Rekenthaler: Long Bonds Are for Fools

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KEotSK66
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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Thu May 21, 2020 8:48 pm

rockstar wrote:
Thu May 21, 2020 8:22 pm
There's an inherent problem in holding long term bonds to maturity. You can never sell them. You cannot use them to rebalance between bonds and equities. You're committed to have them for their entire duration. This doesn't seem realistic for the average investor that tries to maintain an AA. If you have to sell bonds to buy equities to rebalance, you run the risk that your principal dropped since you purchased your bonds. You're also at the mercy of the market depth at that point in time. This is why I stick to the short end. I can time their maturity to rebalance periods.
great post

especially since many investors may be getting their long-term bond exposure via a fund
"i just got fluctuated out of $1,500", jerry

typical.investor
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Re: Rekenthaler: Long Bonds Are for Fools

Post by typical.investor » Thu May 21, 2020 9:11 pm

rockstar wrote:
Thu May 21, 2020 8:22 pm
There's an inherent problem in holding long term bonds to maturity. You can never sell them. You cannot use them to rebalance between bonds and equities. You're committed to have them for their entire duration. This doesn't seem realistic for the average investor that tries to maintain an AA. If you have to sell bonds to buy equities to rebalance, you run the risk that your principal dropped since you purchased your bonds.
In practice though, when stocks are down, it's usually a good time to sell bonds. In fact, long term bonds likely appreciate as investors flee to safety.

I think you are basically forgoing any term premium in exchange for eliminating risk from a stagflation type environment where stocks and bonds both drop, but short term drops less (due to its shorter term being less affected by rising rates). If stagflation keeps you awake at night and makes your hands and knees shake, then I agree you probably have made the right decision.

Anyway, I definitely sold my long term treasuries in the Covid19 crash and I absolutely loved it. I likely won't have a need to buy back until after employment has recovered, stocks have risen and rates are not in stimulate for crisis mode. Of course if stocks and employment rise and long rates are still at their current lows, I may be buying treasuries at the current low rates when my stock allocation gets too high.

The stock bond correlation can change and become positive, especially in higher inflation. However, the term premium on nominal bonds, which also has a benefit in deflation, seems worth that risk especially now where usually you are selling long bonds after they appreciate in a crash and buying them after the economy strengthens and rates go up to cool things off which brings the price down.

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Noobvestor
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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Thu May 21, 2020 9:44 pm

vineviz wrote:
Thu May 21, 2020 7:45 pm
Noobvestor wrote:
Thu May 21, 2020 6:24 pm

If you want to start a movement to redefine a commonly used phrase and get people to use it in a specialized academic way, that's your call. Personally, I think it could be counterproductive for everyday investors and more suitable to another context, but that's just my opinion.
Maybe you are not alone in thinking that individual investors are too dumb to understand the risks they face. That’s not an opinion I happen to share. Maybe you are not alone in preferring to subject yourself to higher levels of interest rate risk because of a desire to speculate on the future direction of bond prices. That’s not an approach I happen to use. We agree that many investors have formed the same (mistaken) understanding of interest rate risk, however. And I happen to think they are capable and deserving of the chance to gain an education on this important topic.
I'm not assuming anyone is dumb - if anything, appeals to academic authority by some in this thread are seriously condescending. I'm also not suggesting people speculate on the future direction of bond prices - I've explicitly said the opposite. I'm just pointing out that people use words to communicate. Lesser-used niche definitions risk semantic confusion. They muddy the waters. You can call things what you want, but please stop 'correcting' me and/or others for using common-sense, widely-accepted definitions, or implying we're fools for doing so. Thanks.
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Noobvestor
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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Thu May 21, 2020 10:04 pm

typical.investor wrote:
Thu May 21, 2020 7:18 pm
Noobvestor wrote:
Thu May 21, 2020 4:49 pm
I believe interest rate risk is a good way to describe a risk of rising interest rates - all of the same words are in there - 'interest rate' and 'risk' - this is basic, common-sense stuff.

Anyway, semantics aside, the risk of rising rates is a risk that leads to and is tied up in other risks, like inflation risk. What bothers me is this insistence that interest rate risk is 'neutralized' by holding to duration. I do agree on one point, which is that if you hold a bond to duration you will get the nominal return promised you - you have eliminated unpredictably in nominal terms. That's one of many risks in the mix.

But the idea that long bonds lower interest rate risks is false if one uses a common-sense, widely-applied meaning of the phrase.
I see your point - interest rate risk and inflation risk are related. Why not make them the same thing and use them interchangeably?
I don't see a reason to conflate those two risks, though they do often show up at the same time. The interest rate risk on long bonds is that their value can go down if rates go up. The inflation risk on long bonds is that inflation can go up while your yield stays flat. More directly, one has nominal dollar implications and one has real dollar implications, but again, these often show up together. In the past, it has been common to find rising inflation and rates paralleling one another, which separately/together devalue existing long bonds in different ways.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Thu May 21, 2020 10:18 pm

In practice though, when stocks are down, it's usually a good time to sell bonds. In fact, long term bonds likely appreciate as investors flee to safety.

if you're duration/liability-matching with a bond you're locked in, why would you run the risk of failing to realize the required cash flow by trading and possibly coming up short
Last edited by KEotSK66 on Thu May 21, 2020 10:23 pm, edited 1 time in total.
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typical.investor
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Re: Rekenthaler: Long Bonds Are for Fools

Post by typical.investor » Thu May 21, 2020 10:22 pm

Noobvestor wrote:
Thu May 21, 2020 10:04 pm
typical.investor wrote:
Thu May 21, 2020 7:18 pm
Noobvestor wrote:
Thu May 21, 2020 4:49 pm
I believe interest rate risk is a good way to describe a risk of rising interest rates - all of the same words are in there - 'interest rate' and 'risk' - this is basic, common-sense stuff.

Anyway, semantics aside, the risk of rising rates is a risk that leads to and is tied up in other risks, like inflation risk. What bothers me is this insistence that interest rate risk is 'neutralized' by holding to duration. I do agree on one point, which is that if you hold a bond to duration you will get the nominal return promised you - you have eliminated unpredictably in nominal terms. That's one of many risks in the mix.

But the idea that long bonds lower interest rate risks is false if one uses a common-sense, widely-applied meaning of the phrase.
I see your point - interest rate risk and inflation risk are related. Why not make them the same thing and use them interchangeably?
I don't see a reason to conflate those two risks, though they do often show up at the same time. The interest rate risk on long bonds is that their value can go down if rates go up. The inflation risk on long bonds is that inflation can go up while your yield stays flat. More directly, one has nominal dollar implications and one has real dollar implications, but again, these often show up together. In the past, it has been common to find rising inflation and rates paralleling one another, which separately/together devalue existing long bonds in different ways.
Yes, that is true. The loss due to interest rate hikes can be recovered by holding to duration. The inflation damage can't. That's why I accept the push to have two terms.
Noobvestor wrote:
Thu May 21, 2020 10:04 pm
As for TIPS: I think they're a great way to go longer without taking on some of the rate risk of LTTs. Of course, there is rate risk for STTs too. Personally, I prefer to avoid the extremes - STT reinvestment risk and LTT term risk. Intermediate works for me. All things in balance.
Funny to hear you talk about TIPS. I'd expect you to be arguing "TIPS yields are negative because nominal yields are less than expected inflation", so why lock into long bonds that have yields less than expected inflation?

