Is holding bonds now dangerous?

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UncleLongHair
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Is holding bonds now dangerous?

Post by UncleLongHair »

I would like to get a sampling of what people think about investing in bonds in the current environment.

For the past 35 or so years, bond yields have on average declined, which has meant that bonds are both safe in terms of principal/interest and have also appreciated.

However with interest rates near zero and in some cases below zero, it seems that they can only go up. Current yields are also below the historic norms for inflation, with the 10-year treasury just over 2%. It seems that holding any bonds with maturities more than a year or two is a likely way to lose money in real terms. If/when inflation and interest rates increase, you'll be behind the curve in terms of yield, appreciation, and inflation.

In other words, we might be at the end of a 30-40 year bull market in bonds.

Not many people directly buy 10+ year bonds but this comes into play with various balanced funds, target funds, for example Vanguard's 2030 target fund is 28% bonds. If I were to retire in 13 years, I don't think I'd want 28% and an increasing percentage of my assets in bonds that are very likely to lose money in real terms between now and then.

Thoughts?
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Re: Is holding bonds now dangerous?

Post by oldcomputerguy »

What would be your objective in holding bonds -- additional gain, or safety in a downturn? If the former, your position might be correct. However, I hold them to provide ballast in case of an equity downturn, and I don't really see that changing all that much.
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Re: Is holding bonds now dangerous?

Post by dwickenh »

I would prefer to think that every person living off of their portfolio(at least as an addition to SS and pension) would be in danger if not holding some bonds. If in the early accumulation phase, bonds are not necessary to bolster the portfolio in a down stock market as there are no withdrawals. It is actually an advantage to keep buying stocks if your stomach allows it during a down market during the accumulation phase.

This horse has been ridden into the ground with posts and the answer appears to always be the same. "Nobody knows nuthin".

I have 50% of my assets in bonds and cash so I speak from having skin in the game.

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Re: Is holding bonds now dangerous?

Post by retiredjg »

In my opinion, holding bonds is not dangerous. The fact that we are in a period of low interest rates does not change the fact that a portfolio needs to have some fixed income assets. In fact, a portfolio without fixed income assets cannot properly be considered "diversified".

If you don't like bonds or bond funds, use CDs.

Fixed income assets are not in your portfolio for high returns. They are in your portfolio for stability. And for those times, even decades, when bonds pay more than stocks. Not holding bonds (or a substitute) because they are acting like bonds act seems unwise to me.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

Playing devil's advocate a bit, current 10 year treasury yields are around 2.3% whereas the S&P index dividend yield is 1.9%. The bond principal and yield is certain never to change over 10 years, whereas the principal and yield on the S&P is likely to increase over the same 10 years.

The "rules" of diversification and safety were developed during the past 30-40 years during which an entire generation of investors views bonds as safe and secure, and both paying an adequate yield and at least treading water in terms of appreciation and inflation. Portfolios are supposed to be diversified because they're supposed to be diversified, but why diversify into investments that are certain to lose money?

In the current environment, there is little difference in yield between bonds, CD's, cash and so it doesn't seem like there is any reason to hold any fixed-income investments with a maturity of longer than a few months.
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Re: Is holding bonds now dangerous?

Post by Tycoon »

I guess it depends on which bonds one is holding. Argentina bonds? I might consider those risky.
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Re: Is holding bonds now dangerous?

Post by jebmke »

I set our allocation at 40/60 (60% bonds) when I retired 10 years ago. I haven't changed it and don't intend to change it now.
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Re: Is holding bonds now dangerous?

Post by retiredjg »

UncleLongHair wrote: Sat Nov 18, 2017 7:20 am Portfolios are supposed to be diversified because they're supposed to be diversified, but why diversify into investments that are certain to lose money?
Because it is good to wear your seat belt all the time instead of just the days you think you are going to have a wreck?

Because what other choice do you have to stabilize a portfolio?

Because sometimes bonds are the only thing in your portfolio making any money?

Because if you consider diversification a good thing, you should not avoid doing it just when one or the other asset class is having a poor showing?
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Re: Is holding bonds now dangerous?

Post by KlangFool »

UncleLongHair wrote: Sat Nov 18, 2017 7:20 am Playing devil's advocate a bit, current 10 year treasury yields are around 2.3% whereas the S&P index dividend yield is 1.9%. The bond principal and yield is certain never to change over 10 years, whereas the principal and yield on the S&P is likely to increase over the same 10 years.
UncleLongHair,

If that is true, don't you think that the bond issuer knows this too. And, they would have priced and issued their bonds accordingly. Then, the price and yield of the current bond reflect this reality. Please note that the expectation is priced into current stock and bond. Only if the unexpected happened, then, the price will change drastically.

Even let assume what you say is true, the detail matters. Are we talking about a slow interest rate going up every year? In that case, the bond's yield and the price will adjust slowly. Only a sudden and unexpected interest rate hike may matters.

Please note that if I can forecast and know any single of this event, I will be rich. But, I know that I know nothing. So, I stick with my current AA. If I am nervous enough, I will buy some gold coins to further diversify my assets.

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Re: Is holding bonds now dangerous?

