My favorite authors are turning their backs on Bonds

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BogleBuddy12
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My favorite authors are turning their backs on Bonds

Post by BogleBuddy12 »

I just bought Charley Ellis’ 8th Edition of “Winning the Loser’s Game.” It was released in May 2021.

In this 2021 edition, Burton Malkiel writes the foreword where he praises Ellis for revising the book to include concerns about “financial repression” and the low bond interest rates. Ellis discusses his concerns with bonds. It seems they both will no longer recommend a classic portfolio such as 60% stocks / 40% bonds.

My concern is that the book touts “timeless strategies.” 60/40 was thought to be a great, long-term way to invest. Many of the authors who pioneered index funds believed in holding a Total Bond Market fund. I don’t believe many of them wrote that bonds are meant for growth, but rather safety and security.

It seems Ellis has shifted his views on the purpose of bonds, due to the fact that they are currently paying very little if anything. Should the current interest rate environment be changing the “timeless strategies” we have relied on, namely the 60/40 portfolio?
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Re: My favorite authors are turning their backs on Bonds

Post by visualguy »

BogleBuddy12 wrote: Sun Jun 06, 2021 11:09 pm I just bought Charley Ellis’ 8th Edition of “Winning the Loser’s Game.” It was released in May 2021.

In this 2021 edition, Burton Malkiel writes the foreword where he praises Ellis for revising the book to include concerns about “financial repression” and the low bond interest rates. Ellis discusses his concerns with bonds. It seems they both will no longer recommend a classic portfolio such as 60% stocks / 40% bonds.

My concern is that the book touts “timeless strategies.” 60/40 was thought to be a great, long-term way to invest. Many of the authors who pioneered index funds believed in holding a Total Bond Market fund. I don’t believe many of them wrote that bonds are meant for growth, but rather safety and security.

It seems Ellis has shifted his views on the purpose of bonds, due to the fact that they are currently paying very little if anything. Should the current interest rate environment be changing the “timeless strategies” we have relied on, namely the 60/40 portfolio?
Putting 40% of your money in something that pays so little makes no sense to me. If I didn't want to put it in stock, I would put it in another investment that actually pays like real estate.
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Re: My favorite authors are turning their backs on Bonds

Post by mikejuss »

OP, what, exactly, are you asking here? What is Ellis recommending instead of 60/40?
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Re: My favorite authors are turning their backs on Bonds

Post by esteen »

In many people's eyes, bonds are turning from a way to "preserve wealth while also growing it somewhat," to a way to "probably preserve wealth, no guarantee, and certainly not grow it". The "preserve wealth" (and reduce volatility and provide diversification benefit) is the part that shouldn't have changed. However I knew some folks who thought bonds are a great way to grow wealth, rather than just preserve it and reduce volatility. If that was someone's former take on bonds, I could see how their perception has changed.

I think a typical stock/bond allocation still works - however it's undeniable that recent low returns and higher stock correlations have made their inclusion less appealing than it was in the past. Does appealing equal good? No, because we don't know the future. But yeah they're certainly less appealing.
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Re: My favorite authors are turning their backs on Bonds

Post by AlohaJoe »

BogleBuddy12 wrote: Sun Jun 06, 2021 11:09 pm My concern is that the book touts “timeless strategies.” 60/40 was thought to be a great, long-term way to invest.
I don't think Ellis or Malkiel ever thought 60/40 was a great timeless strategy. Can you point to a quote of them actually saying that?

In their 2009 book The Elements of Investing they say "The appropriate allocation for individual investors depends upon a few key factors. The primary factor is age." They then go on to give asset allocation ranges that are a glidepath. Malkiel says up until you are 60 you should have at least 65-75% equities (and then it drops to 45-65% in your 60s). Ellis says that you should have 65-90% equities until you are 60 (and then it drops to 60-80% in your 60s). Ellis in particular recommends 100% equities for anyone under 50.

"As you get older, change the mix toward bond investments as the tables indicate."

This is what they say about bonds:
We recommend a substantial allocation to bonds for investors in retirement because bonds provide a relatively steady source of income for living expenses
That was in 2009. I don't think you can really complain about Ellis or Malkiel "recently" changing their minds about bonds. Ellis in particular has never really liked them.

This is what Ellis wrote in his 2009 edition of Winning the Loser's Game:
But what about elderly investors whose life expectancy is less than the 10 years that approximates “long term”? Shouldn’t they, as the conventional wisdom would have it, invest primarily in bonds to preserve capital? As usual, the conventional wisdom may be wrong
On page 55 he specifically argues against a 60/40 portfolio. He argues against it again on page 64 saying it is based on choosing an inappropriate time horizon:
Unfortunately, the time horizon so often used is not chosen for the specific investor but is instead a conventional five years, which usually leads to the familiar recommendation of a 60:40 ratio of equities to debt.
Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Last edited by AlohaJoe on Mon Jun 07, 2021 1:12 am, edited 2 times in total.
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Re: My favorite authors are turning their backs on Bonds