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Thu May 21, 2020 10:32 pm

typical.investor wrote:
Thu May 21, 2020 10:22 pm
Funny to hear you talk about TIPS. I'd expect you to be arguing "TIPS yields are negative because nominal yields are less than expected inflation", so why lock into long bonds that have yields less than expected inflation?
Good question! I would much rather have a slightly negative guaranteed real return personally than a slightly positive guaranteed nominal one. The latter can be eroded by inflation, but at least with the former you know what you'll get back in terms of purchasing power.

But why not have one's cake and eat pie too? I hold intermediate TIPS and Treasuries - a combination of long, short, real, nominal. Some people see 'neutralizing the duration risk' (whatever that means) as Really Important. I think hedging various possibilities is more important. YMMV.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by typical.investor » Thu May 21, 2020 10:37 pm

KEotSK66 wrote:
Thu May 21, 2020 10:18 pm
if you're duration/liability-matching with a bond you're locked in, why would you run the risk of failing to realize the required cash flow by trading and possibly coming up short
Is that statement an argument for staying to short term? If so, I don't think it works.

If you are duration matching and you need to rebalance, just sell so that your duration doesn't change. Again, it's unlikely that you are rebalancing into bonds after your stocks have suffered a (temporary) NAV loss.

Using short term for liability matching seems a sure fire way to underperform. If you know your spending is in 20 years and you forgo the term premium until then, all you are doing is leaving money on the table and walking away.

The only situation you are going to do better would be in a stagflation type environment. So sure you can forgo the term premium and do better in stagflation.

You can also realize the term premium and rebalance effectively by matching your holdings to duration. Actually, longer duration likely works better in an equity crash assuming it's not caused by inflation.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Thu May 21, 2020 11:14 pm

typical.investor wrote:
Thu May 21, 2020 10:37 pm
KEotSK66 wrote:
Thu May 21, 2020 10:18 pm
if you're duration/liability-matching with a bond you're locked in, why would you run the risk of failing to realize the required cash flow by trading and possibly coming up short
Is that statement an argument for staying to short term? If so, I don't think it works.

If you are duration matching and you need to rebalance, just sell so that your duration doesn't change. Again, it's unlikely that you are rebalancing into bonds after your stocks have suffered a (temporary) NAV loss.

Using short term for liability matching seems a sure fire way to underperform. If you know your spending is in 20 years and you forgo the term premium until then, all you are doing is leaving money on the table and walking away.

The only situation you are going to do better would be in a stagflation type environment. So sure you can forgo the term premium and do better in stagflation.

You can also realize the term premium and rebalance effectively by matching your holdings to duration. Actually, longer duration likely works better in an equity crash assuming it's not caused by inflation.
Rockstar made 2 points, not one

first, the whole point of duration/liability matching is the commitment to the future needed cash flow, if you want to jeopardize the future needed cash flow feel free to do so

second, he's using short bonds because he has a future (short term) cash flow need, rebalancing, he's duration-matching on the short end
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 6:26 am

KEotSK66 wrote:
Thu May 21, 2020 11:14 pm
second, he's using short bonds because he has a future (short term) cash flow need, rebalancing, he's duration-matching on the short end
Rebalancing isn't a "cash flow need" because it's not consumption (aka a liability), so it doesn't pay into the duration matching question.

Plus it's not totally rational to have rebalancing as a discrete goal. Rebalancing is, like duration matching, a strategy for managing risk that helps you achieve your ACTUAL goals (i.e. future consumption).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 6:30 am

Noobvestor wrote:
Thu May 21, 2020 9:44 pm
I'm also not suggesting people speculate on the future direction of bond prices - I've explicitly said the opposite.
The entire premise behind intentionally mismatching your duration and your investment time horizon is speculative: it's disingenuous to advocate for mismatching duration while encouraging people to not speculate on bond prices.

It's literally impossible to do the former without doing the latter.

If you don't want to encourage speculation then please stop trying to argue against duration matching. It's really that simple.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

KEotSK66
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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Fri May 22, 2020 6:43 am

vineviz wrote:
Fri May 22, 2020 6:26 am
KEotSK66 wrote:
Thu May 21, 2020 11:14 pm
second, he's using short bonds because he has a future (short term) cash flow need, rebalancing, he's duration-matching on the short end
Rebalancing isn't a "cash flow need" because it's not consumption (aka a liability), so it doesn't pay into the duration matching question.

Plus it's not totally rational to have rebalancing as a discrete goal. Rebalancing is, like duration matching, a strategy for managing risk that helps you achieve your ACTUAL goals (i.e. future consumption).
a cash flow need is whatever the person wants it to be, it's not up to YOU to decide how the person uses the money

:?: :?: :?:
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 8:43 am

KEotSK66 wrote:
Fri May 22, 2020 6:43 am
a cash flow need is whatever the person wants it to be, it's not up to YOU to decide how the person uses the money
I think you misunderstood me.

Like interest rate risk, the phrase cash flow has a definite meaning in this context. The phrase refers exclusively to expenditures (i.e. consumption), which is not what rebalancing is.

My intent was not to express an opinion about rebalancing (I don't think rebalancing is bad, in other words) but to simply point out that rebalancing is not a cash flow and — therefore — has no effect on the process of duration matching.

If someone doesn't WANT to use duration matching, either because it seems too hard or because they prefer to speculate on future changes in bond yields, that's fine with me. I don't happen to agree with that choice, but personal finance is personal for a reason.

Likewise, if an investor doesn't want to invest the time or energy to grapple with the nuances of things like "interest rate risk" or bond durations then whose to say they must? Most people can meet their personal financial goals without getting into the details of stuff like that.

Just let's not pretend like these concepts don't ACTUALLY have meaning, and that sometimes having a firm grasp of that meaning isn't sometimes valuable.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Fri May 22, 2020 9:16 am

vineviz wrote:
Fri May 22, 2020 8:43 am
KEotSK66 wrote:
Fri May 22, 2020 6:43 am
a cash flow need is whatever the person wants it to be, it's not up to YOU to decide how the person uses the money
Like interest rate risk, the phrase cash flow has a definite meaning in this context. The phrase refers exclusively to expenditures (i.e. consumption), which is not what rebalancing is.

the investor decides what to do with money

I used to invest in 1-year cds so the following year i would have money to invest in my roth ira, I held several funds at the time and when I got the money I would put it into whichever fund needed to brought up to its allocation

duration-matching makes a known amount of money available at a specific time for whatever purpose

My intent was not to express an opinion about rebalancing (I don't think rebalancing is bad, in other words) but to simply point out that rebalancing is not a cash flow and — therefore — has no effect on the process of duration matching.

what does that even mean :?: :shock: :oops:

the process or end result of duration matching is the needed cash flow at a point in time
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 9:22 am

KEotSK66 wrote:
Fri May 22, 2020 9:16 am
duration-matching makes a known amount of money available at a specific time for whatever purpose
No. That's wrong, and I just explained why.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Fri May 22, 2020 9:56 am

just like 2 weeks ago when you "explained" how you could duration-match with a bond fund ???
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 10:38 am

KEotSK66 wrote:
Fri May 22, 2020 9:56 am
just like 2 weeks ago when you "explained" how you could duration-match with a bond fund ???
Did you not understand that explanation either? I thought it was very clear, but I’m happy to try again if you’d like.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Fri May 22, 2020 3:04 pm

vineviz wrote:
Fri May 22, 2020 6:30 am
Noobvestor wrote:
Thu May 21, 2020 9:44 pm
I'm also not suggesting people speculate on the future direction of bond prices - I've explicitly said the opposite.
The entire premise behind intentionally mismatching your duration and your investment time horizon is speculative: it's disingenuous to advocate for mismatching duration while encouraging people to not speculate on bond prices.

