What are the disadvantages of taking all risk on equity side?

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danielc
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Re: What are the disadvantages of taking all risk on equity side?

Post by danielc » Sat Jan 12, 2019 8:49 am

delrinson wrote:
Sat Jan 12, 2019 6:47 am
bluquark wrote:
Fri Jan 11, 2019 10:28 pm
OP, perhaps the problem is that your emergency fund is not large enough for comfort? Increasing the size of it might satisfy your need for a "risk-free asset bucket".

If it winds up large enough to seriously affect your yield, you could hold an equal amount of long bonds so that your overall fixed income averages out to intermediate duration. This might be a psychological trick but a lot of personal investment is about psychological tricks :)
This is an interesting observation. While my emergency fund is currently large enough, I'm more thinking 10-15 years down the road. Perhaps if I simply had, say, two years in cash and short treasuries, I would more feel the freedom to have the rest of my fixed income in total bond.
I am currently building my emergency fund. I could imagine that when it becomes "large enough" I might be willing to gradually increase the duration of new bonds.

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Re: What are the disadvantages of taking all risk on equity side?

Post by Valuethinker » Sat Jan 12, 2019 10:07 am

delrinson wrote:
Fri Jan 11, 2019 7:38 am
While I've tried to muster enthusiasm for a broadly diversified fixed income portfolio, I find myself leaning against taking much of any risk at all on the fixed income side. Part of my thinking is simply the irritation/frustration of losing any money at all in the portion of my portfolio that is designed to preserve assets. So I'm gravitating toward having all fixed income assets in money market, CDs, and short term treasuries, putting all the risk on the equity side of the ledger.

What are the disadvantages of this approach? Is it simply the foregoing of the marginal gains I would otherwise reap if I had a more diversified fixed income portfolio? If that's all it is, I can live with that.
The yield curve is upward sloping.

Depending on its slope what you are doing over time is leaving money on the table.

2 or so per cent of lost interest compounded over 30 years is a big chunk of change.

I think the long run evidence is US 90 day T Bills returned about inflation but Treasury bonds beat it by 1 to 2 per cent?

In the 1970s however t bills outperformed bonds or stocks.

For over 10 years to maturity bonds I would recommend TIPS and bonds because of inflation risks. But that is less hedging against deflation, then.

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Re: What are the disadvantages of taking all risk on equity side?

Post by HEDGEFUNDIE » Sat Jan 12, 2019 10:36 am

danielc wrote:
Sat Jan 12, 2019 8:38 am
HEDGEFUNDIE wrote:
Fri Jan 11, 2019 10:52 pm
30 years are still yielding more than 10 years. It’s the middle of the curve that’s inverted.

But regardless of what the curve is doing now, long tends to beat medium tends to beat short. Betting on anything else is just market timing.
You make it sound like looking at the yield curve is gambling. I don't understand why you object so strongly. When I borrow money shop around for a low interest rate. When I lend money, I shop around for a high interest rate. Also, there is always the question of whether you are being fairly compensated for the risk. A while ago @jalbert was explaining to me that long treasuries usually have a very poor return considering the length of the maturity because the main buyers of those treasuries are organizations (pension funds? annuities?) that have very specific long-term liabilities.

Some people in this forum (e.g. Larry Swedroe) have recommended that you require at least 20bp of yield for each additional year of maturity. Right now the yield on 1-year Treasuries is 2.57% and 30-year Treasuries return 3.04%. That's a difference of only 47 bp for an additional 29 years. According to Swedroe's rule, 30-year Treasuries would not be a good deal unless their yield was 14.9% at least.
What would you call someone who invests in equities based on whether they are cheap or expensive, or whether they “fairly compensate you for the risk” at a certain point in time? Obviously, a market timer. Why should it be any different for bonds?

How do you or I or Swedroe know if 47 bp is “fairly compensating you for the risk”? Maybe it stays that way for years, and you have just left 47 bp of return on the table, compounded that is meaningful money. And If it turns out that the yield spread expands again, you miss out on even more.

And if you are still going to market time bonds, at least do it properly. With the spread at “only” 47 bp, which is more likely going forward, that the spread contracts even further or expands?

The argument that insurance companies drive down the yields of long treasuries is not a proven fact. It’s a theory called “preferred habitat theory” and I challenge it here:

viewtopic.php?f=10&t=268670#p4301652

viewtopic.php?f=10&t=268670#p4301744

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Re: What are the disadvantages of taking all risk on equity side?

Post by Northern Flicker » Sat Jan 12, 2019 12:28 pm

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Risk is not a guarantor of return.

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Re: What are the disadvantages of taking all risk on equity side?

