
  • Medium term bonds
  • Long term bonds
  • Real Estate(un-leveraged, i.e. no mortgage)
  • Preferred Stocks
  • Annuities, not SPIC insured
  • Leveraged Real Estate (i.e. mortgaged)
  • Equities
FDIC insured accounts, MMF, generally lose to inflation.

Some treasuries should keep up with inflation at least(tips, etc) but after taxes, you probably won't.

MYGA's are in the same boat, you might be able to beat inflation, but maybe only barely(and involve lots of insurance paperwork, apparently) and after taxes, doubtful.

Bonds can beat inflation, but there is zero guarantee and for the next decade almost certainly won't.

Like willthrill81 mentioned, bonds except for the past 40-ish years have not even kept up with inflation.

Real Estate will probably keep up with inflation, and if you treat it like a real business, you might even make some money.

Preferred stocks should beat inflation, but takes on considerably more risk than everything else below it, but after taxes you probably can make a little.

Equities should beat inflation, risk is obviously higher.

The safer the money, the less people are willing to pay you for it. There is no free lunch.

EDIT: thanks to willthrill81, added SVF's, see discussion below.
Last edited by zie on Sat Oct 10, 2020 3:26 pm, edited 2 times in total.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by willthrill81 »

zie wrote: Sat Oct 10, 2020 10:50 am you have to pay for safety, with rare occasional exceptions(on a real basis, after tax, etc).

Roughly in order of safety:
  • FDIC insured accounts (HYSA, CD's, etc)
  • Treasuries(to include I/EE bonds, tips, etc)
  • Money Market funds(MMF) (Brokerage trade group Insured?)
  • MYGA's (SPIC insured)
  • Bank Accounts not FDIC insured, i.e. you went over the FDIC limits.
  • Short term bonds
  • Medium term bonds
  • Long term bonds
  • Real Estate(un-leveraged, i.e. no mortgage)
  • Preferred Stocks
  • Annuities, not SPIC insured
  • Leveraged Real Estate (i.e. mortgaged)
  • Equities
FDIC insured accounts, MMF, generally lose to inflation.

Some treasuries should keep up with inflation at least(tips, etc) but after taxes, you probably won't.

MYGA's are in the same boat, you might be able to beat inflation, but maybe only barely(and involve lots of insurance paperwork, apparently) and after taxes, doubtful.

Bonds can beat inflation, but there is zero guarantee and for the next decade almost certainly won't.

Like willthrill81 mentioned, bonds except for the past 40-ish years have not even kept up with inflation.

Real Estate will probably keep up with inflation, and if you treat it like a real business, you might even make some money.

Preferred stocks should beat inflation, but takes on considerably more risk than everything else below it, but after taxes you probably can make a little.

Equities should beat inflation, risk is obviously higher.

The safer the money, the less people are willing to pay you for it. There is no free lunch.
Another instrument available to a number of people in their 401k or 403b is a decent stable value fund. Many are still paying around 3% and are quite secure.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by zie »

willthrill81 wrote: Sat Oct 10, 2020 10:58 am
zie wrote: Sat Oct 10, 2020 10:50 am you have to pay for safety, with rare occasional exceptions(on a real basis, after tax, etc).

Roughly in order of safety:
Another instrument available to a number of people in their 401k or 403b is a decent stable value fund. Many are still paying around 3% and are quite secure.
Ah right, thanks!! I forgot those. SVF's would basically equate to a MMF? Are they insured like MMF's?
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by 22twain »

Pushkin wrote: Sat Oct 10, 2020 5:53 am I’m new. What’s this mean for my shares of BND? Do I sell them and buy QQQ? Please help!!!!
Nah, UPRO + TMF are what all the cool kids are investing in, nowadays. :twisted:

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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by willthrill81 »

zie wrote: Sat Oct 10, 2020 11:04 am
willthrill81 wrote: Sat Oct 10, 2020 10:58 am
zie wrote: Sat Oct 10, 2020 10:50 am you have to pay for safety, with rare occasional exceptions(on a real basis, after tax, etc).

Roughly in order of safety:
Another instrument available to a number of people in their 401k or 403b is a decent stable value fund. Many are still paying around 3% and are quite secure.
Ah right, thanks!! I forgot those. SVF's would basically equate to a MMF? Are they insured like MMF's?
They vary tremendously, but I don't think that most SVFs are insured. Many are backed by nothing more than both the underlying assets as well the company offering them. But due to the way they are structured, they can offer higher yields than bonds. For instance, TIAA's model for their 'Traditional' SVF annuity restricts withdrawals in such a way that they can offer higher yields.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by SchruteB&B »

sycamore wrote: Sat Oct 10, 2020 7:10 am
rkhusky wrote: Sat Oct 10, 2020 6:52 am
Lauretta wrote: Sat Oct 10, 2020 6:44 am Well even 400K$ is a relatively small amount for a retiree.
That's just $400K in contributions, the total is likely much more. And that's not your entire portfolio. You might have another $500K in a Total Bond Fund and $1M in stocks.
^^ Agreed.

Lauretta, would you agree that $400K is a huge amount of money for the majority of people?


Yes, good grief what an absurd idea, that 400k is a small amount for a retiree! I know many retirees who retired with a portfolio less than that in total and live extremely comfortable lives.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by SpideyIndexer »

Also if one annually purchases 10K I bonds and 10K EE bonds, that is an $800K investment over 40 years. If I were smarter about investing in the past, I would have purchased more EE bonds....though not 10K per year early in my career.

Anyway I 100% agree that bonds are NOT primarily a way to generate cash.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by Lauretta »

SchruteB&B wrote: Sat Oct 10, 2020 11:30 am
sycamore wrote: Sat Oct 10, 2020 7:10 am
rkhusky wrote: Sat Oct 10, 2020 6:52 am
Lauretta wrote: Sat Oct 10, 2020 6:44 am Well even 400K$ is a relatively small amount for a retiree.
That's just $400K in contributions, the total is likely much more. And that's not your entire portfolio. You might have another $500K in a Total Bond Fund and $1M in stocks.
^^ Agreed.

Lauretta, would you agree that $400K is a huge amount of money for the majority of people?


Yes, good grief what an absurd idea, that 400k is a small amount for a retiree! I know many retirees who retired with a portfolio less than that in total and live extremely comfortable lives.
do they use the 4% rule? That would imply 16K a year.
Probably I have a problem then; because my total worth is one order of magnitude higher than than and I am still very nervous when I think of quitting my job for good.
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Re: "Bonds as a way to generate cash if the stock market is in the toilet"

Post by whodidntante »

Lauretta wrote: Sat Oct 10, 2020 12:27 pm Probably I have a problem then; because my total worth is one order of magnitude higher than than and I am still very nervous when I think of quitting my job for good.
With a 4 million dollar net worth, retirement is certainly possible. Like every financially responsible person, you would just need to spend within your means. Even if 3.9 million of that is in your house, you can sell and move to less expensive area.
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