Is there ever a scenario where bonds aren't safe?

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justsomeguy2018
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Is there ever a scenario where bonds aren't safe?

Post by justsomeguy2018 » Thu Feb 13, 2020 10:49 pm

My understanding of the bond allocation is to help diversify and hedge against market downturns so you aren't 100% exposed to equities. So it's supposed to be a safety thing.

By bonds, let's just say I mean a general bond fund, like the BND Vanguard ETF. I know there are times where sometimes both bonds and stocks decline (though stocks much steeper).

My question is - could a situation arise where a bond fund (which you thought was your safety hedge) no longer be considered a "safe asset"? Are these funds mostly U.S. government debt or do they include private corporate debt as well? If the economy sinks profoundly could the corporate debt become risky because they can't pay back their loans, or does U.S. government debt ever become "unsafe" ?

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Re: Is there ever a scenario where bonds aren't safe?

Post by z3r0c00l » Thu Feb 13, 2020 10:50 pm

Yes, the late 1970's. Bonds can lose quite a bit to an increase in inflation and interest rates. It doesn't come in a sudden crash, but more of a slow, painful attrition.

Your doomsday scenario is not very likely, since the government prints money so they have no need to default. They can just print more. (Not that those scenarios work out well either, e.g. hyperinflation.) If things get that bad, bonds won't do you much good anyway. Then you will want stuff to barter.

heyyou
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Re: Is there ever a scenario where bonds aren't safe?

Post by heyyou » Fri Feb 14, 2020 12:49 am

Bond fund shares are very much relatively "safer" than other riskier assets, as we live in a world where nothing is absolutely safe in every imaginable situation. Risk and reward rule the markets but with assurance of uncertainty about the future.

As mentioned by the earlier poster, bonds were risky in a period of progressively higher inflation in which investors hadn't ever seen rates that high during any previous period of their lives. CDs were paying 14%, but there were several bank failures which hurt retirees who owned those CDs. The FDIC does not reimburse quickly. Was the glass considered to be half empty from the losses, or half full since those savers still had more money left, than those who hadn't saved any at all? We just do what we can, knowing the future will have risks that we are not expecting. Note that this is the longest bull stock market on record, not counting its short fluctuations, so likely it will be followed by a period that will not be pleasant for anyone.

Unladen_Swallow
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Re: Is there ever a scenario where bonds aren't safe?

Post by Unladen_Swallow » Fri Feb 14, 2020 12:51 am

When they lose money.



Bonds are not risk free investments.
"I think it's much more interesting to live not knowing than to have answers which might be wrong." - Richard Feynman

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whodidntante
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Re: Is there ever a scenario where bonds aren't safe?

Post by whodidntante » Fri Feb 14, 2020 1:36 am

Yes. I think of bonds as risk assets because they are. In fact, a 100% bonds portfolio is a really bad idea for a lot of us. But bonds are just not as risky as stocks or risky in the same ways as stocks. Defaults, poor liquidity in a crisis, and a drop in bond prices can all result in losses in nominal terms. A period of high inflation could be devastating to your purchasing power if you hold too much in bonds. At current yields, the expected returns of safe bonds are probably negative for many of us, after-inflation and after-tax. Even T-bills have suffered significant losses in real terms.

If you just want a buffer and don't mind losing money, cash can also provide that.

Never take too much or too little risk. Having some amount allocated to bonds can make sense for some people.

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Forester
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Re: Is there ever a scenario where bonds aren't safe?

Post by Forester » Fri Feb 14, 2020 6:09 am

Bonds in 2020 are speculation. As I dislike "greater fool" speculation I own some gold instead.

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qwertyjazz
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Re: Is there ever a scenario where bonds aren't safe?

