New Investor - are bonds just a higher yielding savings account?

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bojanradovic
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New Investor - are bonds just a higher yielding savings account?

Post by bojanradovic »

I'd like to preface this with I have no investing experience and I'm currently reading and researching as much as possible to understand the ETF world before I venture in. This question comes from a place of wanting to understand the general wisdom around bonds.

Let's assume you have everything in life set up. A reasonable mortgage at a low interest rate. A healthy emergency fund etc. And now you have an extra $50,000 to invest in the market and for the purposes of this example let's say it's in a taxable account. This $50K is the start of your retirement fund.

You then have to decide how you're going to invest that $50,000. A conservative approach might be a 60/40 split between equities and bonds. You are a disciplined investor who will never panic and continue to add a $5,000 lump sum to the account each year and you have 30 years until retirement.

If you've earmarked this money for investment, and don't need to withdraw on it until retirement, is there any reason to own bonds at all for the foreseeable future*? At current yields, it seems like bonds are just acting as a slightly better savings account.

I understand that they reduce risk in your portfolio, but if there's no plan to draw on the money for another 30 years, then what exactly are bonds doing for you besides paying out a nominal amount more than a savings account would be?

Help me understand, as a new investor, why I should be purchasing bonds instead of placing the entire or most of the $50K in equities.

*I understand you'd want more in your portfolio in bonds as you get closer to your retirement age as you will need less volatility at that stage.
suemarkp
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Re: New Investor - are bonds just a higher yielding savings account?

Post by suemarkp »

Many people don't have the stomach for the losses a 100% stock portfolio can have. Bonds are generally less volatile than stocks.

When your stocks end up in the dumps, do you want to buy more stock at those new low prices? Bonds (or cash) can help you do that. With a 100/0 portfolio you don't have anything to buy with unless you're still working and constantly contributing, which you can probably do if you have 30 years to go until withdraw.

To me the question is more of which flavor of bonds -- short, mid, or long, or even cash. I have a stable value fund available, so that's where my bond portion is. But I'm almost retired and there's no way I'm doing a 100/0 or even an 80/20 portfolio right now.

My kids (both in their mid 20's), one is 100% in VTSAX and the other in a 2060 target date fund. So no bonds for one and not much for the other.
Last edited by suemarkp on Sat Oct 17, 2020 12:02 am, edited 1 time in total.
Mark | Kent, WA
mhalley
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Re: New Investor - are bonds just a higher yielding savings account?

Post by mhalley »

Historically, bonds have yielded more than savings accounts, which is why they are recommended over "cash". Many do recommend having no bonds until you get close to retirement. But psychology plays a huge role. If you are 100% stocks and there is a huge crash, you are much more likely to panic and sell than if you have a significant percent in bonds. Also, there have been periods of time when bonds OUTPERFORMED stocks.
You can put in some dates and see here:
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Johm221122
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Re: New Investor - are bonds just a higher yielding savings account?

Post by Johm221122 »

A few thoughts on your thinking

60/40 is very conservative for just starting out

Bonds paying just 1% or 2% more than cash over a 50+ year investing timeline is huge difference in final outcome

The reason you have bonds is based on your exact personal information and personal emotions. Only you can decide this

Your 30 year timeline could change. For instance disability
sycamore
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Re: New Investor - are bonds just a higher yielding savings account?

Post by sycamore »

You've gotten some good replies already. You mentioned "I have no investing experience" so here are a few more comments/pedantic nitpicks:

1. To answer your subject question "are bonds just a higher yielding savings account?" literally, the answer is no. The main difference is a bond (or bond fund) fluctuates in value based on market conditions whereas money in savings account holds a stable value. Also, some bonds actually yield less than a savings account. And a bond or bond fund has to be traded and settle before you can get the money out whereas savings account is more liquid.

2. Regarding "the ETF world", note that while ETFs are a popular way to invest, they're not the only one. Mutual funds are another common "vehicle" for investing. There are some minor differences between them you may want to learn about.

3. I found the Bogleheads wiki has some good articles on assessing risk tolerance and using your ability, willingness, and need to take risk to determine how much to invest in stocks versus bonds. I started investing without a good understanding of my risk tolerance and it ended up costing me early on. It can be hard to know one's willingness to take risk without having gone through a severe bear market. Figuring out your own risk tolerance is what will tell you why purchasing bonds is or isn't a good idea.
jimkinny
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Re: New Investor - are bonds just a higher yielding savings account?