Post by AlohaJoe »

mikejuss wrote: Sun Jun 06, 2021 11:28 pm OP, what, exactly, are you asking here? What is Ellis recommending instead of 60/40?
All Ellis actually says is that hard & fast rules like "60/40 is right for everyone" make no sense, as you need to take into account their age, their income, their bequest plans, etc, etc. I think he's been saying that for 30+ years, so I'm not sure his message has actually changed.
Each investor has "different amounts of money, different incomes, different amounts of savings potential, different attitudes towards risk," Ellis said.
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

AlohaJoe wrote: Mon Jun 07, 2021 12:49 am
Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Can you explain this statement and/or point to threads on the topic? My understanding of Modern Portfolio is very much consistent with what I know of the Bogleheads approach. Don't take risk unless compensated with higher expected return, seek diversification through non-correlated assets, maximize returns relative to risk. What is bunk about that?
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Re: My favorite authors are turning their backs on Bonds

Post by RickBoglehead »

Two points:

1) If I want to sell a book and make money, I'd write something controversial, different from past books, where people who have this fascination with what I say have to buy it so they can go on forums and debate it.

2) I don't read any investing books after reading enough in my personal judgement. I also tend to stay away from the "Theory, News & General" forum... Of course this is in that forum, so for whatever that's worth. :shock:
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Re: My favorite authors are turning their backs on Bonds

Post by Da5id »

aristotelian wrote: Mon Jun 07, 2021 7:47 am
AlohaJoe wrote: Mon Jun 07, 2021 12:49 am
Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Can you explain this statement and/or point to threads on the topic? My understanding of Modern Portfolio is very much consistent with what I know of the Bogleheads approach. Don't take risk unless compensated with higher expected return, seek diversification through non-correlated assets, maximize returns relative to risk. What is bunk about that?
We need new ideas like crypto, GME, AMC! Not stodgy ideas about diversification and such :) Anyway, except for the most vanilla of statements I find general pronouncements about what Bogleheads mostly think to be suspect.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

No suggestion as specific as 60/40 is "timeless" in any sense of the word. I'm not sure anyone ever recommended that.

The idea that bonds are held in order to get income makes no sense and never did.

In general asset allocation can be changed when circumstances change, but one should be extremely cautious about thinking that current interest rate values should be read as a change in circumstances. One would think that risk showing up in bond investing would have been considered as a possibility from the get-go and the plan taking that into account all along.

I don't think the MPT basis that the descriptive statistics for a portfolio are the return and the variability of return is not credited by most investors. Along with that I don't think the idea that the role of bonds in stock bond portfolios is to control risk is going away.

As to real estate, there has never been a problem with people electing to invest in rental properties or even real estate ventures if they want to and have a suitable risk and return assessment to go along with it. Putting rental real estate into a portfolio analysis is probably hard to do.

Recommendations that current level of interest rates would indicate that investors should change asset allocations now can certainly be made if justifications can be mounted.
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Re: My favorite authors are turning their backs on Bonds

Post by Dude2 »

dbr wrote: Mon Jun 07, 2021 8:03 am The idea that bonds are held in order to get income makes no sense and never did.
Seems that the concept always fell into "money illusion" category, believing that as long as the nominal coupon payouts were flowing you could ignore the purchasing power being eaten away part.

Nothing wrong with considering bonds in terms of matching to future liabilities, i.e. the risk portfolio on one hand and the LMP approach on the other.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

Dude2 wrote: Mon Jun 07, 2021 8:12 am
dbr wrote: Mon Jun 07, 2021 8:03 am The idea that bonds are held in order to get income makes no sense and never did.
Seems that the concept always fell into "money illusion" category, believing that as long as the nominal coupon payouts were flowing you could ignore the purchasing power being eaten away part.

Nothing wrong with considering bonds in terms of matching to future liabilities, i.e. the risk portfolio on one hand and the LMP approach on the other.
Right. But this is where the bad luck of coming in at low interest rates can hit home. A 30 year TIPS LMP can produce an inflation indexed 30 year income of 3.3% of initial portfolio when the real rate is 0%. At 2% real the payout is 4.4% and at -1% real it drops to 2.9%. So for this kind of example an investor probably would turn their backs on the LMP under today's interest rates. At the same time payout on an SPIA is depressed at well. Another example is that we don't have I bonds at 2% base rate either.

On the other hand, there is no ready solution in such cases.
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Re: My favorite authors are turning their backs on Bonds

Post by nisiprius »

dbr wrote: Mon Jun 07, 2021 8:03 am...The idea that bonds are held in order to get income makes no sense and never did...
Exactly.

A bond is a legal contract that (often) guarantees the payment of specific numbers of dollars on specific days. We can summarize that phrase in the word "fixed," in the phrase "fixed income."

"Bond" is from the same root as "binding," in a phrase like "binding contract." What makes a bond a "bond" is not the "income" part, but the "fixed" part.