Post by sschullo »

Dangerous? This topic of a bond bull market Armageddon has been discussed here and on the financial media for years now.
I have 68% bond portfolio. If all of the negative prognosticators come true, I would lose value in my portfolio, of course. However, I have A or better rated and have intermediate maturity bonds which means I would welcome higher interest rates as the Total Bond Market index would have completed their selling of mature low-interest paying bonds and buying higher interest bonds in about 7 years. Like equities, I buy and hold my diversified portfolio of bonds: domestic, international, iBonds, Treasuries, and Corporate. I am about as prepared as can be for a bond sell-off, and/or an equity sell-off.
Last edited by sschullo on Sat Nov 18, 2017 7:45 am, edited 1 time in total.
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Re: Is holding bonds now dangerous?

Post by z3r0c00l »

Safe bonds are not dangerous, inflation may be however. A valid question is if safe bonds will beat inflation going forward.
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Re: Is holding bonds now dangerous?

Post by aristotelian »

Stocks are a much bigger risk for negative real return and with much bigger downside. If you want to time the market, you could hold short term bonds. Or, if you find principal loss to be unacceptable, you could hold individual bonds.
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Re: Is holding bonds now dangerous?

Post by Valuethinker »

UncleLongHair wrote: Sat Nov 18, 2017 6:56 am I would like to get a sampling of what people think about investing in bonds in the current environment.

For the past 35 or so years, bond yields have on average declined, which has meant that bonds are both safe in terms of principal/interest and have also appreciated.

However with interest rates near zero and in some cases below zero, it seems that they can only go up. Current yields are also below the historic norms for inflation, with the 10-year treasury just over 2%. It seems that holding any bonds with maturities more than a year or two is a likely way to lose money in real terms. If/when inflation and interest rates increase, you'll be behind the curve in terms of yield, appreciation, and inflation.

In other words, we might be at the end of a 30-40 year bull market in bonds.

Not many people directly buy 10+ year bonds but this comes into play with various balanced funds, target funds, for example Vanguard's 2030 target fund is 28% bonds. If I were to retire in 13 years, I don't think I'd want 28% and an increasing percentage of my assets in bonds that are very likely to lose money in real terms between now and then.

Thoughts?
I have moved a lot of money from stocks into bonds in the last few months.

Holding stocks is a lot more dangerous than holding bonds, at this point. I would take a -10% return on the former, against a -50% return on the latter.
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Re: Is holding bonds now dangerous?

Post by ruralavalon »

We hold Vanguard Intermediate-term Bond Index Fund Admiral Shares (VBILX) and are not concerned. Our asset allocation is 50% bonds.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

If that is true, don't you think that the bond issuer knows this too. And, they would have priced and issued their bonds accordingly. Then, the price and yield of the current bond reflect this reality. Please note that the expectation is priced into current stock and bond. Only if the unexpected happened, then, the price will change drastically.
Well the bond issuers do not have control over interest rates, and in the case of the US Treasury, are obligated to issue bonds at prevailing interest rates and the bonds are bought and sold on that basis too. So if you buy 10 year treasury bonds today you get today's interest rate even if it is low. If rates increase, your bond will be paying a below-market rate and thus would sell for less than you paid for it.
Even let assume what you say is true, the detail matters. Are we talking about a slow interest rate going up every year? In that case, the bond's yield and the price will adjust slowly. Only a sudden and unexpected interest rate hike may matters.
Say you buy 2% bonds today and 2 years from now rates are 4%. Your bond that you paid $1000 for will probably be worth something like $950, and everyone else buying bonds will be getting a 4% yield. Cash savings accounts will probably also pay more than 2%, and if inflation is 2% or more, you will lose money on inflation-adjusted basis. In other words, the "safe" bond that you bought is actually losing you money.
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Re: Is holding bonds now dangerous?

Post by BolderBoy »

UncleLongHair wrote: Sat Nov 18, 2017 6:56 amIn other words, we might be at the end of a 30-40 year bull market in bonds.
Didn't bond guru Bill Gross lose his job by making such a bet?

The key word in your statement = "might". The word "might" must include "might not".

Nobody knows...
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Re: Is holding bonds now dangerous?

Post by livesoft »

In the current environment, I think holding bonds is the same as it ever was. Bonds that are marked to market and bond funds go up and down like they always have and like they always will.

I see that Fed Fund rate hikes through June 2018 are already thought to be priced into the prices of bonds. Also I see that bond funds were up quite a bit this past week.

So I have no qualms about purchasing additional shares of bond funds whenever I follow my Investing Policy Statement. And indeed, the only time I have to think about bond funds is when I am answering questions such as those posed in this thread. Otherwise, there is not much to think about.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go. And bonds have an extremely simple relationship with interest rates. Rates go up, bonds go down in value, and vice versa. This isn't about making a prediction but just arithmetic. The only situation in which bonds don't lose money in real terms going forward is if both rates and inflation remain at zero for the long term which has never happened in history.
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Re: Is holding bonds now dangerous?

Post by livesoft »

The interest rate arithmetic that you allude to is kinda funny, isn't it? FFR went up 3 times in the past 12 months, but bond funds still went up in value. What's up with that? :)
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Re: Is holding bonds now dangerous?