Post by jimkinny »

The answer is in this: your need, ability and willingness to take risk.

Here is the Boglehead wiki explanation https://www.bogleheads.org/wiki/Risk_tolerance
Topic Author
bojanradovic
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Re: New Investor - are bonds just a higher yielding savings account?

Post by bojanradovic »

Thanks for the replies so far.

Re: risk tolerance...in my original post the hypothetical assumes that the investor is disciplined, will not panic (in a bad market), and will continue to invest the same amount each year.

I understand this is different in real life but just comparing the value of bonds vs equities with personal discipline removed over a long period of time, it looks like from the calculator provided above, that equities will greatly outperform bonds over most long term periods of time.

So is the value of bonds, for the most part, more psychological in the sense that they help keep you focused on your investing goals year to year, at least in bad markets, because instead of losing 50% of your portfolio you only lose 30%? Losing only that 30% allows you to keep investing because hey at least I haven't lost most of it?

Of course the value is more than that as you get closer to retirement and are actually about to withdraw cash. But are people investing in bonds as an actual good investment or just to manage their risk/psychology over the years?
snailderby
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Re: New Investor - are bonds just a higher yielding savings account?

Post by snailderby »

Mostly to manage risk, like you said. And because there have been 30 year periods where bonds have outperformed stocks: viewtopic.php?t=263020.

But if you have a high tolerance for risk, the discipline to stay the course even if your portfolio's value is cut in half, and 30 years until retirement, a 100% stock allocation is perfectly defensible.
nix4me
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Re: New Investor - are bonds just a higher yielding savings account?

Post by nix4me »

Then there are times like the last few weeks where bonds have lost money. Worse than a savings account.
KlangFool
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Re: New Investor - are bonds just a higher yielding savings account?

Post by KlangFool »

bojanradovic wrote: Sat Oct 17, 2020 8:49 am Thanks for the replies so far.

Re: risk tolerance...in my original post the hypothetical assumes that the investor is disciplined, will not panic (in a bad market), and will continue to invest the same amount each year.

I understand this is different in real life but just comparing the value of bonds vs equities with personal discipline removed over a long period of time, it looks like from the calculator provided above, that equities will greatly outperform bonds over most long term periods of time.

So is the value of bonds, for the most part, more psychological in the sense that they help keep you focused on your investing goals year to year, at least in bad markets, because instead of losing 50% of your portfolio you only lose 30%? Losing only that 30% allows you to keep investing because hey at least I haven't lost most of it?

Of course the value is more than that as you get closer to retirement and are actually about to withdraw cash. But are people investing in bonds as an actual good investment or just to manage their risk/psychology over the years?
bojanradovic,


<<Re: risk tolerance...in my original post the hypothetical assumes that the investor is disciplined, will not panic (in a bad market), and will continue to invest the same amount each year.>>

The assumption is obviously false. It is unknowable how the investor will react in a bad market.


<<So is the value of bonds, for the most part, more psychological in the sense that they help keep you focused on your investing goals year to year, at least in bad markets, because instead of losing 50% of your portfolio you only lose 30%? Losing only that 30% allows you to keep investing because hey at least I haven't lost most of it?>>


No. The bonds and the stocks do not necessarily move at the same direction and some magnitude. And, both the stock and the bond market do not go up in a straight line. They oscillate in an predictable fashion.


If you keep a fixed allocation of 60/40, you get to "Buy Low and Sell High".

A) If the stock is up in your allocation, you buy the bond. Aka, you buy low.


B) If the stock goes up too much, you sell the stock to buy the bond. Aka, you sell high.


C) If you "Sell High and Buy Low", you make money.


A fixed AA of 60/40 is a good "market timing" tool. You buy whatever is cheap and sell whatever is expensive.


For a new investor, an all-in-one fund with a fixed AA of 60/40 is a good way to start. You do not need to know and worry whether the stock and/or the bond is overpriced.

KlangFool
ivgrivchuck
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Re: New Investor - are bonds just a higher yielding savings account?

Post by ivgrivchuck »

Historically bonds have been doing very well, because when the interest rates decline, the value of bonds goes up.

Unfortunately interest rates can't go much lower any more, so that train has already gone. And when/if the rates start climbing back, the value of bonds will go down.