It's literally impossible to do the former without doing the latter.

If you don't want to encourage speculation then please stop trying to argue against duration matching. It's really that simple.
We can go in circles forever about what is and isn't speculative. I believe it's speculative to go only or primarily with long nominal bonds given that we don't know what our nominal obligations will be in 20 to 30 years. You think it's speculative to hold something closer to a market-weighted (neutral) duration. The crux of your argument seems to be that by eliminating one variable (nominal uncertainty) speculation is vanquished.

The difference is that I understand your opinion (even if I disagree) while you insist it is fact and anyone else is speculating - whether you like it or not, tilting toward LLTs involves speculating about future spending needs and inflation. All investing involves some amount of speculation in one form or another (rates, inflation, etc...). There is no risk-free option in stocks or bonds, just different risks. I think rates could go up or down, inflation could go up or down, and I choose a middle ground to hedge those outcomes, because the future is uncertain. Right now we're at record-low rates. I don't know what's next. Some LTT advocates in this thread are confident we're headed for lower rates, though. That's speculation.

For context: the reason I'm engaged in this discussion of long bonds isn't because I think long bonds are intrinsically bad - I just think they have a lot of risks that get buried under the rhetoric of them 'neutralizing' rate risk (as if it that made them safe). It's not a coincidence that investor interest in long bonds spikes after they do well. I know you've been a champion of them since before this crash. I'm not accusing you of market timing your arguments. In part, I'm trying to caution other investors about the risks of a buying into a recently outperforming asset class. I also think people should consider a more multifaceted risk model rather than just a black-and-white view that with LTTs they can avoid speculation.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 3:53 pm

Noobvestor wrote:
Fri May 22, 2020 3:04 pm
We can go in circles forever about what is and isn't speculative. I believe it's speculative to go only or primarily with long nominal bonds given that we don't know what our nominal obligations will be in 20 to 30 years.
No sweat: if your future cash flows are sensitive to unexpected changes in consumer prices then choose long-term TIPS instead of long-term nominal bonds. There is no need to take on more interest rate risk merely to address your inflation risk. You can minimize both risks at the same time.
Noobvestor wrote:
Fri May 22, 2020 3:04 pm
The difference is that I understand your opinion (even if I disagree) while you insist it is fact and anyone else is speculating - whether you like it or not, tilting toward LLTs involves speculating about future spending needs and inflation. All investing involves some amount of speculation in one form or another (rates, inflation, etc...). There is no risk-free option in stocks or bonds, just different risks.
The fact that a claim to "understand" interest rate risk is followed by statements like "tilting toward LLTs involves speculating" and "there is no risk-free option in stocks or bonds" demonstrates quite clearly that the understanding is incomplete, at best.

There is ABSOLUTLEY NO SPECULATION involved in buying a bond that promises to yield 1.5% nominal or 0% real and which has absolutely no chance of yielding ANYTHING BUT THOSE AMOUNTS over the duration the bond. There is literally no definition of "speculative" which includes an investment whose time horizon and total return is known with 100% certainty at the time it is made.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by firebirdparts » Fri May 22, 2020 3:58 pm

I speculate on them all the time. With leverage, even. If I bought individual long term bonds and kept them, sure, I could escape the speculating. But I don't want to.

How is this a fascinating argument? It seems like you couldn't possibly misunderstand any of this. Are you just pretending to argue?
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Re: Rekenthaler: Long Bonds Are for Fools

Post by rockstar » Fri May 22, 2020 4:06 pm

vineviz wrote:
Fri May 22, 2020 3:53 pm
There is ABSOLUTLEY NO SPECULATION involved in buying a bond that promises to yield 1.5% nominal or 0% real and which has absolutely no chance of yielding ANYTHING BUT THOSE AMOUNTS over the duration the bond. There is literally no definition of "speculative" which includes an investment whose time horizon and total return is known with 100% certainty at the time it is made.
It's speculative only if you don't hold them maturity. If you sell them before maturity, you might not get your principal back, or you might make more money if rates have dropped since you bought. Now, historically, treasury bonds have dropped for the last thirty years, but there's no guarantee that they will drop for the next thirty.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Fri May 22, 2020 4:10 pm

firebirdparts wrote:
Fri May 22, 2020 3:58 pm
I speculate on them all the time. With leverage, even. If I bought individual long term bonds and kept them, sure, I could escape the speculating. But I don't want to.
Intentionally choosing a mismatch between duration and your investment horizon is the way in which you are choosing to speculate. That's outside the scope of my statement, which was written specifically to include both time horizon AND total return so as to exclude cases like yours.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Beensabu » Fri May 22, 2020 8:54 pm

vineviz wrote:
Wed May 20, 2020 7:53 am
rockstar wrote:
Tue May 19, 2020 7:34 pm
Now, here's the tricky part: how do you rebalance without taking interest rate risk if you buy a 30 year?
You probably wouldn't be rebalancing from long-term bonds to short-term bonds, so rebalancing doesn't typically affect your average portfolio duration.
So you would not be rebalancing from long-term bonds to equities at any point? That seemed to be what rockstar was asking. How would you be able to do so without taking interest rate risk?

You have said that the high volatility of long-term treasury bonds and their general non-correlation to equities leads to lower volatility for a portfolio, and that long-term bonds are thus better diversifiers than short-term or intermediate-term bonds due to their higher volatility. How does that work without rebalancing?

Vineviz - If you have the time and inclination, could you please explain this?
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Re: Rekenthaler: Long Bonds Are for Fools

Post by cheezit » Fri May 22, 2020 10:12 pm

Beensabu wrote:
Fri May 22, 2020 8:54 pm
vineviz wrote:
Wed May 20, 2020 7:53 am
rockstar wrote:
Tue May 19, 2020 7:34 pm
Now, here's the tricky part: how do you rebalance without taking interest rate risk if you buy a 30 year?
You probably wouldn't be rebalancing from long-term bonds to short-term bonds, so rebalancing doesn't typically affect your average portfolio duration.
So you would not be rebalancing from long-term bonds to equities at any point? That seemed to be what rockstar was asking. How would you be able to do so without taking interest rate risk?

You have said that the high volatility of long-term treasury bonds and their general non-correlation to equities leads to lower volatility for a portfolio, and that long-term bonds are thus better diversifiers than short-term or intermediate-term bonds due to their higher volatility. How does that work without rebalancing?

Vineviz - If you have the time and inclination, could you please explain this?
I'm not vineviz, but I don't get the difficulties people are anticipating with rebalancing supposedly causing you to get stuck selling before maturity when the bond portion of one's portfolio is composed of long treasurys.

In simplified terms:
Stocks up / bonds up: no trades occur
Stocks down / bonds up: selling bonds before maturity, but at a profit so is this really a problem?
Stocks up / bonds down: you're buying bonds rather than selling, so it is impossible for this scenario to cause you to sell before maturity
Stocks down / bonds down: no trades occur

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Re: Rekenthaler: Long Bonds Are for Fools

Post by rockstar » Fri May 22, 2020 11:06 pm

cheezit wrote:
Fri May 22, 2020 10:12 pm
Beensabu wrote:
Fri May 22, 2020 8:54 pm
vineviz wrote:
Wed May 20, 2020 7:53 am
rockstar wrote:
Tue May 19, 2020 7:34 pm
Now, here's the tricky part: how do you rebalance without taking interest rate risk if you buy a 30 year?
You probably wouldn't be rebalancing from long-term bonds to short-term bonds, so rebalancing doesn't typically affect your average portfolio duration.
So you would not be rebalancing from long-term bonds to equities at any point? That seemed to be what rockstar was asking. How would you be able to do so without taking interest rate risk?