Post by qwertyjazz » Fri Feb 14, 2020 6:23 am

Bonds are based on the underlying government or company that pays them. So if the government tanks (Russian bonds pre-communist revolution. Venezuela bonds etc etc). Or as above they can still have value but interest rates increase at a rate so high that they are worth less than the interest you get on them. They are an obligation to pay you back some amount of money with some interest. Either factor can become problematic.
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Ramjet
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Re: Is there ever a scenario where bonds aren't safe?

Post by Ramjet » Fri Feb 14, 2020 6:36 am

Stagflation: persistent, abnormally high inflation combined with high unemployment and a stagnant economy

This would be a rough time for everyone, especially bond holders

Ari
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Re: Is there ever a scenario where bonds aren't safe?

Post by Ari » Fri Feb 14, 2020 8:57 am

When bonds are riskier than stocks

Image
Bond returns seem to be very episodic with decade-long super-cycles

You can have many decades in a row of very strong returns, but also multi-decade phases of sideways or even strong negative real returns. There was an 80+ year time window from 1898 to 1981 when bonds had zero real returns. We consider that the mother of all risks! Bonds also had a 40Y return window with -2.08% average real return, compared to +2.62% as the worst equity 40Y return window.
All in, all the time.

acegolfer
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Re: Is there ever a scenario where bonds aren't safe?

Post by acegolfer » Fri Feb 14, 2020 9:13 am

justsomeguy2018 wrote:
Thu Feb 13, 2020 10:49 pm
My question is - could a situation arise where a bond fund (which you thought was your safety hedge) no longer be considered a "safe asset"? Are these funds mostly U.S. government debt or do they include private corporate debt as well? If the economy sinks profoundly could the corporate debt become risky because they can't pay back their loans, or does U.S. government debt ever become "unsafe" ?
Seems you are only considering the default risk in bonds. Bonds even the safest Treasuries suffer interest rate risk. As interest rate increases, bond value will decrease. If the price drop is bigger than the coupon payment, the bond will have a negative return. Historically, 1 in 10 yrs, long term bonds had negative annual returns.

In sum, bonds are not safe. But it's safer than stocks.

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gmaynardkrebs
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Re: Is there ever a scenario where bonds aren't safe?

Post by gmaynardkrebs » Fri Feb 14, 2020 9:38 am

If you are looking for total safety, TIPS are "risk free," in the sense that you will never lose money in real terms if held to maturity (tax-deferred accounts are best). However, the income stream will vary with inflation. I don't consider that a risk, but if you depend on the income from your TIPS, it might be a risk for you. All other bonds have a higher degree of risk, although something like Total Bond is not "risky" compared to stocks, which are quite risky.

dbr
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Re: Is there ever a scenario where bonds aren't safe?

Post by dbr » Fri Feb 14, 2020 9:55 am

Bonds are always "not safe" by some idea of what safety is . . . . or they are always safe by some other idea of what safety is.

As to scenarios, if you were invested in bonds of certain countries in recent years you lost everything -- so there is a scenario. If you owned GM bonds, there was another example.

Probably a classic example of "not safe" is the high likelihood of running out of money after a few decades if trying to support a 4% withdrawal rate from a 100% bond portfolio when having 40% or so in stocks reduces that failure rate by a large margin, at least in historical experience in the US.

What bonds are you talking about and what do you mean by safe?

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Re: Is there ever a scenario where bonds aren't safe?

Post by 7eight9 » Fri Feb 14, 2020 10:03 am

Ari wrote:
Fri Feb 14, 2020 8:57 am
When bonds are riskier than stocks

Image
Bond returns seem to be very episodic with decade-long super-cycles

You can have many decades in a row of very strong returns, but also multi-decade phases of sideways or even strong negative real returns. There was an 80+ year time window from 1898 to 1981 when bonds had zero real returns. We consider that the mother of all risks! Bonds also had a 40Y return window with -2.08% average real return, compared to +2.62% as the worst equity 40Y return window.
Did the S&P 500 even exist in 1870? Just quickly googling it seems to have come into existance in 1957 -- https://en.wikipedia.org/wiki/S%26P_500_Index.