Post by midareff »

UncleLongHair wrote: Sat Nov 18, 2017 10:17 am
Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go. And bonds have an extremely simple relationship with interest rates. Rates go up, bonds go down in value, and vice versa. This isn't about making a prediction but just arithmetic. The only situation in which bonds don't lose money in real terms going forward is if both rates and inflation remain at zero for the long term which has never happened in history.
Interest rates are not at zero and since the Fed raised rates three times recently they could just as easily go down three or more times. Arithmetic is easy but you need to tell the markets to follow your arithmetic. ALL of my bond funds covering taxable and tax advantaged space produced positive REAL returns over a rolling 12 month CPI-U of 2.05% YTD.
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Re: Is holding bonds now dangerous?

Post by jebmke »

UncleLongHair wrote: Sat Nov 18, 2017 10:17 am
Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go. And bonds have an extremely simple relationship with interest rates. Rates go up, bonds go down in value, and vice versa. This isn't about making a prediction but just arithmetic. The only situation in which bonds don't lose money in real terms going forward is if both rates and inflation remain at zero for the long term which has never happened in history.
What would you invest in instead? In another thread you weren't too keen on equity given the current valuations.
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Re: Is holding bonds now dangerous?

Post by bikechuck »

UncleLongHair wrote: Sat Nov 18, 2017 10:17 am
Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go. And bonds have an extremely simple relationship with interest rates. Rates go up, bonds go down in value, and vice versa. This isn't about making a prediction but just arithmetic. The only situation in which bonds don't lose money in real terms going forward is if both rates and inflation remain at zero for the long term which has never happened in history.
I think this is correct and is possibly why in a recent article or post Wade Pfau advocates that retirees hold annuities rather than bonds. I have seen others that I respect advocate for CDs instead of bonds.

In my case I am using TIAA traditional (currently paying 4%) and a fixed annuity with another insurance co, (which I have not annuitized) that pays a guaranteed minimum 4.5% as bond substitutes for approx 2/3 of my fixed income investments. The rest of the fixed portion of my portfolio is in traditional mid term bond funds. At some point I might annuitize my TIAA or fixed annuity but I will likely wait until my wife and I are in our 70s and hopefully interest rates are higher before doing so. If everything starts going to Hell I might annuitize sonner.
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Re: Is holding bonds now dangerous?

Post by BolderBoy »

UncleLongHair wrote: Sat Nov 18, 2017 10:17 am
Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go.
While it is a common refrain, interest rates have at least two ways to go: horizontal being one of them.
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Re: Is holding bonds now dangerous?

Post by nisiprius »

Let me state this very precisely.

For me, "holding bonds" means holding a "core" bond fund--meaning a diversified fund that holds only investment-grade bonds, and no longer than intermediate-term on average. Vanguard Total Bond Market Index Fund is an example of such a fund; there are many others.

For me, "dangerous" means "subject to a sudden decline in value that is so big that it would require a wrenching downward readjustment of our retirement plans."

By that definition: I think that holding bonds is not dangerous.

If you define "dangerous" to mean "having a chance that some cleverer investor could beat your results," then, gee, I dunno. Maybe, but I don't care. It's not about bragging or ego, it's about living off our money.

As for "now," I can look to the past at many examples of bad times in the bond market, including cases where people made warnings that came true, and none of them amount to enough to scare me.

This chart, for example, includes several very different "core" bond funds. Blue is one of the ones I hold, Vanguard Total Bond Market Index Fund, VBMFX. Orange is the famous PIMCO Total Return, once the biggest mutual fund, of any kind, in the world. Dodge & Cox Income Fund, DODIX, is in there because I don't know it and haven't charted it before... it has $50 billion in assets.

Source
Image

Here's my point. Here are some of the events included in this time period.
  • The "bond bubble," as it was called after the fact, of 1993, and the "bond massacre" of 1994 that followed it.
  • The period from 2004 to 2006, when the Fed raised the fed funds rate from 1% to 5.25%.
  • The time in August, 2010 when Jeremy Siegel and Jeremy Schwartz warned of a "Great American Bond Bubble" which they said would have worse consequences to investors than the NASDAQ crash of 2000, and the time in 2011 when their interest rate predictions essentially came true, the ten-year rate rising well into the range they warned about.
  • The time in March 2011 when Bill Gross, the then "Bond King," who apparently agreed with Siegel and Schwartz, dumped Treasuries completely, telling CNBC that Treasuries were "mispriced relative to the inflationary environment and the growth we see ahead and there are better alternatives in order to capture yield." The result was that in 2011, for I think the first time in history, PTTRX underperformed Total Bond. The result was described by the press as a disaster to the fund and Bill Gross's reputation and led to a massive outflow from PTTRX and eventually Gross's departure.
The point is that you can see each of these events on the chart if you know where to look for them--and not one of them was scary to me, at the time or in retrospect. For example, Bill Gross's "Error--centerfield." Morningstar's charts are weird, 2011 is the part of the chart just after the line marked 2010. This is the time when owners of PTTRX, the orange line, experienced the horrible results of Gross's catastrophic error. It just doesn't look like much of a problem to me.

In 2009, a poster in this forum wrote
I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit. So isn't it wise to go short in this environment where rates can only go up?
People have been saying that for eight years now. They have even talked of disaster "when rates eventually go up," unaware that rates had actually been going up!