You have said that the high volatility of long-term treasury bonds and their general non-correlation to equities leads to lower volatility for a portfolio, and that long-term bonds are thus better diversifiers than short-term or intermediate-term bonds due to their higher volatility. How does that work without rebalancing?

Vineviz - If you have the time and inclination, could you please explain this?
I'm not vineviz, but I don't get the difficulties people are anticipating with rebalancing supposedly causing you to get stuck selling before maturity when the bond portion of one's portfolio is composed of long treasurys.

In simplified terms:
Stocks up / bonds up: no trades occur
Stocks down / bonds up: selling bonds before maturity, but at a profit so is this really a problem?
Stocks up / bonds down: you're buying bonds rather than selling, so it is impossible for this scenario to cause you to sell before maturity
Stocks down / bonds down: no trades occur
You're assuming that bonds are going up and down at the same rate as equities. This mismatch in grow rates is what will cause you rebalance at less than optimal times. And it really depends how much you paid for your equities and bonds.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by typical.investor » Fri May 22, 2020 11:07 pm

cheezit wrote:
Fri May 22, 2020 10:12 pm
In simplified terms:
Stocks up / bonds up: no trades occur
Stocks down / bonds up: selling bonds before maturity, but at a profit so is this really a problem?
Stocks up / bonds down: you're buying bonds rather than selling, so it is impossible for this scenario to cause you to sell before maturity
Stocks down / bonds down: no trades occur
I think the above is a good way to look at it.

Stocks up / bonds up: no trades occur

Of course, over time stocks will probably be up more and rebalanced into bonds. It's difficult to see this going on for that long. If the economy is doing well, rates will go up and we'll be in the stocks up / bonds down scenario. Anyway, I see no advantage for short term here.

Stocks down / bonds up: selling bonds before maturity, but at a profit so is this really a problem?

No problem. And if you are holding longer maturities in a crisis, or if rates have dropped to stimulate the economy, then those longer term bonds will be up more and be better for rebalancing. Longer term maturities are better here I think.

Stocks up / bonds down: you're buying bonds rather than selling, so it is impossible for this scenario to cause you to sell before maturity
Exactly, the least of my worries. Usually when the economy is good and stocks are good, rates tend to go up to cool any inflation risk. And when rates go up, prices go down. Good time to buy. Longer term is better here.


Stocks down / bonds down: no trades occur
Of course, this could be a stagflation type environment where stocks are down more than bonds. That would be the one case where short duration wins. Rising rates will hurt long duration more.

Again, is it worth protecting against the unlikely case of stagflation by forgoing and term returns?

So I don't think it's a one size fits all situation, and different investors may have different concerns.

Anyway, with bonds today being priced to return less than inflation expectations, I think any bond short/long TIPS/nominal is expected to have a REAL loss. Alternatively, realized inflation perhaps will come in lower than expected and there will be a REAL gain.

In any case, stagflation would seem the most unlikely outcome (unless of course the US and China decouple economically). I think it's really difficult for us to predict inflation (or deflation), and so the choice of short/long TIPS/nominal isn't 100% clear.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Sat May 23, 2020 2:53 am

vineviz wrote:
Fri May 22, 2020 3:53 pm
There is ABSOLUTLEY NO SPECULATION involved in buying a bond that promises to yield 1.5% nominal or 0% real and which has absolutely no chance of yielding ANYTHING BUT THOSE AMOUNTS over the duration the bond. There is literally no definition of "speculative" which includes an investment whose time horizon and total return is known with 100% certainty at the time it is made.
I can't really debate with you if we can't agree on the meanings of words. All investments involve speculation. Whether that's speculation about inflation, future rates, equity returns, expenses, there's just no getting around it - investing (like life) is a speculative endeavor. I very narrowly agree that if someone buys a nominal bond and holds it to duration, they are (barring default risk) guaranteed a certain nominal return. But that's a very narrow definition of non-speculative, and not super useful in my opinion (again note: I'm stating opinions, not claiming universal truths). If nothing else, you're speculating that those nominal payouts will prove more useful than alternative options over the specified time frame. Also, any stock/bond allocation is speculative, not to mention a choice of Treasuries over a Total Bond approach. So much speculation going on here!

The least speculative option in terms of knowing future returns (again, a limited definition, but for the sake of argument) would be something like an annuity - a product that (barring default risk) will give you a predictable ongoing nominal return. That seems like the logical end point of your argument (i.e. knowing exact future nominal returns = good) - if we're going to focus on predictability, why not go for annuities? It seems much simpler than annually adjusting one's bond duration, and meets your key criteria: knowing exactly what return you'll get going forward. Strangely, few people seem to be that concerned with absolute nominal certitude, buying into non-inflation-adjusted annuities. I'm speculating (no pun intended) that many people value bonds for a variety of reasons in their portfolio that go beyond duration-matching. YMMV.

Anyway, you're laser-focused on knowns. Here are some things I don't know: (1) my future expenses in nominal terms, (2) future interest rates, (3) future inflation rates, (4) future equity returns, (5) whether or not matching bond duration will provide higher or lower returns than alternative options. From your perspective: there's no speculation w/LTTs because you know what you'll get in nominal dollars. I get that I'm not going to change your mind on this, but for anyone else reading this thread I hope they'll consider the limited utility of knowing nominal future returns. Alas, too, believing they 'avoided speculation' would provide little comfort to someone who invested in LTTs from the 40s through the 70s. I get it - on some theoretical model, given certain constraints and limited academic definitions, they avoiding speculation, but try telling that to them.

P.S. I've noted this before, but can you please avoid the all-caps text? It's against forum policy and reads like screaming. Thanks. rules
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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Sat May 23, 2020 3:05 am

typical.investor wrote:
Fri May 22, 2020 11:07 pm
Of course, this could be a stagflation type environment where stocks are down more than bonds. That would be the one case where short duration wins. Rising rates will hurt long duration more. Again, is it worth protecting against the unlikely case of stagflation by forgoing and term returns?

So I don't think it's a one size fits all situation, and different investors may have different concerns.

Anyway, with bonds today being priced to return less than inflation expectations, I think any bond short/long TIPS/nominal is expected to have a REAL loss. Alternatively, realized inflation perhaps will come in lower than expected and there will be a REAL gain.

In any case, stagflation would seem the most unlikely outcome (unless of course the US and China decouple economically). I think it's really difficult for us to predict inflation (or deflation), and so the choice of short/long TIPS/nominal isn't 100% clear.
It's interesting to see the combination of speculation and anti-speculators in this thread. You clearly think that stagflation is unlikely. That's fine - you may be right. It's also implicit in the argument for duration-matching LTTs made by others (I say this because all theories aside if stagflation shows up a stock + long bond portfolio is likely to do relatively poorly - I think we can all agree on this). Personally, I try not to get too hung up on what is more or less likely, and stay diversified. An all-weather approach suits me, but I agree: different investors may have different concerns.

As for TIPS versus nominal, long versus short - I agree on that front, too - so I hold follow a middle path and hope for the best :beer
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Re: Rekenthaler: Long Bonds Are for Fools

Post by typical.investor » Sat May 23, 2020 4:04 am

Noobvestor wrote:
Sat May 23, 2020 3:05 am
typical.investor wrote:
Fri May 22, 2020 11:07 pm
Of course, this could be a stagflation type environment where stocks are down more than bonds. That would be the one case where short duration wins. Rising rates will hurt long duration more. Again, is it worth protecting against the unlikely case of stagflation by forgoing and term returns?