Which, if true, kind of makes the entire chart suspect.
I guess it all could be much worse. | They could be warming up my hearse.

Boglegrappler
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Re: Is there ever a scenario where bonds aren't safe?

Post by Boglegrappler » Fri Feb 14, 2020 10:11 am

https://www.berkshirehathaway.com/letters/2011ltr.pdf

Read from the middle of page 17 through page 19.


It will be helpful in considering bonds. There is quite a bit more wisdom there than meets the eye of most readers, IMO.

Valuethinker
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Re: Is there ever a scenario where bonds aren't safe?

Post by Valuethinker » Fri Feb 14, 2020 10:34 am

justsomeguy2018 wrote:
Thu Feb 13, 2020 10:49 pm
My understanding of the bond allocation is to help diversify and hedge against market downturns so you aren't 100% exposed to equities. So it's supposed to be a safety thing.

By bonds, let's just say I mean a general bond fund, like the BND Vanguard ETF. I know there are times where sometimes both bonds and stocks decline (though stocks much steeper).

My question is - could a situation arise where a bond fund (which you thought was your safety hedge) no longer be considered a "safe asset"? Are these funds mostly U.S. government debt or do they include private corporate debt as well? If the economy sinks profoundly could the corporate debt become risky because they can't pay back their loans, or does U.S. government debt ever become "unsafe" ?
1994. Interest rate spike - the Fed tightened much faster than the market expected (raised interest rates). From memory the US 10 year Treasury Bond fell by about 10% *but* it also yielded more, so the actual total return for the year was more like 5%.

1970s. Rising inflation steadily crushed bond yields (after inflation). Horrible decade for bond investors.

2008-09 - Global Financial Crisis. US Treasury bonds went up, as did just about any other security with a US government guarantee (GNMAs etc). By contrast bonds issued by private issuers fell

Solutions?

- to the 1994 situation you just have to ride the storm (those who did profited from double digit bond returns in 1995)

- to the the 1970s situation you hold more TIPS bonds

- to the 2008/9 you hold US Treasury bonds

Caduceus
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Re: Is there ever a scenario where bonds aren't safe?

Post by Caduceus » Fri Feb 14, 2020 10:36 am

That depends on how you're defining risk and safety, and what you're identifying as the principal things you're trying to guard against. If all you mean by "risk" is the preservation of principal, then US government bonds are less "risky" than stocks. Over long periods of time, the primary risks you should be trying to defend again, however, are the risks of inflation, of not earning sufficient returns, etc. If those are the true risks over your time horizon, then bonds are riskier.

I don't find a need to buy anything in the way of bonds at current rates of return. The additional return over something like investing in a short-term CD or ultra-short term Treasury ETF (less than 3 months maturity) is not high enough to entice me into them. My non-stock portfolio is entirely in cash and cash equivalents, with occasional writing of out-of-the-money put options on things I don't mind buying if the options were exercised.

Independent George
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Re: Is there ever a scenario where bonds aren't safe?

Post by Independent George » Fri Feb 14, 2020 12:12 pm

The major bond risks are default, inflation, currency, and liquidity (during a panic, there might not be buyers even if you were willing to take an 80% haircut). Worse, they are correlated, so you are likely to hit at least two of them at the same time.

rockstar
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Re: Is there ever a scenario where bonds aren't safe?

Post by rockstar » Fri Feb 14, 2020 12:41 pm

I’d treat high yield and emerging market debt as equities from a risk perspective. Also, longer duration is more risky than short duration bonds. They’re more interest rate sensitive.

Angst
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Re: Is there ever a scenario where bonds aren't safe?