Too many people with products or strategies to sell will say "Bonds provide an income stream. My pet asset class (real estate, dividend stocks, covered calls, whatever) provides an income stream. Therefore my pet asset class is a bond substitute." No.
Last edited by nisiprius on Mon Jun 07, 2021 8:26 am, edited 2 times in total.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

aristotelian wrote: Mon Jun 07, 2021 7:47 am
AlohaJoe wrote: Mon Jun 07, 2021 12:49 am
Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Can you explain this statement and/or point to threads on the topic? My understanding of Modern Portfolio is very much consistent with what I know of the Bogleheads approach. Don't take risk unless compensated with higher expected return, seek diversification through non-correlated assets, maximize returns relative to risk. What is bunk about that?
Yeah, I don't think this particular observation about MPT and the 60/40 portfolio is on the mark.

Although a 60/40 portfolio might be consistent with the premise of modern portfolio theory, nothing about MPT leads to 60/40 being special in any way relative to other possible allocations.

And any Boglehead who thinks MPT is "bunk" is mistaken, and perhaps dangerously so.
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Re: My favorite authors are turning their backs on Bonds

Post by nisiprius »

With regard to MPT there is an obvious fact that should be noted.

Disclaimer: I'm staying within the usual frame of reference for MPT, including concepts that can be challenged.

If the return of stocks, bonds, and the riskless asset all decline by the same amount, then the optimum portfolio allocation does not change. The efficient frontier and capital market line look just the same as before. Everything slides down the same amount on the Y axis, and the tangent line kisses the efficient frontier in the same place as before. Even if the return from the riskless asset and bonds goes negative, nothing special happens. The tangent portfolio stays in the same place, and continues to be the optimum. Which in this case is the least of an efficient frontier of evils.

Allocation is based on the relative performance of stocks, bonds, and cash. Sure, if the spread between the return of stocks and bonds widens--bonds pay less but stocks stay the same--MPT will say to allocate less to bonds and more to stocks. If bonds don't pay any more than bank accounts, MPT will say to put nothing in bonds and to divide your portfolio between stocks and cash.

But if their relative relationship to each doesn't change, the absolute returns don't matter.

Just because you don't like the optimum portfolio doesn't necessarily mean there must be something better. And the idea that there must be something better can be used to exploit investors into fooling around after strange assets.
Last edited by nisiprius on Mon Jun 07, 2021 8:42 am, edited 4 times in total.
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Re: My favorite authors are turning their backs on Bonds

Post by Nowizard »

When bonds perform similar to equities, as they have over the recent past, but stop, you will have different recommendations based on factors other than safety as others have mentioned. This will particularly occur, of course, with financial folks with a vested interest in having investors sell and trade frequently. This is at least somewhat unusual to have more traditional folks joining the parade. It also points out what may be differences in goals for those who are in accumulation phases rather than preservation ones.

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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

I would suspect that authors are constantly putting out new stuff and stuff that appears to "account for the current environment" because that is what authors do. What is a writer to do when people are relying on their advice and those people take into their heads that something has changed in a big way. "Nothing new to see here" does not sell books.

The reading to look for would be the analysis before the fact of how one might respond to different hypothetical circumstances should they materialize. Can anyone cite some examples? I do know that Larry Swedroe had made some comments about TIPS regarding switching between real and nominal bonds or across duration of TIPS depending on real rates. That is a pretty narrow set of advice.

Also, the scheme of need, ability, and willingness to take risk could hypothetically result in a changing investment choice if one has a different estimate of expected return for duration of the plan. Whether one should have said changed expectation begs the question. It might be the actual change in that context is to realize that one is going to have to reevaluate objectives, aka need.
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Re: My favorite authors are turning their backs on Bonds

Post by snackdog »

My favorite authors have never mentioned bonds or stocks as far as I know,
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Re: My favorite authors are turning their backs on Bonds

Post by 1210sda »

Isn't one of the concepts of MPT that you should look at portfolio return in total and not at the individual components of the portfolio.

Is this right?
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

1210sda wrote: Mon Jun 07, 2021 8:42 am Isn't one of the concepts of MPT that you should look at portfolio return in total and not at the individual components of the portfolio.

Is this right?
Yes, that is how I understand it as well. Would add volatility, not just returns, but I think that is what you mean.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

snackdog wrote: Mon Jun 07, 2021 8:42 am My favorite authors have never mentioned bonds or stocks as far as I know,
Good one :D

I concur.
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Re: My favorite authors are turning their backs on Bonds

Post by Broken Man 1999 »

Eh, just wait until the next financial crisis and we will see how many people (perhaps even your favorite authors) feel about turning their backs on bonds.

I'm betting they will do a 180 PDQ.

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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

aristotelian wrote: Mon Jun 07, 2021 8:47 am
1210sda wrote: Mon Jun 07, 2021 8:42 am Isn't one of the concepts of MPT that you should look at portfolio return in total and not at the individual components of the portfolio.