So I don't think it's a one size fits all situation, and different investors may have different concerns.

Anyway, with bonds today being priced to return less than inflation expectations, I think any bond short/long TIPS/nominal is expected to have a REAL loss. Alternatively, realized inflation perhaps will come in lower than expected and there will be a REAL gain.

In any case, stagflation would seem the most unlikely outcome (unless of course the US and China decouple economically). I think it's really difficult for us to predict inflation (or deflation), and so the choice of short/long TIPS/nominal isn't 100% clear.
It's interesting to see the combination of speculation and anti-speculators in this thread. You clearly think that stagflation is unlikely. That's fine - you may be right. It's also implicit in the argument for duration-matching LTTs made by others (I say this because all theories aside if stagflation shows up a stock + long bond portfolio is likely to do relatively poorly - I think we can all agree on this).
No, I don't think anyone agrees that Long Term TIPS will be hurt by stagflation. If you are worried about stagflation though, are Short Term TIPS really better than long? At current prices, Short Term TIPS will underperform Long Term TIPS by more. You kinda have to bet that the situation will change to choose Short Term TIPS.
Noobvestor wrote:
Sat May 23, 2020 3:05 am
Personally, I try not to get too hung up on what is more or less likely, and stay diversified. An all-weather approach suits me, but I agree: different investors may have different concerns.

As for TIPS versus nominal, long versus short - I agree on that front, too - so I hold follow a middle path and hope for the best :beer
Yeah, unless we know whether we'll see inflation or deflation, I don't see how we perfectly optimize our fixed income.

Expecting stable rates or deflation would favor Long Term Nominals
Expecting more inflation would favor Long Term TIPS

Expecting a change from deflation to inflation would seem to favor Short Term Nominals
Needing to protect immediate spending power would favor Short Term TIPS

It's just weird that nominals are priced to return less than expected inflation. Does that mean inflation is expected to come down, or that too many people in the market (insurance companies, central banks, foreign investors looking for higher safe yield but not worried about US inflation) are bringing yield down?

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Sat May 23, 2020 4:23 am

typical.investor wrote:
Sat May 23, 2020 4:04 am
Noobvestor wrote:
Sat May 23, 2020 3:05 am
It's interesting to see the combination of speculation and anti-speculators in this thread. You clearly think that stagflation is unlikely. That's fine - you may be right. It's also implicit in the argument for duration-matching LTTs made by others (I say this because all theories aside if stagflation shows up a stock + long bond portfolio is likely to do relatively poorly - I think we can all agree on this).
No, I don't think anyone agrees that Long Term TIPS will be hurt by stagflation. If you are worried about stagflation though, are Short Term TIPS really better than long? At current prices, Short Term TIPS will underperform Long Term TIPS by more. You kinda have to bet that the situation will change to choose Short Term TIPS.
Sorry, to be clear: I wasn't talking about TIPS - by LTTs meant long-term nominal Treasuries. As for short versus long TIPS: I never quite understood the appeal of short - in practice, they have apparently tracked inflation better (from what I've read) but in a pinch I have to imagine they'd get bid up if higher inflation kicked in, so reinvestment risk would become a serious issue. Intermediate/long seem intuitively better.
typical.investor wrote:
Sat May 23, 2020 4:04 am
Expecting stable rates or deflation would favor Long Term Nominals
Expecting more inflation would favor Long Term TIPS

Expecting a change from deflation to inflation would seem to favor Short Term Nominals
Needing to protect immediate spending power would favor Short Term TIPS

It's just weird that nominals are priced to return less than expected inflation. Does that mean inflation is expected to come down, or that too many people in the market (insurance companies, central banks, foreign investors looking for higher safe yield but not worried about US inflation) are bringing yield down?
I agree it's hard to say - there are a lot of big institutional players not to mention Fed interventions pushing around different bonds. I don't see anything wrong with trying to parse it more finely, but this is part of the reason for my relatively 'lazy' middle-of-the-road approach: per my signature line (the quote from Larry) I just try to balance various possibilities and accept that I can't know for sure in advance. Best guess: the flight-to-safety is still in effect and pushing yields on Treasuries down (we saw this in the last crisis, too) but who knows. TIPS are also priced to return less than inflation, too, so it doesn't surprise me that nominals are as well (assuming insurance premium more/less = liquidity discount).
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Sat May 23, 2020 5:49 am

Noobvestor wrote:
Sat May 23, 2020 2:53 am
P.S. I've noted this before, but can you please avoid the all-caps text? It's against forum policy and reads like screaming. Thanks. rules
As I’ve told you when you’ve said this elsewhere, we have excellent moderators to whom you can report stuff like this. I don’t think the considered use of all caps for emphasis is either prohibited or screaming, but if YOU think it is feel free to flag my posts.

Or, you know, just stop reading them.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Sat May 23, 2020 5:52 am

vineviz wrote:
Sat May 23, 2020 5:49 am
Noobvestor wrote:
Sat May 23, 2020 2:53 am
P.S. I've noted this before, but can you please avoid the all-caps text? It's against forum policy and reads like screaming. Thanks. rules
As I’ve told you when you’ve said this elsewhere, we have excellent moderators to whom you can report stuff like this. I don’t think the considered use of all caps for emphasis is either prohibited or screaming, but if YOU think it is feel free to flag my posts.
The guideline comes directly from the Bogleheads page I linked: "avoid posting in ALL CAPITAL LETTERS or otherwise using distracting formatting"

I was trying to be polite about it - a civil and direct request to avoid burdening the volunteer moderators. Anyway, do what you will.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Sat May 23, 2020 6:11 am

Beensabu wrote:
Fri May 22, 2020 8:54 pm
vineviz wrote:
Wed May 20, 2020 7:53 am
rockstar wrote:
Tue May 19, 2020 7:34 pm
Now, here's the tricky part: how do you rebalance without taking interest rate risk if you buy a 30 year?
You probably wouldn't be rebalancing from long-term bonds to short-term bonds, so rebalancing doesn't typically affect your average portfolio duration.
So you would not be rebalancing from long-term bonds to equities at any point? That seemed to be what rockstar was asking. How would you be able to do so without taking interest rate risk?

You have said that the high volatility of long-term treasury bonds and their general non-correlation to equities leads to lower volatility for a portfolio, and that long-term bonds are thus better diversifiers than short-term or intermediate-term bonds due to their higher volatility. How does that work without rebalancing?

Vineviz - If you have the time and inclination, could you please explain this?
Well I'm not sure I understand why people think rebalancing is a problem, or even complication, for duration matching so I'm not quite sure from which angle to attempt an explanation for why it's not.

Maybe people are getting stuck on the fact that rebalancing might require selling a bond before it matures? Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

Rebalancing from bonds to stocks or vice versa won't effect the average duration of the bond holdings (unless the investor intentionally tries to do that).

In practice, I'd counsel investors not to structure their portfolio in such a way that they'd be likely to use individudal bonds as a potential source of funds for rebalancing for a host of practical reasons. One of those reasons is that it could be difficult to reduce each individual bond holding proportionately to effect a rebalancing.