That's why there has been a lot of talk recently about if holding bonds is still a good idea. So people are considering all kind of alternatives: savings accounts, CDs, I-bonds, gold, dividend stocks, TIPS etc.

When we talk about "stocks/bonds allocation", it doesn't necessarily means strictly "stocks" and strictly "bonds", but rather "high risk high expected yield assets" and "low risk low expected yield assets".
44% VTI | 36% VXUS | 10% I-bonds | 10% EE-bonds
7eight9
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Re: New Investor - are bonds just a higher yielding savings account?

Post by 7eight9 »

bojanradovic wrote: Sat Oct 17, 2020 8:49 am Thanks for the replies so far.

Re: risk tolerance...in my original post the hypothetical assumes that the investor is disciplined, will not panic (in a bad market), and will continue to invest the same amount each year.

I understand this is different in real life but just comparing the value of bonds vs equities with personal discipline removed over a long period of time, it looks like from the calculator provided above, that equities will greatly outperform bonds over most long term periods of time.

So is the value of bonds, for the most part, more psychological in the sense that they help keep you focused on your investing goals year to year, at least in bad markets, because instead of losing 50% of your portfolio you only lose 30%? Losing only that 30% allows you to keep investing because hey at least I haven't lost most of it?

Of course the value is more than that as you get closer to retirement and are actually about to withdraw cash. But are people investing in bonds as an actual good investment or just to manage their risk/psychology over the years?
Why stop at 50%. US stocks have lost more than that before and they might again.

Stock prices peaked in early October 1929 then famously crashed, plunging some 30 percent over the first three months of the Great Depression. By 1932, stock prices were down nearly 85 percent from their August 1929 level.
https://research.stlouisfed.org/publica ... depression
I guess it all could be much worse. | They could be warming up my hearse.
KlangFool
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Re: New Investor - are bonds just a higher yielding savings account?

Post by KlangFool »

https://www.amazon.com/Four-Pillars-Inv ... 1932378014


OP,

Please buy and read this book.


KlangFool
musicagogo
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Re: New Investor - are bonds just a higher yielding savings account?

Post by musicagogo »

ivgrivchuck wrote: Sat Oct 17, 2020 3:36 pm Historically bonds have been doing very well, because when the interest rates decline, the value of bonds goes up.

Unfortunately interest rates can't go much lower any more, so that train has already gone. And when/if the rates start climbing back, the value of bonds will go down.

That's why there has been a lot of talk recently about if holding bonds is still a good idea. So people are considering all kind of alternatives: savings accounts, CDs, I-bonds, gold, dividend stocks, TIPS etc.

When we talk about "stocks/bonds allocation", it doesn't necessarily means strictly "stocks" and strictly "bonds", but rather "high risk high expected yield assets" and "low risk low expected yield assets".
This is spot on for me. I had been 60/40 but last summer cashed out of bonds. Why? Because for the first time in my life-with such extremely low interest rates- the bond risk is not worth the minuscule gains. I’ll use CD’s, savings accounts, and cash as my ballast
ivgrivchuck
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Re: New Investor - are bonds just a higher yielding savings account?

Post by ivgrivchuck »

7eight9 wrote: Sat Oct 17, 2020 3:48 pm
Why stop at 50%. US stocks have lost more than that before and they might again.

Stock prices peaked in early October 1929 then famously crashed, plunging some 30 percent over the first three months of the Great Depression. By 1932, stock prices were down nearly 85 percent from their August 1929 level.
https://research.stlouisfed.org/publica ... depression
Simply because FED won't let it happen anymore. The financial system is so leveraged these days that such a drop would effectively lead to a full collapse of the financial system.

FED knows that, and rightly or wrongly, they will print money to keep stock prices "high enough". And since they have an infinite money supply, they can do that.

I'm not saying that this is morally sustainable, but that's just the way it is.
44% VTI | 36% VXUS | 10% I-bonds | 10% EE-bonds
pkcrafter
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Re: New Investor - are bonds just a higher yielding savings account?

Post by pkcrafter »

Let's make sure we know the definition of risk--

Not having the money for something important when YOU need it .

If the market cannot fall 80%, how much can it fall?

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
Buy_N_Hold
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Re: New Investor - are bonds just a higher yielding savings account?