I've been trying unsuccessfully to make sense of the disconnect between all of the shrill warnings of doom and nothing much happening. The best I can make of it is that in the world of Wall Street, people, seeing the relative reliability and low risk of bonds, customarily build complex cathedrals of exquisitely balanced, arbitraged, leveraged positions in bonds, with flying buttresses of derivatives holding the arch together. They count on their behaving with high-precision predictability; and a tiny shock that people in stone houses don't even notice, causes a little crack in the flying buttresses that bring the cathedral down. If it's not something like that, I don't know what it is.
Last edited by nisiprius on Sat Nov 18, 2017 11:06 am, edited 1 time in total.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

The relationship between yield and bonds is pretty straightforward, this isn't something that I made up, it is taught in freshman finance and is the basis of fixed income markets worldwide. Surprised this is a topic of discussion. Sure over periods of a year or two anything can happen, especially in a bond fund where bonds can be bought and sold and rebalanced. If you think bonds are going to do well if long term rates rise from 2% to 6% then I think you're in for a surprise.

And yes as I noted in another thread I think stocks are very highly valued and we're due for a correction. Timing the market and predicting stock movements is difficult/impossible so I don't want to dwell on that. In my particular case I have a long investment horizon so I don't really care about a bad year or three. If I had barely enough money for a major expense like retirement or college and I was 100% in equities I'd be worried though.

I know it is goring a sacred cow but to me it is just common sense that bonds yielding 2% are going to lose money in economic/real terms over the next 10+ years, and the whole idea that bonds are "safe" was drilled into an entire generation of investors over the past 40 years as bond yields steadily fell, and despite falling still provided a reasonable yield for most of the time.

If you are retired and living off of the income from your bonds and that income is enough to sustain your lifestyle you might not care about any of this. But if you're going to retire in 10-20 years and want to keep your retirement funds "safe" by putting 25-50% of them in bonds I think that will be a big mistake because that portion of your portfolio is going to lose money.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

Interest rates are not at zero
It depends on what rates we're talking about, I tend to focus on 10 year US treasury since that's a common benchmark and core part of bond funds and that indeed is not at zero, currently around 2%. But if you look in Europe you'll find rates of 0% or even negative rates. Pause to consider the semantics of a negative risk-free rate! Savings accounts pay basically zero or close to it. Money market and CD's are slightly better but not really.

Can US Treasuries fall below 2%? Mathematically, yes. Likely? Can this be sustained? For how long?
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Re: Is holding bonds now dangerous?

Post by Tycoon »

UncleLongHair wrote: Sat Nov 18, 2017 10:54 am But if you're going to retire in 10-20 years and want to keep your retirement funds "safe" by putting 25-50% of them in bonds I think that will be a big mistake because that portion of your portfolio is going to lose money.
Respectfully, I disagree.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

For me, "dangerous" means "subject to a sudden decline in value that is so big that it would require a wrenching downward readjustment of our retirement plans."
...
If you define "dangerous" to mean "having a chance that some cleverer investor could beat your results," then, gee, I dunno. Maybe, but I don't care. It's not about bragging or ego, it's about living off our money.
"Dangerous" to me means permanent loss of capital over the long term. Most of us can ignore a market blip of a month, a year, or even a few years. Most of us don't care if the neighbor earns 8% CAGR while we earn 5% CAGR. And depending on your financial station, you might even be able to lose money over the next 20 years and still be happy, but if that is the case we don't really have anything to talk about on a web site about improving your finances. I mean if you have enough cash that you can't spend it for the rest of your life then why bother to invest it or even discuss it.

Where it does matter is if you have money that needs to at least retain if not grow its value over the next 10+ years, such as someone who holds the Vanguard 2030 Target fund, or someone who has just retired at 60 and hopes to live to 80. Generally speaking any investment strategy that is likely to lose you money doesn't sound like a good idea.
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Re: Is holding bonds now dangerous?

Post by UncleLongHair »

Respectfully, I disagree.
That is ok, almost everyone in this thread disagrees with me :). But why? Why is holding bonds for the next 10-20 years to prepare for retirement a good thing?
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Re: Is holding bonds now dangerous?

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Topic moved to Investing - Theory, News & General.
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Re: Is holding bonds now dangerous?

Post by Tycoon »

UncleLongHair wrote: Sat Nov 18, 2017 11:06 am
Respectfully, I disagree.
That is ok, almost everyone in this thread disagrees with me :). But why? Why is holding bonds for the next 10-20 years to prepare for retirement a good thing?
Quite simply because I haven't a clue what bonds, or equities, will do over the next 10-20 years; and holding cash doesn't appeal to me. So I balance my risk by holding bonds and equities in percentages that give me comfort.
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Re: Is holding bonds now dangerous?

Post by Tyler Aspect »

UncleLongHair wrote: Sat Nov 18, 2017 10:54 am The relationship between yield and bonds is pretty straightforward, this isn't something that I made up, it is taught in freshman finance and is the basis of fixed income markets worldwide. Surprised this is a topic of discussion. Sure over periods of a year or two anything can happen, especially in a bond fund where bonds can be bought and sold and rebalanced. If you think bonds are going to do well if long term rates rise from 2% to 6% then I think you're in for a surprise.
For people who are buy and hold investors, the short term effect of net asset value changes are less significant than the long term trend of the coupon rate. This is because in a bond index fund a customer can hold the index fund longer than its average maturity. Higher coupon rate earns you more money over the long term. You can view the effect of the coupon rate change to be in opposition to the change in net asset value. If you only look at the net asset value change, then you are only seeing half of the picture.
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Re: Is holding bonds now dangerous?