And the reason an investor might set up their entire bond portfolio in individual bonds is to do something more like cash-flow matching (which is like duration matching on steroids), in which case the appropriate policy would be to NOT rebalance between stocks and bonds anyway.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by HEDGEFUNDIE » Sat May 23, 2020 6:20 am

Noobvestor wrote:
Sat May 23, 2020 2:53 am
Anyway, you're laser-focused on knowns. Here are some things I don't know: (1) my future expenses in nominal terms, (2) future in rates, (3) future inflation rates, (4) future equity returns, (5) whether or not matching bond duration will provide higher or lower returns than alternative options. From your perspective: there's no speculation w/LTTs because you know what you'll get in nominal dollars. I get that I'm not going to change your mind on this, but for anyone else reading this thread I hope they'll consider the limited utility of knowing nominal future returns.
It’s a wonder anyone ever retires with so many known unknowns. If only someone could come up with a rule of thumb for a “safe” retirement portfolio target, expressed as a multiple of your future expected annual expenses in nominal terms. But oh who am I kidding, estimating your future expenses in nominal terms is just useless, right?

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Re: Rekenthaler: Long Bonds Are for Fools

Post by Noobvestor » Sat May 23, 2020 6:28 am

HEDGEFUNDIE wrote:
Sat May 23, 2020 6:20 am
Noobvestor wrote:
Sat May 23, 2020 2:53 am
Anyway, you're laser-focused on knowns. Here are some things I don't know: (1) my future expenses in nominal terms, (2) future in rates, (3) future inflation rates, (4) future equity returns, (5) whether or not matching bond duration will provide higher or lower returns than alternative options. From your perspective: there's no speculation w/LTTs because you know what you'll get in nominal dollars. I get that I'm not going to change your mind on this, but for anyone else reading this thread I hope they'll consider the limited utility of knowing nominal future returns.
It’s a wonder anyone ever retires with so many known unknowns. If only someone could come up with a target retirement-ready portfolio size, able to yield a rule of thumb for a “safe” withdrawal rate in nominal terms. But oh who am I kidding, estimating your future expenses in nominal terms is just useless, right?
Typically, SWR calculations assume inflation adjustments, including the famous Trinity Study among others. So no, not nominal. :wink:

As for there being so many unknowns, well, that's why some of us diversify to plan for and hedge various possible scenarios. Investing 101.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by LadyGeek » Sat May 23, 2020 7:25 am

With regards to some earlier posts, the discussion is getting a bit contentious.

Please stay on-topic.
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*

Post by KEotSK66 » Sat May 23, 2020 8:15 am

Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

selling an individual bond before maturity in order to shorten the duration of the portfolio exposes the investor to interest rate risk
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Re: Rekenthaler: Long Bonds Are for Fools

Post by petulant » Sat May 23, 2020 8:30 am

vineviz wrote:
Sat May 23, 2020 6:11 am
Beensabu wrote:
Fri May 22, 2020 8:54 pm
vineviz wrote:
Wed May 20, 2020 7:53 am
rockstar wrote:
Tue May 19, 2020 7:34 pm
Now, here's the tricky part: how do you rebalance without taking interest rate risk if you buy a 30 year?
You probably wouldn't be rebalancing from long-term bonds to short-term bonds, so rebalancing doesn't typically affect your average portfolio duration.
So you would not be rebalancing from long-term bonds to equities at any point? That seemed to be what rockstar was asking. How would you be able to do so without taking interest rate risk?

You have said that the high volatility of long-term treasury bonds and their general non-correlation to equities leads to lower volatility for a portfolio, and that long-term bonds are thus better diversifiers than short-term or intermediate-term bonds due to their higher volatility. How does that work without rebalancing?

Vineviz - If you have the time and inclination, could you please explain this?
Well I'm not sure I understand why people think rebalancing is a problem, or even complication, for duration matching so I'm not quite sure from which angle to attempt an explanation for why it's not.

Maybe people are getting stuck on the fact that rebalancing might require selling a bond before it matures? Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

Rebalancing from bonds to stocks or vice versa won't effect the average duration of the bond holdings (unless the investor intentionally tries to do that).

In practice, I'd counsel investors not to structure their portfolio in such a way that they'd be likely to use individudal bonds as a potential source of funds for rebalancing for a host of practical reasons. One of those reasons is that it could be difficult to reduce each individual bond holding proportionately to effect a rebalancing.

And the reason an investor might set up their entire bond portfolio in individual bonds is to do something more like cash-flow matching (which is like duration matching on steroids), in which case the appropriate policy would be to NOT rebalance between stocks and bonds anyway.
Generally an investor rebalances between stocks and bonds either to buy stocks after large stock losses, or to buy bonds after large stock gains. The latter isn't relevant since it doesn't involve the risk of bonds themselves. The former can be relevant. An investor is generally intending to take more risk on the stock side and less risk on the bond side, so when stocks drop the investor is hoping that the bond side A) remains a ballast and B) can possibly be used for rebalancing to purchase stocks when they are low. What the investor in long-term bonds will find, some of the time, is that this has not occurred. Even though the investor would normally be indifferent to the market value of the long-term bonds in themselves since the investor has duration matched, for the portfolio as a whole the investor may find, some of the time, that long-term bonds have declined in value along with stocks. This means that the investor will experience greater psychological remorse than they would otherwise, and the investor will have lost at least some opportunity to rebalance, purchasing stocks at a lower value with higher expected reward.

So, here is the point. The value of duration matching is premised on immunizing against interest rate risk, an important determinant of volatility in bond prices. But volatility, and interest rate risk, can still impact the investor by creating time periods where the portfolio as a whole declines more than the investor would like.

One response the boosters of long-term bonds might make is that long-term bonds generally don't decline in value at the same time as stocks. I take it that isn't your point, vineviz, and at any rate it is plagued by recency bias and insecure economic theory. Just because treasury bonds have been a safe haven during many recent declines doesn't mean it's impossible for long-term bonds to decline during bad periods, to which the 1968-1981 period can attest. There might still be something here that long-term bonds have a low correlation with stocks, so they provide diversification--the flipside of which is, yes, the long-term bonds can sometimes go in the same direction as stocks. That just tees up the question whether the asset itself is worth including in a diversified portfolio regardless of duration issues since that point is true of any number of low correlation assets, including gold.

Another response might be that long-term bonds may still serve as a ballast in the portfolio since they probably would not decline as much as stocks and, however far they fall, they also themselves have a higher expected return afterward. The direction this response would go is that the investor should be less concerned about volatility in the portfolio right now because they have plenty of time to earn returns and reach their goals.

But that leads to another question that undermines the whole point of long-term bonds. If the investor has a need for the funds far enough in the future to have a long duration, then the investor also presumably has little near-term need for the stock portion of the portfolio. The same principle that immunizes the investor from interest rate risk by giving them the duration to earn the now higher expected return should also apply to stocks. So, the question becomes, again, whether the asset (long-term bonds) is worth including in a diversified portfolio.

In other words, if rebalancing is valuable, long-term bonds undermine it; if rebalancing isn't valuable, the investor's comfort with volatility and a long duration would presumably also apply to stocks. So long-term bonds really need to be worth it to own them. At these returns, and in light of inflation risk, that is a serious problem. I really don't get why, five pages in, people are still arguing about interest rate risk instead of these other aspects of the asset.

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Re: *

Post by vineviz » Sat May 23, 2020 8:44 am

KEotSK66 wrote:
Sat May 23, 2020 8:15 am
Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

selling an individual bond before maturity in order to shorten the duration of the portfolio exposes the investor to interest rate risk
It won't if the investor's time horizon has shortened as well. As long as the durations remain matched, the exposure to interest rate risk will not increase merely because a bond was sold before maturity.