Is this right?
Yes, that is how I understand it as well. Would add volatility, not just returns, but I think that is what you mean.
Exactly. It is not just that a portfolio is, well, a portfolio, but also that the descriptive statistics are the volatility of the return and not just the return as well as what relationship might exist between the two.

Statistically if you fall back on simplifying assumptions such as normal distributions, then this comes out in the wash as the normal distribution is defined by its mean and standard deviation. Other distributions might have more or fewer than two parameters.

In any case, aside from theory, no practical investor is going to ignore risk. Here on this forum the idea that one should understand one's portfolio as a whole and that investment volatility matters is pretty fundamental without having to take the additional step of trying to optimize something. I agree that the optimization step probably does not get a lot of enthusiasm from the general audience here except in the case of safe withdrawal rates, where the agonizing is unending.
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Re: My favorite authors are turning their backs on Bonds

Post by Nicolas »

snackdog wrote: Mon Jun 07, 2021 8:42 am My favorite authors have never mentioned bonds or stocks as far as I know,
Mine have. Mark Twain mentioned them. Gold and Silver mining stocks figured prominently in Roughing It, one of my favorite books by one of my favorite authors.
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Re: My favorite authors are turning their backs on Bonds

Post by Devil's Advocate »

nisiprius wrote: Mon Jun 07, 2021 8:27 am With regard to MPT there is an obvious fact that should be noted.

Disclaimer: I'm staying within the usual frame of reference for MPT, including concepts that can be challenged.

If the return of stocks, bonds, and the riskless asset all decline by the same amount, then the optimum portfolio allocation does not change. The efficient frontier and capital market line look just the same as before. Everything slides down the same amount on the Y axis, and the tangent line kisses the efficient frontier in the same place as before. Even if the return from the riskless asset and bonds goes negative, nothing special happens. The tangent portfolio stays in the same place, and continues to be the optimum. Which in this case is the least of an efficient frontier of evils.

Allocation is based on the relative performance of stocks, bonds, and cash. Sure, if the spread between the return of stocks and bonds widens--bonds pay less but stocks stay the same--MPT will say to allocate less to bonds and more to stocks. If bonds don't pay any more than bank accounts, MPT will say to put nothing in bonds and to divide your portfolio between stocks and cash.

But if their relative relationship to each doesn't change, the absolute returns don't matter.

Just because you don't like the optimum portfolio doesn't necessarily mean there must be something better. And the idea that there must be something better can be used to exploit investors into fooling around after strange assets.
Thank you Nisi. Another great post.

This argument seems very plausible and I will continue to stay the course. Holding my nose if bonds real return is less than zero. But once again, bonds are for preserving wealth, not for growing it.

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Re: My favorite authors are turning their backs on Bonds

Post by Nahtanoj »

I’m looking forward to reading this new edition to see what Ellis has to say about bonds.

But in earlier editions he seemed to link the bond allocation to when the invested money would be needed - saying, for example, that any money that wouldn’t be needed in the next ten years should be in equities. Note: *not* that money needed in less than ten years should be in fixed income - he seemed to leave open the possibility that some part of the money needed in less than 10 years could be in equities, too.

Ellis gave an interview recently (I can’t remember where) in which he again linked the fixed income allocation to time horizon — moving up from money needed in the next couple of years, which would be put in very safe fixed income and/or cash, all the way out to seven or eight years, where you could hear the hesitation in his voice and he confirmed that maybe, maybe, you might want to consider putting that money in fixed income, too.

So it does sound as if there may have been a bit of a shift, and I will be interested in reading the new edition to get the details.
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Re: My favorite authors are turning their backs on Bonds

Post by AlohaJoe »

aristotelian wrote: Mon Jun 07, 2021 7:47 am
AlohaJoe wrote: Mon Jun 07, 2021 12:49 am
Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Can you explain this statement and/or point to threads on the topic? My understanding of Modern Portfolio is very much consistent with what I know of the Bogleheads approach. Don't take risk unless compensated with higher expected return, seek diversification through non-correlated assets, maximize returns relative to risk. What is bunk about that?
MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates. From Markowitz's paper
The second stage starts with the relevant beliefs about future performances and ends with the choice of portfolio. This paper is concerned with the second stage.
All you have to do is look at any thread on Bogleheads about future performance to find that the standard Boglehead response is to scoff at expected returns and say "nobody knows nothing" ... even though they are the foundation of MPT. Likewise, no Boglehead actually performs mean-variance optimization (i.e. what MPT actually is, what Markowitz actually wrote) to select their portfolio. Maybe 20 years ago Vanguard Diehards who read William Bernstein's early articles were excited about MPT and mean-variance optimization (which probably explains all the slice-and-dice from back then) but that died out a long time ago.

A 2013 Bogleheads thread on MPT has a reply that says
In the past there were a number of posts about portfolio optimization. People building spreadsheets and models. I haven't seen any discussions recently.

The problem is the the correlations between asset classes change over time and the markets tend to move together when things head South. Optimizers are good for telling you what you should have done in the past, not as accurate at telling you where to go now.
At the time Nisiprius said "MPT devotees simply substitute "chasing correlations" for "chasing performance."" and called MPT "garbage in, garbage out". Nedsaid agreed.