Post by WildBill »

UncleLongHair wrote: Sat Nov 18, 2017 11:06 am
Respectfully, I disagree.
That is ok, almost everyone in this thread disagrees with me :). But why? Why is holding bonds for the next 10-20 years to prepare for retirement a good thing?
Howdy

Because the alternatives suck even worse.

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Re: Is holding bonds now dangerous?

Post by birdog »

Tycoon wrote: Sat Nov 18, 2017 11:14 am
Quite simply because I haven't a clue what bonds, or equities, will do over the next 10-20 years; and holding cash doesn't appeal to me. So I balance my risk by holding bonds and equities in percentages that give me comfort.
Yes. This is how I feel as well.
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Re: Is holding bonds now dangerous?

Post by nisiprius »

UncleLongHair wrote: Sat Nov 18, 2017 10:54 am...The relationship between yield and bonds is pretty straightforward, this isn't something that I made up, it is taught in freshman finance and is the basis of fixed income markets worldwide. Surprised this is a topic of discussion. Sure over periods of a year or two anything can happen, especially in a bond fund where bonds can be bought and sold and rebalanced. If you think bonds are going to do well if long term rates rise from 2% to 6% then I think you're in for a surprise...
Well, we can do a simulation. You weren't too specific, but let's say we are talking about a rotating bond ladder with a duration of 6 years, i.e. about the same as Total Bond, under a scenario where the rate that applies to the bonds in the ladder start out at 2% and rise to 6% over a period of four years. The value shown is total value including reinvested bond interest, and assumes that the reinvested interest can be reinvested to buy more of the same portfolio. Bonds are assumed to be bought at issue, at par, and held to maturity.
  • The bond portfolio grows slowly and steadily from $1,000 to $1,231 until the interest rate rises hits.
  • While the interest rate is rising, the portfolio continuously loses value and reaches a minimum $1,138, i.e. a -8% loss.
  • When the interest rate levels off, the portfolio starts to gain again.
  • It makes back the lost ground in about two more years.
  • By about year #18, i.e. 8 years after the start of the interest rate increase, it is ahead of where it would have been if here had been no rate increase.
  • It is now growing faster than it did before the rate increase. If the investor had a time horizon of at least ten years, she is better off than if there had been no rate increase
Image

I think bond funds will do perfectly well under a rise in rates from 2% to 6%, if they are intermediate-term investment-grade bonds and if your holding time is on the order of ten years or so. That isn't to say some other strategy might not do better.
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Re: Is holding bonds now dangerous?

Post by fipt2030 »

aristotelian wrote: Sat Nov 18, 2017 7:47 am Stocks are a much bigger risk for negative real return and with much bigger downside. If you want to time the market, you could hold short term bonds. Or, if you find principal loss to be unacceptable, you could hold individual bonds.
Holding individual bonds sounds better
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Re: Is holding bonds now dangerous?

Post by hoops777 »

UncleLongHair wrote: Sat Nov 18, 2017 11:06 am
Respectfully, I disagree.
That is ok, almost everyone in this thread disagrees with me :). But why? Why is holding bonds for the next 10-20 years to prepare for retirement a good thing?
There is a big difference between 10 and 20 years.Which is it?
Try going 100 pct stocks for 10 years right before you retire and check back and tell us how that worked out.
K.I.S.S........so easy to say so difficult to do.
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Re: Is holding bonds now dangerous?

Post by aristotelian »

fipt2030 wrote: Sat Nov 18, 2017 11:34 am
aristotelian wrote: Sat Nov 18, 2017 7:47 am Stocks are a much bigger risk for negative real return and with much bigger downside. If you want to time the market, you could hold short term bonds. Or, if you find principal loss to be unacceptable, you could hold individual bonds.
Holding individual bonds sounds better
Actually the net result over the period of the bond is likely to be the same. Remember that when the price of a bond fund decreases, its dividend yield increases.
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Re: Is holding bonds now dangerous?

Post by arcticpineapplecorp. »

UncleLongHair wrote: Sat Nov 18, 2017 11:05 am "Dangerous" to me means permanent loss of capital over the long term. Most of us can ignore a market blip of a month, a year, or even a few years. Most of us don't care if the neighbor earns 8% CAGR while we earn 5% CAGR. And depending on your financial station, you might even be able to lose money over the next 20 years and still be happy, but if that is the case we don't really have anything to talk about on a web site about improving your finances. I mean if you have enough cash that you can't spend it for the rest of your life then why bother to invest it or even discuss it.