In other words, it is duration (and not maturity alone) that matters.
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Re: *

Post by KEotSK66 » Sat May 23, 2020 8:56 am

vineviz wrote:
Sat May 23, 2020 8:44 am
KEotSK66 wrote:
Sat May 23, 2020 8:15 am
Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

selling an individual bond before maturity in order to shorten the duration of the portfolio exposes the investor to interest rate risk
It won't if the investor's time horizon has shortened as well. As long as the durations remain matched, the exposure to interest rate risk will not increase merely because a bond was sold before maturity.
[ quote fixed by admin LadyGeek]

just the act of selling the individual bond increases interest rate risk, especially true if the bond being sold to accomplish duration-shortening of the portfolio is a long term bond
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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Sat May 23, 2020 9:08 am

petulant wrote:
Sat May 23, 2020 8:30 am
But that leads to another question that undermines the whole point of long-term bonds. If the investor has a need for the funds far enough in the future to have a long duration, then the investor also presumably has little near-term need for the stock portion of the portfolio. The same principle that immunizes the investor from interest rate risk by giving them the duration to earn the now higher expected return should also apply to stocks. So, the question becomes, again, whether the asset (long-term bonds) is worth including in a diversified portfolio.
I don't think we have to look very hard to see how the premise of this argument might be weak. The goal of saving and investing for retirement isn't to maximize expected return. Instead, the goal is to maximize future consumption. As we well know, those goals don't always align.

During the period extending from roughly five years before retirement to ten years after retirement, most investors are very exposed to sequence of returns risk and so managing portfolio volatility becomes incredibly important. In many ways, volatility management is arguably MORE important than return management since 45% loss in portfolio value the day after retirement is a LOT more damaging than a 20% loss regardless of whether the long-run returns are similar or not.

Someone who retires at, for example, age 65 is definitely a long-term investor (with a time horizon well in excess of 10-15 years) but I think we can agree that a 100% equity portfolio might not be optimal for them even if we leave aside questions about risk tolerance and behavioral problems.

I certainly wouldn't assume that every long-term investor needs ANY bonds. Young accumulators, for instance, probably should only have them if they are exceedingly risk averse. Yet I remain befuddled that the notion that investors who — for whatever reasons they might have — choose to allocate part of their portfolio to bonds should do so with an eye towards matching the duration of those bonds with their investment horizon.

People have been doing that for, quite literally, centuries and there is plenty of both empirical and theoretical evidence to support this exceptionally reasonable and logical approach. Somehow the rise of total bond market funds which, although they are a fine product, has contributed to a widespread misperception that intermediate-term bonds are somehow less risky for EVERYONE when that is quite obviously not the case.
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Re: *

Post by vineviz » Sat May 23, 2020 9:15 am

KEotSK66 wrote:
Sat May 23, 2020 8:56 am
vineviz wrote:
Sat May 23, 2020 8:44 am
KEotSK66 wrote:
Sat May 23, 2020 8:15 am
Duration matching doesn't actually require holding a bond to maturity, though, in order to achieve it. All that matters is keeping the weighted average duration of the bonds equal (or approximately equal) to the weighted average time to the investor's future expenditures (i.e. their time horizon).

selling an individual bond before maturity in order to shorten the duration of the portfolio exposes the investor to interest rate risk
It won't if the investor's time horizon has shortened as well. As long as the durations remain matched, the exposure to interest rate risk will not increase merely because a bond was sold before maturity.
[ quote fixed by admin LadyGeek]

just the act of selling the individual bond increases interest rate risk, especially true if the bond being sold to accomplish duration-shortening of the portfolio is a long term bond
This is completely false.

By definition, interest rate risk exists ONLY when the asset duration is not matched with the liability duration. As long as those two numbers remain equal then interest rate risk remains neutralized.

Let's say I have an investment time horizon of 10 years and I own equal amounts* of three bonds: Bond 1 with a duration of 5 years, Bond 2 with a duration of 10 years, and Bond 3 with a duration of 15 years. The weighed average duration is 10 years, so I'm immunized: no interest rate risk.

If I sell all of my holdings of Bonds 1 and 3 in order to buy more of Bond 2 then my interest rate risk has not changed at all because my weighted average duration has not changed.

Or let's say that I'm doing my annual portfolio review and my investment time horizon has dropped from 10 years to 9 years because one year has passed. I sell 30% of my Bond 3 holdings and reinvest that money in Bond 1. Again, because my weighted average duration is now 9 years (same as my investment horizon) I have no remaining interest rate risk despite selling some of Bond 3 before maturity.

*Simplifying for ease of comprehension.
Last edited by vineviz on Sat May 23, 2020 9:20 am, edited 1 time in total.
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petulant
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Re: Rekenthaler: Long Bonds Are for Fools

Post by petulant » Sat May 23, 2020 9:18 am

vineviz wrote:
Sat May 23, 2020 9:08 am
petulant wrote:
Sat May 23, 2020 8:30 am
But that leads to another question that undermines the whole point of long-term bonds. If the investor has a need for the funds far enough in the future to have a long duration, then the investor also presumably has little near-term need for the stock portion of the portfolio. The same principle that immunizes the investor from interest rate risk by giving them the duration to earn the now higher expected return should also apply to stocks. So, the question becomes, again, whether the asset (long-term bonds) is worth including in a diversified portfolio.
I don't think we have to look very hard to see how the premise of this argument might be weak. The goal of saving and investing for retirement isn't to maximize expected return. Instead, the goal is to maximize future consumption. As we well know, those goals don't always align.

During the period extending from roughly five years before retirement to ten years after retirement, most investors are very exposed to sequence of returns risk and so managing portfolio volatility becomes incredibly important. In many ways, volatility management is arguably MORE important than return management since 45% loss in portfolio value the day after retirement is a LOT more damaging than a 20% loss regardless of whether the long-run returns are similar or not.

Someone who retires at, for example, age 65 is definitely a long-term investor (with a time horizon well in excess of 10-15 years) but I think we can agree that a 100% equity portfolio might not be optimal for them even if we leave aside questions about risk tolerance and behavioral problems.

I certainly wouldn't assume that every long-term investor needs ANY bonds. Young accumulators, for instance, probably should only have them if they are exceedingly risk averse. Yet I remain befuddled that the notion that investors who — for whatever reasons they might have — choose to allocate part of their portfolio to bonds should do so with an eye towards matching the duration of those bonds with their investment horizon.

People have been doing that for, quite literally, centuries and there is plenty of both empirical and theoretical evidence to support this exceptionally reasonable and logical approach. Somehow the rise of total bond market funds which, although they are a fine product, has contributed to a widespread misperception that intermediate-term bonds are somehow less risky for EVERYONE when that is quite obviously not the case.
While I take your point that retirees might still want some duration, I think this dodges the point by limiting the analysis to a very specific group of investors. Accumulators are a key group of investors who might have an interest in long term bonds, and the upshot is that they would be better off with stocks in the current environment.

Even on the terms of your analysis, while the retirees' time horizon might be long, that doesn't mean the bond and equity allocations of the portfolio should both be equally matched to all time periods of the time horizon. For example, take a 65-year-old retiree with a need for some dollar amount during each future period, putting aside social security. It is not the case that this investor should determine an equity allocation in the abstract, then do duration matching for the bond allocation to all future time periods. It would be more rational for the time horizon to be tied to the allocation, such that distant time periods in 15-30 years would be expected to be funded more heavily by stocks while shorter-term needs in 5-10 years would be met by bonds. Thus, even for this hypothetical "long-term" investor, the optimal duration-matched portfolio, taking into account that stocks are arguably long-duration assets, might still have a bond portfolio with a duration that is squaring on the low end of intermediate.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Sat May 23, 2020 9:25 am

petulant wrote:
Sat May 23, 2020 9:18 am
While I take your point that retirees might still want some duration, I think this dodges the point by limiting the analysis to a very specific group of investors. Accumulators are a key group of investors who might have an interest in long term bonds, and the upshot is that they would be better off with stocks in the current environment.
Can we agree that saying that accumulators would be "better off" with 100% stocks might be ignoring some things we know to be true, such as the fact that investors are typically loss averse and are prone to innumerable behavioral biases?