Post by Buy_N_Hold »

The classic 60/40 portfolio did so well for the past 40 years due to the long-term secular bull market in bonds. As interest rates have fallen and fallen and fallen, investors holding bonds have been rewarded with the double whammy of consistent capital gains on the bonds AND the ballast of the bond exposure in times of market turbulence.

We find ourselves now at a critical juncture in market history. How much lower can interest rates go? There could be a few additional modest cuts, but with rates near zero there is obviously not much room left. Therefore, the tailwind that bonds have received for almost 40 years seems to be coming to a close.

For the investor in your hypothetical situation, maintaining a 100% stock portfolio seems like a tenable position. The biggest risk in my opinion, and one that is not often discussed, is whether it may be possible for the US to experience an 80-90% crash in the stock market, similar to Japan’s in the late 80’s and early 90’s, from which it could take more than 30 years to recover. How likely is this scenario? No one knows, but in my opinion anything is possible. In such a scenario, someone holding even 20% bonds would be glad that they did.

To be totally fair, I am 28 y/o and am 100% in equities in my retirement accounts, so I don’t necessarily find that argument persuasive enough to change my allocation. It is something I think about a lot though, and to be fair I am still keeping quite a bit of cash on the sidelines for now. Despite all the rhetoric about the impossibility of market timing, it does seem to me like having an abundance of cash during a market crash seems like the very best way to take advantage of the advantageous prices.
“To turn $100 into $110 is work. To turn $100 million into $110 million is inevitable.” -Edgar Bronfman
ivgrivchuck
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Re: New Investor - are bonds just a higher yielding savings account?

Post by ivgrivchuck »

pkcrafter wrote: Sat Oct 17, 2020 6:40 pm
If the market cannot fall 80%, how much can it fall?
That is of course in the hands of FED.

My estimation is that fed might tolerate a drop of 50-60 percent over time but no more.

In a fiat currency economy it is also mistake to think cash as risk-free. Technically fed can overnight put the value of cash to zero overnight, not that they would be doing that, but it's an interesting thought experiment.
44% VTI | 36% VXUS | 10% I-bonds | 10% EE-bonds
ivgrivchuck
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Re: New Investor - are bonds just a higher yielding savings account?

Post by ivgrivchuck »

Buy_N_Hold wrote: Sat Oct 17, 2020 7:01 pm
For the investor in your hypothetical situation, maintaining a 100% stock portfolio seems like a tenable position. The biggest risk in my opinion, and one that is not often discussed, is whether it may be possible for the US to experience an 80-90% crash in the stock market, similar to Japan’s in the late 80’s and early 90’s, from which it could take more than 30 years to recover. How likely is this scenario? No one knows, but in my opinion anything is possible. In such a scenario, someone holding even 20% bonds would be glad that they did.
Stock markets around the world are much more correlated now than 30 years ago, and U.S. stock market makes around 50% of the world market cap. If people decided to withdraw all their money from the stocks where would it go?

I agree though that there are certain low probability scenarios where stock market might be down by 25% globally even at 20 year timespan. That's why having even 10% of your assets in something else than stocks is wise IMO.
44% VTI | 36% VXUS | 10% I-bonds | 10% EE-bonds
Buy_N_Hold
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Re: New Investor - are bonds just a higher yielding savings account?

Post by Buy_N_Hold »

ivgrivchuck wrote: Sat Oct 17, 2020 7:37 pm
Buy_N_Hold wrote: Sat Oct 17, 2020 7:01 pm
For the investor in your hypothetical situation, maintaining a 100% stock portfolio seems like a tenable position. The biggest risk in my opinion, and one that is not often discussed, is whether it may be possible for the US to experience an 80-90% crash in the stock market, similar to Japan’s in the late 80’s and early 90’s, from which it could take more than 30 years to recover. How likely is this scenario? No one knows, but in my opinion anything is possible. In such a scenario, someone holding even 20% bonds would be glad that they did.
Stock markets around the world are much more correlated now than 30 years ago, and U.S. stock market makes around 50% of the world market cap. If people decided to withdraw all their money from the stocks where would it go?

I agree though that there are certain low probability scenarios where stock market might be down by 25% globally even at 20 year timespan. That's why having even 10% of your assets in something else than stocks is wise IMO.
It would go into bonds. :oops:
“To turn $100 into $110 is work. To turn $100 million into $110 million is inevitable.” -Edgar Bronfman
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