Where it does matter is if you have money that needs to at least retain if not grow its value over the next 10+ years, such as someone who holds the Vanguard 2030 Target fund, or someone who has just retired at 60 and hopes to live to 80. Generally speaking any investment strategy that is likely to lose you money doesn't sound like a good idea.
have you read William Bernstein's book "Deep Risk"? He defines the difference between shallow and deep risk. He writes about the deep risks (hyperinflation, prolonged deflation, government confiscation of assets, and devastation (wars, geopolitical events, etc.). And he also draws a distinction between risk for younger people and older (or retirees):
Bernstein takes the time to distinguish the between older and younger investors when it comes to the riskiness of your portfolio:

The moral of this exercise is that older savers, with few working years/human capital remaining, will have extreme emotional difficulty maintaining their investment strategy when confronted with the face of potential deep risk; in this case, steering their portfolio by the shallow risk lighthouse and holding a higher percentage of fixed income assets would seem to be the most prudent policy.

And on the other end of the spectrum:

Contrariwise, younger investors should navigate by the deep-risk lighthouse. After all, their best case scenario deploys their investment capital at low prices – assuming they keep their jobs through the hard times.

source: http://awealthofcommonsense.com/2014/04 ... tein-risk/
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Re: Is holding bonds now dangerous?

Post by aristotelian »

UncleLongHair wrote: Sat Nov 18, 2017 11:06 am
Respectfully, I disagree.
That is ok, almost everyone in this thread disagrees with me :). But why? Why is holding bonds for the next 10-20 years to prepare for retirement a good thing?
I currently hold 25% in fixed income because I do not want to put my entire portfolio at risk of a 2008 (or worse) scenario. A 70/30 portfolio is thought to produce approximately 90% of the return of a 100/0 portfolio but with much less volatility. If you can accept the volatility, many people go 100% stock and you can do so at your own risk.
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Re: Is holding bonds now dangerous?

Post by whodidntante »

Of course it's risky. You could realistically lose 10% holding TBM, or 50% holding TSM. Both events are unlikely to occur in a given year, but it's realistic. Avoid holding EM bonds, junk bonds, individual bonds (other than treasury/TIPS, etc.), long bonds, and bond funds that use derivatives, leverage, and other tricks to juice returns. Then you could lose much more than 10%.
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Re: Is holding bonds now dangerous?

Post by jebmke »

fipt2030 wrote: Sat Nov 18, 2017 11:34 am
aristotelian wrote: Sat Nov 18, 2017 7:47 am Stocks are a much bigger risk for negative real return and with much bigger downside. If you want to time the market, you could hold short term bonds. Or, if you find principal loss to be unacceptable, you could hold individual bonds.
Holding individual bonds sounds better
Individual bonds can also lose value.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
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Re: Is holding bonds now dangerous?

Post by tibbitts »

UncleLongHair wrote: Sat Nov 18, 2017 7:20 am Playing devil's advocate a bit, current 10 year treasury yields are around 2.3% whereas the S&P index dividend yield is 1.9%. The bond principal and yield is certain never to change over 10 years, whereas the principal and yield on the S&P is likely to increase over the same 10 years.

The "rules" of diversification and safety were developed during the past 30-40 years during which an entire generation of investors views bonds as safe and secure, and both paying an adequate yield and at least treading water in terms of appreciation and inflation. Portfolios are supposed to be diversified because they're supposed to be diversified, but why diversify into investments that are certain to lose money?

In the current environment, there is little difference in yield between bonds, CD's, cash and so it doesn't seem like there is any reason to hold any fixed-income investments with a maturity of longer than a few months.
I have some sympathy for your position, and like that you're saying we're overly basing recommendations on 30-40 years, until you run off the rails with thinking the S&P is likely to increase over the same 10 years when bonds will return nothing. I see no reason to think that - I'd say losses in the S&P over, say, fifty year periods will be a non-event once we accumulate thousands of years of S&P history, by which time I'm guessing many less pleasant scenarios will have played out.
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Re: Is holding bonds now dangerous?

Post by Seasonal »

nisiprius wrote: Sat Nov 18, 2017 11:32 amWell, we can do a simulation. You weren't too specific, but let's say we are talking about a rotating bond ladder with a duration of 6 years, i.e. about the same as Total Bond, under a scenario where the rate that applies to the bonds in the ladder start out at 2% and rise to 6% over a period of four years. The value shown is total value including reinvested bond interest, and assumes that the reinvested interest can be reinvested to buy more of the same portfolio. Bonds are assumed to be bought at issue, at par, and held to maturity.
  • The bond portfolio grows slowly and steadily from $1,000 to $1,231 until the interest rate rises hits.
  • While the interest rate is rising, the portfolio continuously loses value and reaches a minimum $1,138, i.e. a -8% loss.
  • When the interest rate levels off, the portfolio starts to gain again.
  • It makes back the lost ground in about two more years.
  • By about year #18, i.e. 8 years after the start of the interest rate increase, it is ahead of where it would have been if here had been no rate increase.
  • It is now growing faster than it did before the rate increase. If the investor had a time horizon of at least ten years, she is better off than if there had been no rate increase
[images]

I think bond funds will do perfectly well under a rise in rates from 2% to 6%, if they are intermediate-term investment-grade bonds and if your holding time is on the order of ten years or so. That isn't to say some other strategy might not do better.
This is a key point and one many people just don't seem to internalize. Rate rises are good for bond investors with a long horizon. The higher rate more than makes up for the initial loss of principal value.