In other words, I'm hoping to avoid derailing this thread by asking you to stipulate that IF a long-term accumulator decides to hold bonds THEN long-term bonds are the choice that minimizes interest rate risk.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by HEDGEFUNDIE » Sat May 23, 2020 9:29 am

vineviz wrote:
Sat May 23, 2020 9:25 am
petulant wrote:
Sat May 23, 2020 9:18 am
While I take your point that retirees might still want some duration, I think this dodges the point by limiting the analysis to a very specific group of investors. Accumulators are a key group of investors who might have an interest in long term bonds, and the upshot is that they would be better off with stocks in the current environment.
Can we agree that saying that accumulators would be "better off" with 100% stocks might be ignoring some things we know to be true, such as the fact that investors are typically loss averse and are prone to innumerable behavioral biases?

In other words, I'm hoping to avoid derailing this thread by asking you to stipulate that IF a long-term accumulator decides to hold bonds THEN long-term bonds are the choice that minimizes interest rate risk.
And minimizes portfolio drawdown risk too!

Man, LTTs, what can’t they do?

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Re: Rekenthaler: Long Bonds Are for Fools

Post by KEotSK66 » Sat May 23, 2020 9:29 am

By definition, interest rate risk exists ONLY when the asset duration is not matched with the liability duration. As long as those two numbers remain equal then interest rate risk remains neutralized.

you're dodging the point I made about selling

and since you will be selling individual bonds over years if not decades to shorten the portfolio duration you will be exposing yourself to interest rate risk and reinvestment risk frequently
Last edited by KEotSK66 on Sat May 23, 2020 9:32 am, edited 1 time in total.
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Re: Rekenthaler: Long Bonds Are for Fools

Post by petulant » Sat May 23, 2020 9:30 am

HEDGEFUNDIE wrote:
Sat May 23, 2020 9:29 am
vineviz wrote:
Sat May 23, 2020 9:25 am
petulant wrote:
Sat May 23, 2020 9:18 am
While I take your point that retirees might still want some duration, I think this dodges the point by limiting the analysis to a very specific group of investors. Accumulators are a key group of investors who might have an interest in long term bonds, and the upshot is that they would be better off with stocks in the current environment.
Can we agree that saying that accumulators would be "better off" with 100% stocks might be ignoring some things we know to be true, such as the fact that investors are typically loss averse and are prone to innumerable behavioral biases?

In other words, I'm hoping to avoid derailing this thread by asking you to stipulate that IF a long-term accumulator decides to hold bonds THEN long-term bonds are the choice that minimizes interest rate risk.
And minimizes portfolio drawdown risk too!

Man, LTTs, what can’t they do?
As I said earlier:
petulant wrote:One response the boosters of long-term bonds might make is that long-term bonds generally don't decline in value at the same time as stocks. I take it that isn't your point, vineviz, and at any rate it is plagued by recency bias and insecure economic theory. Just because treasury bonds have been a safe haven during many recent declines doesn't mean it's impossible for long-term bonds to decline during bad periods, to which the 1968-1981 period can attest. There might still be something here that long-term bonds have a low correlation with stocks, so they provide diversification--the flipside of which is, yes, the long-term bonds can sometimes go in the same direction as stocks. That just tees up the question whether the asset itself is worth including in a diversified portfolio regardless of duration issues since that point is true of any number of low correlation assets, including gold.

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Re: Rekenthaler: Long Bonds Are for Fools

Post by vineviz » Sat May 23, 2020 9:30 am

petulant wrote:
Sat May 23, 2020 9:18 am
Even on the terms of your analysis, while the retirees' time horizon might be long, that doesn't mean the bond and equity allocations of the portfolio should both be equally matched to all time periods of the time horizon.
Perhaps some people think this way, I don't know. It would be a form of mental accounting that would lead to a sub-optimal approach to portfolio construction.

Trying to apply concepts like risk-adjusted returns or return-maximization to the problem of retirement income will generally lead to poor outcomes because those concepts are answers to a different set of questions than the ones that retirees need to be asking.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Rekenthaler: Long Bonds Are for Fools

Post by petulant » Sat May 23, 2020 9:35 am

vineviz wrote:
Sat May 23, 2020 9:25 am
petulant wrote:
Sat May 23, 2020 9:18 am
While I take your point that retirees might still want some duration, I think this dodges the point by limiting the analysis to a very specific group of investors. Accumulators are a key group of investors who might have an interest in long term bonds, and the upshot is that they would be better off with stocks in the current environment.
Can we agree that saying that accumulators would be "better off" with 100% stocks might be ignoring some things we know to be true, such as the fact that investors are typically loss averse and are prone to innumerable behavioral biases?

In other words, I'm hoping to avoid derailing this thread by asking you to stipulate that IF a long-term accumulator decides to hold bonds THEN long-term bonds are the choice that minimizes interest rate risk.
It is concerning that you continue to quote only a portion of posts and ignore arguments you don't want to deal with. It is also concerning that you keep trying to come back to reinvestment risk, when the point I am making over and over again is that reinvestment risk is beside the point compared to expected returns and inflation risk.

Nowhere did I say accumulators would be "better off" with 100% stocks. What I am arguing is that, to the extent they are considering long-term bonds, they are better off using more stocks.

What I also argued is that behavioral risk cuts against long-term bonds. Long-term bonds are more volatile than short-term bonds. I expressly argued that while duration matching should immunize a long-term investor from the effects of volatility, they might still be impacted by it psychologically. If they are not, they are better off with stocks. Why are you ignoring what I actually said?

vineviz, you are the one derailing this thread. This is not a thread about you proving your definition of interest rate risk. This is a thread about whether long-term bonds are good investments. This is how the thread started:
Rekenthaler argues that long-term investors should avoid long bonds, because at current low rates the expected return is a non-starter.

petulant
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Re: Rekenthaler: Long Bonds Are for Fools

Post by petulant » Sat May 23, 2020 9:37 am

vineviz wrote:
Sat May 23, 2020 9:30 am
petulant wrote:
Sat May 23, 2020 9:18 am
Even on the terms of your analysis, while the retirees' time horizon might be long, that doesn't mean the bond and equity allocations of the portfolio should both be equally matched to all time periods of the time horizon.
Perhaps some people think this way, I don't know. It would be a form of mental accounting that would lead to a sub-optimal approach to portfolio construction.

Trying to apply concepts like risk-adjusted returns or return-maximization to the problem of retirement income will generally lead to poor outcomes because those concepts are answers to a different set of questions than the ones that retirees need to be asking.
I really am not sure if you know what mental accounting means. You're saying it makes sense to match the duration of a portfolio to the expected time period of the need, but an investor isn't allowed to match a longer duration asset like stocks with a longer term need. The corollary of what you are saying is that an investor can't really use average duration of two bond funds, either, because they are really funding short-term needs with long-dated bonds and long-term needs with short-dated bonds at the same time. But you expressly argue against that. Your point about averaging bond fund duration applies with equal force to a mix of stocks and bonds. The speed with which you deny that insight makes me think you're just hand waving at this point.

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