Post by danielc » Sat Jan 12, 2019 1:02 pm

HEDGEFUNDIE wrote:
Sat Jan 12, 2019 10:36 am
What would you call someone who invests in equities based on whether they are cheap or expensive, or whether they “fairly compensate you for the risk” at a certain point in time? Obviously, a market timer. Why should it be any different for bonds?
Because nominal Treasuries are not company stock. They have a fully predictable cashflow and the only risk I have is the risk of having to sell them before maturity (also add inflation risk for long maturities). This is also why I am willing to hold individual treasuries but I am not willing to hold individual stocks. I do not see any of this as market timing. I am not trying to predict the market. I am literally just buying a fully predictable cashflow for the best price I can. I also shop around when I buy a TV.
HEDGEFUNDIE wrote:
Sat Jan 12, 2019 10:36 am
And if you are still going to market time bonds, at least do it properly. With the spread at “only” 47 bp, which is more likely going forward, that the spread contracts even further or expands?
I don't know what you mean by those terms.

HEDGEFUNDIE wrote:
Sat Jan 12, 2019 10:36 am
The argument that insurance companies drive down the yields of long treasuries is not a proven fact. It’s a theory called “preferred habitat theory” and I challenge it here:

viewtopic.php?f=10&t=268670#p4301652

viewtopic.php?f=10&t=268670#p4301744
Thanks for the links.

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Re: What are the disadvantages of taking all risk on equity side?

Post by HEDGEFUNDIE » Sat Jan 12, 2019 3:44 pm

danielc wrote:
Sat Jan 12, 2019 1:02 pm
HEDGEFUNDIE wrote:
Sat Jan 12, 2019 10:36 am
What would you call someone who invests in equities based on whether they are cheap or expensive, or whether they “fairly compensate you for the risk” at a certain point in time? Obviously, a market timer. Why should it be any different for bonds?
Because nominal Treasuries are not company stock. They have a fully predictable cashflow and the only risk I have is the risk of having to sell them before maturity (also add inflation risk for long maturities). This is also why I am willing to hold individual treasuries but I am not willing to hold individual stocks. I do not see any of this as market timing. I am not trying to predict the market. I am literally just buying a fully predictable cashflow for the best price I can. I also shop around when I buy a TV.
If all you cared about was steady cash flow, you would buy the bond paying 3% instead of 2.5%. Buying the 2.5% bond is saying you expect interest rates to rise and so you are waiting for that to happen so you can reinvest at the higher interest rate in one year. Pure market timing.

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Re: What are the disadvantages of taking all risk on equity side?

Post by danielc » Sat Jan 12, 2019 4:22 pm

HEDGEFUNDIE wrote:
Sat Jan 12, 2019 3:44 pm
danielc wrote:
Sat Jan 12, 2019 1:02 pm
Because nominal Treasuries are not company stock. They have a fully predictable cashflow and the only risk I have is the risk of having to sell them before maturity (also add inflation risk for long maturities). This is also why I am willing to hold individual treasuries but I am not willing to hold individual stocks. I do not see any of this as market timing. I am not trying to predict the market. I am literally just buying a fully predictable cashflow for the best price I can. I also shop around when I buy a TV.
If all you cared about was steady cash flow, you would buy the bond paying 3% instead of 2.5%.
Indeed. And as I said in the post you quoted, that is not the only thing I care about. I also consider the risk of having to sell them before maturity (which exposes me to changes in the interest rate) as well as inflation risk for long maturities. If I bought a 30-year Treasury, I would worry a lot that I might have to sell it early at a bad price. All other things being equal, I will prefer a treasury with a duration that matches my needs and goals. To convince me to deviate from that, I would expect to be compensated in proportion to the risk.

Also, if my goal really was a 30-year maturity, I would worry about inflation and I suspect I would choose TIPS or I-bonds instead of nominal treasuries.
HEDGEFUNDIE wrote:
Sat Jan 12, 2019 3:44 pm
Buying the 2.5% bond is saying you expect interest rates to rise and so you are waiting for that to happen so you can reinvest at the higher interest rate in one year. Pure market timing.
Nope. I have absolutely no opinion on whether interest rates will go up or down. I seriously don't. Haven't given it a moment's thought. I do, however, have an opinion on roughly when my liabilities might be and what range of durations I am comfortable with.

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Re: What are the disadvantages of taking all risk on equity side?