A 2009 Bogleheads thread on MPT has Valuethinker saying "they tend to weight your portfolio to what last did well" and Adrian Nenu called it "basically worthless". Rodc said "worthless might be an over-statement, but the value, if any, is very limited".

This is what MPT says the optimal portfolio was, as of Q2 2019:

Image

What Boglehead has a portfolio like that?
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

AlohaJoe wrote: Mon Jun 07, 2021 9:13 am
What Boglehead has a portfolio like that?
At one point my 401k included the service of running Financial Engines for fund selection advice and asset allocation. I remember running that a few times and getting just absolutely bizarre distributions selected and completely different recommendations from one time to the next. This was the evident over specification and lack of stability of mean variance methods.
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Re: My favorite authors are turning their backs on Bonds

Post by mikejuss »

Broken Man 1999 wrote: Mon Jun 07, 2021 8:56 am Eh, just wait until the next financial crisis and we will see how many people (perhaps even your favorite authors) feel about turning their backs on bonds.

I'm betting they will do a 180 PDQ.

Broken Man 1999
+1.
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Re: My favorite authors are turning their backs on Bonds

Post by Random Walker »

BogleBuddy12 wrote: Sun Jun 06, 2021 11:09 pmShould the current interest rate environment be changing the “timeless strategies” we have relied on, namely the 60/40 portfolio?
Ellis’ book has been one of my all time favorites. I’ve read two editions and will definitely read this one. The most “timeless strategy” of all is diversification. It is highly valuable to view diversification in terms of unique and independent sources of risk rather than just number of stocks or stocks versus bonds. I would say the current interest rate environment is simply a reminder to diversify as broadly as possible across unique sources of risk, not avoid bonds all together or time maturities.

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Re: My favorite authors are turning their backs on Bonds

Post by Da5id »

Broken Man 1999 wrote: Mon Jun 07, 2021 8:56 am Eh, just wait until the next financial crisis and we will see how many people (perhaps even your favorite authors) feel about turning their backs on bonds.

I'm betting they will do a 180 PDQ.

Broken Man 1999
Yep. And from bogleheads the "bonds are terrible, everyone should be 100% US stocks" type threads will likewise vanish, as presumably will the GME and AMC style threads.
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Re: My favorite authors are turning their backs on Bonds

Post by Random Walker »

AlohaJoe wrote: Mon Jun 07, 2021 12:49 am Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Why would Bogleheads think MPT is bunk? The basic principles of mixing less than perfectly correlated assets in a portfolio seems rock solid and timeless to me.

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Re: My favorite authors are turning their backs on Bonds

Post by mikejuss »

Da5id wrote: Mon Jun 07, 2021 9:39 am
Broken Man 1999 wrote: Mon Jun 07, 2021 8:56 am Eh, just wait until the next financial crisis and we will see how many people (perhaps even your favorite authors) feel about turning their backs on bonds.

I'm betting they will do a 180 PDQ.

Broken Man 1999
Yep. And from bogleheads the "bonds are terrible, everyone should be 100% US stocks" type threads will likewise vanish, as presumably will the GME and AMC style threads.
What about the threads where people ask if taking out a personal loan or a loan against the value of their house to invest in stocks is a good idea? I hope those go too. :mrgreen:
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Re: My favorite authors are turning their backs on Bonds

Post by AlohaJoe »

Random Walker wrote: Mon Jun 07, 2021 9:41 am
AlohaJoe wrote: Mon Jun 07, 2021 12:49 am Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Why would Bogleheads think MPT is bunk? The basic principles of mixing less than perfectly correlated assets in a portfolio seems rock solid and timeless to me.

Dave
That's not what MPT is. The investors at Lloyds of London figured out hundreds of years ago to mix non-correlated assets. Nothing modern about it.

Open up Markowitz's paper. It has a lot of math. His 350+ page book Portfolio Selection has even more math. That's what MPT is.
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

AlohaJoe wrote: Mon Jun 07, 2021 9:13 am MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates.
The fact that people "knew about diversification" long before 1952 has no bearing on seismic shift that resulted from the insight that Markowitz published.

Before Markowitz there was no coherent formal theory which guided portfolio construction. Portfolio construction was essentially just a matter of doing security analysis to identify assets with high expected returns and then putting them together. The concept of diversification certainly existed, but only in a vague way.

The "theory" part of "modern portfolio theory" is the insight that investors care (or should care) only about the risk and return of the whole portfolio and not merely the risk and return of each individual asset.

And while mean-variance analysis was also described by Markowitz, primarily as a model for implementing the insights provided by MPT, it is distinct enough that it must be treated separately. This is largely because, being a model, mean-variance analysis depends upon some key assumptions that do not literally hold true in the real world. Nonetheless, MVA remains surprisingly useful and predictive despite its highly simplified nature.