The major caveat is that if you're selling a large part of your bond portfolio (rather than reinvesting) the situation is not as favorable or could be negative. If that's the case, you should have a portfolio with a shorter average maturity / duration.

For these purposes, there does not seem any significant difference between a rolling ladder and a fund.
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Re: Is holding bonds now dangerous?

Post by lack_ey »

Okay, if you're going to do any tactical allocations, which is a bit dangerous (though less so if just mucking around with fixed income, and not changing overall risk exposures much), you need to understand and evaluate the alternatives.

What matters is not the 10-year yield but the yield relative to short-term bonds, cash, CDs, or whatever else you might be looking at.

You also shouldn't evaluate the performance of any given component of your asset allocation in isolation. Don't compare each component with inflation but examine the big picture. Also, the underlying yields and returns are out of your control, and ratcheting up risk to meet a return target rather than being more steady with risk exposure can really backfire. If real bond yields were -4%, that's the world we would have to invest in, and I don't think that automatically means you can only invest in junk bonds because nothing else has a chance of beating inflation.

There are multiple components to bonds as potential diversification and enhancing portfolio efficiency:
1. Term premium (source of return)
2. Term premium relationship to other risks, such as equity risk
3. Credit risk premium (source of return)
4. Credit risk relationship to other risks, such as equity risk

A few decades ago, the term premium was actually positively correlated with equity risk. Now it's been negative for over a decade, which is great, as that improves diversification properties. The issue is that this may not continue forever, and there are plausible scenarios under which this relationship could readily change. With respect to the credit risk premium, there can't be a lot now, as corporate spreads are relatively low. So unless there are basically no defaults or credit downgrades, or the spread gets even lower, this can't add a substantial amount of return, at least in the investment-grade sense. But junk bond spreads are relatively low too.

The biggest thing to watch out for really, which many people are not acknowledging, is that the term premium looks low now, maybe even negative.

As I've laid out here:
viewtopic.php?f=10&t=230547&p=3586009#p3586009

with some links for further reading, there are a number of ways to estimate this, but one method from some NY Fed economists gives us this:

Image

That implies that bonds are not being priced as if they're risky, that investors are willing to accept lower returns in case short-term yields don't rise as quickly as expected, or maybe to hold as diversification for equities (after all, with the negative correlation, they've effectively had negative equity market beta). A lot of the past bond excess return over cash is about investors getting paid for taking on term risk, but what if that's not priced for a positive excess return anymore? That said, the actual outcome could be better or worse than the average projected future, and different models will say different things. Regardless, I don't think you can argue that there's much of any significantly positive term premium priced in, with yields where they are, expectations of FFR increases, etc.

To be honest, if you're willing to do more babysitting of the portfolio, going a little outside the market and investing more in CDs for fixed income may make more sense. You get an excess return over Treasuries without more credit risk, taking advantage of the FDIC insurance, and early withdrawal options are favorable to the investor.

There's a decent chance rates on intermediate-term bonds don't go up much, or maybe they even fall, but that's maybe not the most optimal bet to take now.

For those with relatively small fixed income allocations it's probably not going to matter much anyway, though. I don't think there's much danger, but not much potential benefit either, especially on average. Kind of ho-hum.
Last edited by lack_ey on Sat Nov 18, 2017 1:30 pm, edited 1 time in total.
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Re: Is holding bonds now dangerous?

Post by retiredjg »

UncleLongHair wrote: Sat Nov 18, 2017 11:05 am Generally speaking any investment strategy that is likely to lose you money doesn't sound like a good idea.
What is your suggested alternative?
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Re: Is holding bonds now dangerous?

Post by TD2626 »

nisiprius wrote: Sat Nov 18, 2017 10:51 am Let me state this very precisely.

For me, "holding bonds" means holding a "core" bond fund--meaning a diversified fund that holds only investment-grade bonds, and no longer than intermediate-term on average. Vanguard Total Bond Market Index Fund is an example of such a fund; there are many others.

For me, "dangerous" means "subject to a sudden decline in value that is so big that it would require a wrenching downward readjustment of our retirement plans."

By that definition: I think that holding bonds is not dangerous.

If you define "dangerous" to mean "having a chance that some cleverer investor could beat your results," then, gee, I dunno. Maybe, but I don't care. It's not about bragging or ego, it's about living off our money.

As for "now," I can look to the past at many examples of bad times in the bond market, including cases where people made warnings that came true, and none of them amount to enough to scare me.

This chart, for example, includes several very different "core" bond funds. Blue is one of the ones I hold, Vanguard Total Bond Market Index Fund, VBMFX. Orange is the famous PIMCO Total Return, once the biggest mutual fund, of any kind, in the world. Dodge & Cox Income Fund, DODIX, is in there because I don't know it and haven't charted it before... it has $50 billion in assets.