Post by HEDGEFUNDIE » Sat Jan 12, 2019 4:26 pm

danielc wrote:
Sat Jan 12, 2019 4:22 pm
HEDGEFUNDIE wrote:
Sat Jan 12, 2019 3:44 pm
danielc wrote:
Sat Jan 12, 2019 1:02 pm
Because nominal Treasuries are not company stock. They have a fully predictable cashflow and the only risk I have is the risk of having to sell them before maturity (also add inflation risk for long maturities). This is also why I am willing to hold individual treasuries but I am not willing to hold individual stocks. I do not see any of this as market timing. I am not trying to predict the market. I am literally just buying a fully predictable cashflow for the best price I can. I also shop around when I buy a TV.
If all you cared about was steady cash flow, you would buy the bond paying 3% instead of 2.5%.
Indeed. And as I said in the post you quoted, that is not the only thing I care about. I also consider the risk of having to sell them before maturity (which exposes me to changes in the interest rate) as well as inflation risk for long maturities. If I bought a 30-year Treasury, I would worry a lot that I might have to sell it early at a bad price. All other things being equal, I will prefer a treasury with a duration that matches my needs and goals. To convince me to deviate from that, I would expect to be compensated in proportion to the risk.
Then we are talking about two different things. I am talking about the bond allocation in your investment portfolio which you won’t draw down until you retire. I am assuming you are decades away from that point.

You seem to be talking about using the proceeds from bonds for some shorter term spending goal.

I agree 100% that your time horizon for the money should dictate your choice of bond duration. That is in fact the only way not to market time.

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Re: What are the disadvantages of taking all risk on equity side?

Post by bluquark » Sat Jan 12, 2019 4:34 pm

danielc wrote:
Sat Jan 12, 2019 8:38 am
Some people in this forum (e.g. Larry Swedroe) have recommended that you require at least 20bp of yield for each additional year of maturity. Right now the yield on 1-year Treasuries is 2.57% and 30-year Treasuries return 3.04%. That's a difference of only 47 bp for an additional 29 years. According to Swedroe's rule, 30-year Treasuries would not be a good deal unless their yield was 14.9% at least.
Swedroe’s rule of thumb is 20bps per year of *duration*. Still out of consideration for long Treasuries, but at the moment his criteria does bring us up to the high end of intermediate for many classes of bonds.

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Re: What are the disadvantages of taking all risk on equity side?

Post by whodidntante » Sat Jan 12, 2019 6:05 pm

The market timer in me says this is not a good time for taking term risk. A 5% loss in a bond fund annoys me because it seems inevitable, but a similar loss in equities seems like noise. I could be wrong of course.

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Re: What are the disadvantages of taking all risk on equity side?

Post by hdas » Sat Jan 12, 2019 6:52 pm

whodidntante wrote:
Sat Jan 12, 2019 6:05 pm
The market timer in me says this is not a good time for taking term risk. A 5% loss in a bond fund annoys me because it seems inevitable, but a similar loss in equities seems like noise. I could be wrong of course.
1. It would annoy you less if it’s a LT bond
2. Just count!. There are ways to “equalize” risk of say SHY vs TLT and have a model to time your exposure...but that’s an excercise for the reader. :twisted:

Cheers :greedy
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Re: What are the disadvantages of taking all risk on equity side?

Post by Northern Flicker » Sat Jan 12, 2019 8:05 pm

The argument that insurance companies drive down the yields of long treasuries is not a proven fact. It’s a theory called “preferred habitat theory” and I challenge it here:

viewtopic.php?f=10&t=268670#p4301652

viewtopic.php?f=10&t=268670#p4301744
That pensions also have short-term liabilities is irrelevant. The duration of their overall liabilities is long, and that is what they match to.
Risk is not a guarantor of return.

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Re: What are the disadvantages of taking all risk on equity side?

Post by HEDGEFUNDIE » Sat Jan 12, 2019 8:17 pm

jalbert wrote:
Sat Jan 12, 2019 8:05 pm
The argument that insurance companies drive down the yields of long treasuries is not a proven fact. It’s a theory called “preferred habitat theory” and I challenge it here:

viewtopic.php?f=10&t=268670#p4301652

viewtopic.php?f=10&t=268670#p4301744
That pensions also have short-term liabilities is irrelevant. The duration of their overall liabilities is long, and that is what they match to.
What is the average age of a US pension participant? How do you know how long their overall liabilities are?

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Re: What are the disadvantages of taking all risk on equity side?

Post by danielc » Sat Jan 12, 2019 9:02 pm

HEDGEFUNDIE wrote:
Sat Jan 12, 2019 4:26 pm
Then we are talking about two different things. I am talking about the bond allocation in your investment portfolio which you won’t draw down until you retire. I am assuming you are decades away from that point.

You seem to be talking about using the proceeds from bonds for some shorter term spending goal.
Sort of, yes. I only started investing recently. When I got started, I had nothing and my first goal was to build a minimal emergency fund. Although I hoped to never use that money, I was worried about ultra-short-term needs. So I had the money in a savings account. As the savings grew, I gradually felt more comfortable looking farther into the future and I gradually moved money to longer term bonds. I expect this trend to continue, and at some point I'm sure I'll be buying 10-year TIPS.

HEDGEFUNDIE wrote:
Sat Jan 12, 2019 4:26 pm
I agree 100% that your time horizon for the money should dictate your choice of bond duration. That is in fact the only way not to market time.
Well, I'm glad. Thank you for the advice.

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