We've seen many refinements to the mean-variance model over the past 70 years, but the core insight of modern portfolio theory remains as true and relevant as always.
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Re: My favorite authors are turning their backs on Bonds

Post by BolderBoy »

Devil's Advocate wrote: Mon Jun 07, 2021 8:59 amBut once again, bonds are for preserving wealth, not for growing it.
This is the key point when one cuts through all the anti-bond noise.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

Random Walker wrote: Mon Jun 07, 2021 9:41 am
AlohaJoe wrote: Mon Jun 07, 2021 12:49 am Anyway, the 60/40 portfolio was a result of Modern Portfolio Theory in the 1950s ... and Bogleheads nowadays mostly think MPT is bunk. So it is a little weird to be fixated on a result from a theory you think is BS. After all, I'm pretty sure you ignore the current results of running an MPT analysis. Why ignore the 2021 results by stand by the 1952 results?
Why would Bogleheads think MPT is bunk? The basic principles of mixing less than perfectly correlated assets in a portfolio seems rock solid and timeless to me.

Dave
Probably for posters on this forum it is not a question of the theory being bunk so much as not seeing the method as being significantly helpful. They don't do it in order to consider the portfolio as a whole. I think a lot of investors here don't arrive at an asset allocation by thinking about the risk and return of their portfolio but rather prefer to divide it up so they can view some collection of assets as safe and others as chances to get rich. That applies whether it is a retiree keeping x years in "safe" assets or a young investor who eschews bonds because "they don't return anything."

The other most common stop on the path is to seek a rule for asset allocation, such as age in bonds, or to defer the whole question to Vanguard and buy a Target Date fund. It is common in 401k offerings these days to try to take asset selection and allocation out of the hands of plan participants by pushing them into TD funds.

They also don't do it with the idea of optimizing mean variance or anything else. A problem is that the utility functions chosen may not be perceived as relevant or actionable.

Probably the living example of portfolio optimization that is meaningful to most posters here is the portfolio that optimizes safe withdrawal rate, especially if there is an asset allocation glide path that defeats that supposed demon of sequence of returns risk. Unfortunately the inputs that most affect SWR, namely withdrawal rate, expected time span, and luck of when you start don't involve portfolio design. Of course the standing academic position on that is that retirement spending should be funded by using the assets to buy an annuity, so it is not a portfolio problem at all. When we had Financial Engines access in our 401k and you wanted to consider the best allocation in retirement that problem was not available in the tool because the endpoint of accumulation was assumed to be purchase of an annuity.
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Re: My favorite authors are turning their backs on Bonds

Post by BolderBoy »

mikejuss wrote: Mon Jun 07, 2021 9:42 am
Da5id wrote: Mon Jun 07, 2021 9:39 am
Broken Man 1999 wrote: Mon Jun 07, 2021 8:56 am Eh, just wait until the next financial crisis and we will see how many people (perhaps even your favorite authors) feel about turning their backs on bonds.

I'm betting they will do a 180 PDQ.

Broken Man 1999
Yep. And from bogleheads the "bonds are terrible, everyone should be 100% US stocks" type threads will likewise vanish, as presumably will the GME and AMC style threads.
What about the threads where people ask if taking out a personal loan or a loan against the value of their house to invest in stocks is a good idea? I hope those go too. :mrgreen:
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Re: My favorite authors are turning their backs on Bonds

Post by aristotelian »

AlohaJoe wrote: Mon Jun 07, 2021 9:13 am

MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates. From Markowitz's paper
The second stage starts with the relevant beliefs about future performances and ends with the choice of portfolio. This paper is concerned with the second stage.
All you have to do is look at any thread on Bogleheads about future performance to find that the standard Boglehead response is to scoff at expected returns and say "nobody knows nothing" ... even though they are the foundation of MPT. Likewise, no Boglehead actually performs mean-variance optimization (i.e. what MPT actually is, what Markowitz actually wrote) to select their portfolio. Maybe 20 years ago Vanguard Diehards who read William Bernstein's early articles were excited about MPT and mean-variance optimization (which probably explains all the slice-and-dice from back then) but that died out a long time ago.

A 2013 Bogleheads thread on MPT has a reply that says
In the past there were a number of posts about portfolio optimization. People building spreadsheets and models. I haven't seen any discussions recently.

The problem is the the correlations between asset classes change over time and the markets tend to move together when things head South. Optimizers are good for telling you what you should have done in the past, not as accurate at telling you where to go now.
At the time Nisiprius said "MPT devotees simply substitute "chasing correlations" for "chasing performance."" and called MPT "garbage in, garbage out". Nedsaid agreed.

A 2009 Bogleheads thread on MPT has Valuethinker saying "they tend to weight your portfolio to what last did well" and Adrian Nenu called it "basically worthless". Rodc said "worthless might be an over-statement, but the value, if any, is very limited".