Post by Angst » Fri Feb 14, 2020 12:50 pm

7eight9 wrote:
Fri Feb 14, 2020 10:03 am
Ari wrote:
Fri Feb 14, 2020 8:57 am
When bonds are riskier than stocks

Image
Bond returns seem to be very episodic with decade-long super-cycles

You can have many decades in a row of very strong returns, but also multi-decade phases of sideways or even strong negative real returns. There was an 80+ year time window from 1898 to 1981 when bonds had zero real returns. We consider that the mother of all risks! Bonds also had a 40Y return window with -2.08% average real return, compared to +2.62% as the worst equity 40Y return window.
Did the S&P 500 even exist in 1870? Just quickly googling it seems to have come into existance in 1957 -- https://en.wikipedia.org/wiki/S%26P_500_Index.

Which, if true, kind of makes the entire chart suspect.
Thank you Ari for posting a link to this excellent article. It's very well written and I highly recommend it too! The graph (above) from it which you chose to include was my favorite.

Yes, 7eight9 asks an appropriate question which is addressed in the notes and comments below the article. Note Siamond's discussion in the comments.

TomCat96
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Re: Is there ever a scenario where bonds aren't safe?

Post by TomCat96 » Fri Feb 14, 2020 1:12 pm

justsomeguy2018 wrote:
Thu Feb 13, 2020 10:49 pm
My understanding of the bond allocation is to help diversify and hedge against market downturns so you aren't 100% exposed to equities. So it's supposed to be a safety thing.

By bonds, let's just say I mean a general bond fund, like the BND Vanguard ETF. I know there are times where sometimes both bonds and stocks decline (though stocks much steeper).

My question is - could a situation arise where a bond fund (which you thought was your safety hedge) no longer be considered a "safe asset"? Are these funds mostly U.S. government debt or do they include private corporate debt as well? If the economy sinks profoundly could the corporate debt become risky because they can't pay back their loans, or does U.S. government debt ever become "unsafe" ?
Hyperinflation

RubyTuesday
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Re: Is there ever a scenario where bonds aren't safe?

Post by RubyTuesday » Fri Feb 14, 2020 1:18 pm

Forester wrote:
Fri Feb 14, 2020 6:09 am
Bonds in 2020 are speculation. As I dislike "greater fool" speculation I own some gold instead.
I find your stated dislike and choice of asset at odds.
“Doing nothing is better than being busy doing nothing.” – Lao Tzu

RubyTuesday
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Re: Is there ever a scenario where bonds aren't safe?

Post by RubyTuesday » Fri Feb 14, 2020 1:26 pm

As I use bonds as my safe asset, they are mostly US treasury instruments or funds, and CDs. I mostly avoid corporate debt (except for tiny remaining position in BND).

These type of bonds are much less risky than equities or corporate debt due to the almost complete lack of credit risk. And while longer bonds do have more interest rate risk, that risk is compensated by higher yield (or should be), and also if bonds are used to duration match a liability, it is not an issue at all.
“Doing nothing is better than being busy doing nothing.” – Lao Tzu

garlandwhizzer
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Re: Is there ever a scenario where bonds aren't safe?

Post by garlandwhizzer » Fri Feb 14, 2020 1:45 pm

Persistently increasing inflation over a long period of years kills real bond returns. Death by million paper cuts as time wears on. Bonds are expected to suffer more than stocks in that long run scenario and both suffer more than than commodities. There isn't a good place to hide out when inflation heats up severely and persistently except perhaps gold. Gold does not work reliably as an inflation hedge in modest or stable inflation, but when severe inflation gets so bad that investors lose confidence in currencies as a storehouse for value, they often flock to gold. TIPS preserves wealth in all inflation scenarios but gold has the potential to not only preserve but also make huge outsized returns when inflation goes into overdrive and stays there for a long time.

Garland Whizzer

JonnyB
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Re: Is there ever a scenario where bonds aren't safe?

Post by JonnyB » Fri Feb 14, 2020 1:46 pm

That graph is somewhat misleading because it shows accumulated growth over 150 years and is logarithmic. For example, look at the S&P over at 2009 on the right. Just looks like a tiny little blip. If you look closer it is actually a loss of more than half of your entire accumulated wealth over 150 years. Hardly comforting.

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