Source
Image

Here's my point. Here are some of the events included in this time period.
  • The "bond bubble," as it was called after the fact, of 1993, and the "bond massacre" of 1994 that followed it.
  • The period from 2004 to 2006, when the Fed raised the fed funds rate from 1% to 5.25%.
  • The time in August, 2010 when Jeremy Siegel and Jeremy Schwartz warned of a "Great American Bond Bubble" which they said would have worse consequences to investors than the NASDAQ crash of 2000, and the time in 2011 when their interest rate predictions essentially came true, the ten-year rate rising well into the range they warned about.
  • The time in March 2011 when Bill Gross, the then "Bond King," who apparently agreed with Siegel and Schwartz, dumped Treasuries completely, telling CNBC that Treasuries were "mispriced relative to the inflationary environment and the growth we see ahead and there are better alternatives in order to capture yield." The result was that in 2011, for I think the first time in history, PTTRX underperformed Total Bond. The result was described by the press as a disaster to the fund and Bill Gross's reputation and led to a massive outflow from PTTRX and eventually Gross's departure.
The point is that you can see each of these events on the chart if you know where to look for them--and not one of them was scary to me, at the time or in retrospect. For example, Bill Gross's "Error--centerfield." Morningstar's charts are weird, 2011 is the part of the chart just after the line marked 2010. This is the time when owners of PTTRX, the orange line, experienced the horrible results of Gross's catastrophic error. It just doesn't look like much of a problem to me.

In 2009, a poster in this forum wrote
I see the total bond fund and intermediate treasuries recommended a lot on here. I know people don't like to market time but interest rates are currently zero and whether rates rise in 2010 or 2011 or 2015, eventually they will rise and intermediate term bonds will get hit. So isn't it wise to go short in this environment where rates can only go up?
People have been saying that for eight years now. They have even talked of disaster "when rates eventually go up," unaware that rates had actually been going up!

I've been trying unsuccessfully to make sense of the disconnect between all of the shrill warnings of doom and nothing much happening. The best I can make of it is that in the world of Wall Street, people, seeing the relative reliability and low risk of bonds, customarily build complex cathedrals of exquisitely balanced, arbitraged, leveraged positions in bonds, with flying buttresses of derivatives holding the arch together. They count on their behaving with high-precision predictability; and a tiny shock that people in stone houses don't even notice, causes a little crack in the flying buttresses that bring the cathedral down. If it's not something like that, I don't know what it is.
Very excellent points. I especially liked the point about "it depends on your definition of dangerous". Yes, there's a danger that TBM underperforms (insert clever alternative investment), but there's always that danger. I presume this debate is whether that danger of underperformance is particularly high. There should be little ambiguity over what most people initially think of as danger - there is relatively minimal risk that something like TBM experiences nominal stock-crash level declines. (There is inflation risk, of course).

In answer to whether the danger of underperformance vis-a-vis some other alternative is particularly high right now, I feel the best answer is the classic "nobody knows 'nuthing". I feel the efficient market hypothesis, particularly the strong one, if it holds, would make this so. There is a chance that buying long-term bonds yielding ~2% a year would leave you with lots of underperformance for decades if interest rates rise. There is a chance that interest rates fall, though -- and someone with a 2% bond would be holding a overperforming asset. Essentially, investors who believe interest rates will rise and those who feel interest rates may fall likely (if markets are efficient) would bid against each other until prices/yields are fair, in my opinion.
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Re: Is holding bonds now dangerous?

Post by livesoft »

TD2626 wrote: Sat Nov 18, 2017 1:24 pm
nisiprius wrote: Sat Nov 18, 2017 10:51 am Let me state this very precisely.
[...]
Very excellent points. [...]
Indeed, very excellent points. I love to read these kinds of posts from nisiprius. The thought and effort that go into them are works of art and knowledge.
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Re: Is holding bonds now dangerous?

Post by dwickenh »

UncleLongHair wrote: Sat Nov 18, 2017 10:17 am
Nobody knows...
I agree that the markets are hard/impossible to predict. But with interest rates at zero, there is only one way for interest rates to go. And bonds have an extremely simple relationship with interest rates. Rates go up, bonds go down in value, and vice versa. This isn't about making a prediction but just arithmetic. The only situation in which bonds don't lose money in real terms going forward is if both rates and inflation remain at zero for the long term which has never happened in history.
People were saying that 5 years ago also. I think it will happen also, just tell me exactly when so I can cash out all of my bonds and move it to my 1% savings account. Your crystal ball is needed!! Not to determine 'IF" it will happen, but "WHEN" it will happen.
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Re: Is holding bonds now dangerous?

Post by flyingaway »

UncleLongHair wrote: Sat Nov 18, 2017 6:56 am I would like to get a sampling of what people think about investing in bonds in the current environment.

For the past 35 or so years, bond yields have on average declined, which has meant that bonds are both safe in terms of principal/interest and have also appreciated.

However with interest rates near zero and in some cases below zero, it seems that they can only go up. Current yields are also below the historic norms for inflation, with the 10-year treasury just over 2%. It seems that holding any bonds with maturities more than a year or two is a likely way to lose money in real terms. If/when inflation and interest rates increase, you'll be behind the curve in terms of yield, appreciation, and inflation.

In other words, we might be at the end of a 30-40 year bull market in bonds.

Not many people directly buy 10+ year bonds but this comes into play with various balanced funds, target funds, for example Vanguard's 2030 target fund is 28% bonds. If I were to retire in 13 years, I don't think I'd want 28% and an increasing percentage of my assets in bonds that are very likely to lose money in real terms between now and then.

Thoughts?
30-40 years of bond bull market, why can't it be 50 years?
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