This is what MPT says the optimal portfolio was, as of Q2 2019:

Image

What Boglehead has a portfolio like that?
Ah, if that is what is meant by MPT I would agree it is overly specific. I think most people have a broader understanding beyond that particular article. If we are talking about the same thread, I see posters taking issue with some specific implications drawn from MPT but nothing really against the theory itself. I still see people using efficient frontier and combining non correlated risk assets to maximize overall return relative to risk. Even if those are "vague bromides" they were new to me and I still find them helpful.
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Re: My favorite authors are turning their backs on Bonds

Post by Seasonal »

Modern Portfolio Theory was started by Harry Markowitz in 1952. The core concept of a trade-off between risk and expected return is timeless. Otherwise, it's not really current, especially the idea that volatility equals risk (and mean-variance optimizing).
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Re: My favorite authors are turning their backs on Bonds

Post by 1210sda »

vineviz wrote: Mon Jun 07, 2021 10:03 am
AlohaJoe wrote: Mon Jun 07, 2021 9:13 am MPT isn't a bunch of vague bromides. People knew about diversification thousands of years ago. MPT is a mathematical optimization technique that requires asset correlation matrices, expected future variance estimates, and expected future returns estimates.
The fact that people "knew about diversification" long before 1952 has no bearing on seismic shift that resulted from the insight that Markowitz published.

Before Markowitz there was no coherent formal theory which guided portfolio construction. Portfolio construction was essentially just a matter of doing security analysis to identify assets with high expected returns and then putting them together. The concept of diversification certainly existed, but only in a vague way.

The "theory" part of "modern portfolio theory" is the insight that investors care (or should care) only about the risk and return of the whole portfolio and not merely the risk and return of each individual asset.

And while mean-variance analysis was also described by Markowitz, primarily as a model for implementing the insights provided by MPT, it is distinct enough that it must be treated separately. This is largely because, being a model, mean-variance analysis depends upon some key assumptions that do not literally hold true in the real world. Nonetheless, MVA remains surprisingly useful and predictive despite its highly simplified nature.

We've seen many refinements to the mean-variance model over the past 70 years, but the core insight of modern portfolio theory remains as true and relevant as always.
Thanks vineviz. You are always able to eloquently put these concepts into understandable language.
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Re: My favorite authors are turning their backs on Bonds

Post by Vanguard Fan 1367 »

Because of Malkiel and Ellis I have a higher Stock to Bond Ratio. So far I am smelling like a rose. We shall see what happens.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

I think for relevance to Boglehead the framing in MPT is important. What I mean by that is it is important to conceive of investment returns as a random (or not so random) variable sample from a distribution and that the mean and standard deviation of that distribution is what we want to attend to when we pick investments. The step to a portfolio is to recognize that the statistics of the portfolio will be related to the statistics of the component assets.

What is weird about this every time I look at it is that if one has a collection of data points, such as the returns in a series or years, and one regards them statistically then one naturally computes things such as the average, the standard deviation, and so on. One my even go so far as to attempt to discern one of the standard mathematical distributions as a fit for the data. Where weird starts is when one names the average return as "the" return, and the standard deviation as the "risk."* And it is right there that you enter a specialist world of jargon where it is no longer clear that the discussion has anything to do with the typical individual investor.

And yet it has lots to do with the individual investor because this model tells you that investing is at least as complicate as this model if not more complicated. It tells you that you cannot expect the expected return. It tells you that past results do not predict future results (but in a very nuanced sense). It tells you that you cannot determine how much you can withdraw from a portfolio over time by simply running out a fixed interest amortization. It tells you that short term risk has long term consequences, and so on.

I think that the important step a beginning investor should take is to grasp the underlying statistical nature of the subject.

*As to risk, there is nothing wrong with accepting nomenclature. Obviously for a variable phenomenon the variability as well as the mean behavior is important. Disputing what the name is has no relevance. The whole discussion is still just about return and the properties of return.

"Risk" in a general sense is not a complete expression. It should be "risk of x" where x is something we care about, usually to avoid it. That might be risk of losing a certain amount of money in a year, or the risk of not meeting an objective, or the risk of a retirement portfolio running out of money too soon. The irony is that many of those things actually are related to and can be calculated from risk as defined in investing.
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Re: My favorite authors are turning their backs on Bonds

Post by sycamore »

dbr wrote: Mon Jun 07, 2021 8:03 am The idea that bonds are held in order to get income makes no sense and never did.
I'm coming in late to this thread but the above sentence doesn't seem right. People have been investing in bonds for centuries to get income. Were they all doing something nonsensical? Am I just missing what was meant?

(emphasis mine below)
From Bogleheads wiki :
Bonds are typically used by investors to stabilize the value of a portfolio and/or produce a stream of income.
From Vanguard: What is a bond? A way to get income & stability.

From investor.gov: Why do people buy bonds?
Investors buy bonds because:

- They provide a predictable income stream. Typically, bonds pay interest twice a year.
- If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
- Bonds can help offset exposure to more volatile stock holdings.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

sycamore wrote: Mon Jun 07, 2021 11:46 am
dbr wrote: Mon Jun 07, 2021 8:03 am The idea that bonds are held in order to get income makes no sense and never did.
I'm coming in late to this thread but the above sentence doesn't seem right. People have been investing in bonds for centuries to get income. Were they all doing something nonsensical? Am I just missing what was meant?

(emphasis mine below)
From Bogleheads wiki :
Bonds are typically used by investors to stabilize the value of a portfolio and/or produce a stream of income.
From Vanguard: What is a bond? A way to get income & stability.

From investor.gov: Why do people buy bonds?
Investors buy bonds because:

- They provide a predictable income stream. Typically, bonds pay interest twice a year.
- If the bonds are held to maturity, bondholders get back the entire principal, so bonds are a way to preserve capital while investing.
- Bonds can help offset exposure to more volatile stock holdings.
Yes, you are right and I should retract that in part. Historically investors did not have transaction cost free and more or less instantaneous means to extract payments from an investment to match the certainty and convenience of collecting coupon payments from a bond. Today market transaction technology and the development of mutual funds which allow people to hold entire portfolios of investments at practically no cost and almost perfect liquidity mean that owning bonds in order to extract income from investments is simply not necessary and usually not even helpful. Other mechanics are probably more convenient and more suitable for today's investor than setting a bond, CD, or whatever allocation for the purpose of extracting cash flow.
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Re: My favorite authors are turning their backs on Bonds

Post by SteadyOne »

Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
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Re: My favorite authors are turning their backs on Bonds

Post by dbr »

SteadyOne wrote: Mon Jun 07, 2021 12:14 pm Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
In withdrawal rate studies the danger of too high volatility and the advantage of higher return offset so that there is a small optimum in portfolio survival at about half of each. However, the loss in being all stocks is not nearly as severe as the loss should one elect too little in stocks while seeking minimum volatility.

Note that from a point of view of the behavior of a portfolio cash is simply part of a continuum of low risk, low return assets that has no special advantage. Gold is more problematic because gold is risky though possibly not very well correlated with stocks. How helpful it might be to own gold is a whole topic.

Probably the unanswered question is what is the purpose of giving up return to reduce the volatility of a portfolio? My own answer is that I just don't want high volatility and I want the impact of any possible extreme events diluted. There is no evidence that supporting my retirement or meeting any other goals is much advanced by having more in stocks or having less in stocks, so I take a moderate course. If someone were to come in tomorrow and somehow force me to sell all my bonds and hold only stocks it would not be the end of the world.
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Re: My favorite authors are turning their backs on Bonds

Post by dogagility »

In practice, perhaps bonds are the new Emergency Fund and not part of one's asset allocation. :twisted:
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Re: My favorite authors are turning their backs on Bonds

Post by vineviz »

SteadyOne wrote: Mon Jun 07, 2021 12:14 pm Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
I often see things like this repeated here, but it's (mostly) not true.

Reducing portfolio volatility is not the purpose of bonds. The purpose of bonds (from the perspective of the investor, at least) is to obtain a predictable stream of income or cash flows.

One effect of including bonds in the portfolio is that it USUALLY reduces portfolio volatility, but this is a byproduct and not generally the actual goal.
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Re: My favorite authors are turning their backs on Bonds

Post by NoRegret »

dbr wrote: Mon Jun 07, 2021 12:32 pm
SteadyOne wrote: Mon Jun 07, 2021 12:14 pm Purpose of bonds is to decrease volatility of the portfolio. This is especially important at the withdrawal phase as you do not want to sell stocks at the bottom. Alternatives are cash and gold I guess.
In withdrawal rate studies the danger of too high volatility and the advantage of higher return offset so that there is a small optimum in portfolio survival at about half of each. However, the loss in being all stocks is not nearly as severe as the loss should one elect too little in stocks while seeking minimum volatility.

Note that from a point of view of the behavior of a portfolio cash is simply part of a continuum of low risk, low return assets that has no special advantage. Gold is more problematic because gold is risky though possibly not very well correlated with stocks. How helpful it might be to own gold is a whole topic.

Probably the unanswered question is what is the purpose of giving up return to reduce the volatility of a portfolio? My own answer is that I just don't want high volatility and I want the impact of any possible extreme events diluted. There is no evidence that supporting my retirement or meeting any other goals is much advanced by having more in stocks or having less in stocks, so I take a moderate course. If someone were to come in tomorrow and somehow force me to sell all my bonds and hold only stocks it would not be the end of the world.
The math problem is portfolio value optimization under decumulation. Out of prudence and acknowledging the asymmetry in my own marginal utility function I prefer to optimize for a lower-percentile rather than average or expected outcome. In other words I value certainty over maximizing the average outcome.

If the WR is low enough, a high-growth, high-volatility strategy may still be optimal. However, for most reasonable WRs, volatility really matters. This is where historically the Permanent Portfolio and its variants have shined. Going forward though, potential positive correlation between stocks/bonds are at least as problematic as low and rising bond yields.

I personally have been looking towards tail hedging and timing strategies but they are not for everyone.
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