Bonds - what are they good for?

[yobyot]

May I be forgiven for an intentionally provocative thread title, but I have a confession to make:

I don't like bonds. Except I Bonds.

Yes, yes, I understand, efficient frontier, reduced volatility, sequence of returns risk, Trinity Study, and yada-yada-yada.

I also understand that if you hold the bond fund for its average duration, you are unlikely to lose any money.

Enter inflation:



So even TIPS funds didn't really protect their holders from unexpected inflation.

(I get it one could buy TIPS directly, but that is not something I am interested in ever pursuing, so let's leave that out; you still have to hold them to maturity to eliminate the interest rate risk).

And here is 70/30 VT/BND vs 100% VT:



A pretty harsh penalty for the "safety" of bonds.

Otherwise a responsible boglehead (having held without panicking since early 2000s), I find it difficult to convince myself to commit significantly to bond funds, lagging somewhat behind my already aggressive IPS, with most bond holdings in I Bonds (which, of course, would show as a perfect straight or a gently curving up line on the top chart, pre-tax). If I could fill my bonds bucket entirely with I Bonds, I would do that and call it a portfolio.

I once heard somewhere bonds were called "certificates of guaranteed confiscation", and it really struck a chord with me.

Can y'all talk some sense into me?

Well, there aren't many of us but I hate bonds, too.

Maybe it's that I didn't take my cod liver oil as a kid but in nearly 40 years of investing, I've never made a dime on bonds.

Bought in the secondary market, pricing is opaque. Buying and selling them in a brokerage account requires guessing interest rates, credit risk and a boatload of other factors that make it impossible for anyone except the middlemen to profit. At auction or via a brokered CD, they're uninteresting.

I'm tired of experts telling me...imploring me...to do something I stink at and, in contrast to equities, I've never been successful at doing. Too much risk for you in equities? Keep five years of cash on hand. (I can't wait for the responses to that idea, even though now you can probably do better with T-bills than you could with "safe" bonds.)

This is a case of the Bogelheads world rationalizing what it wants to be true vs. what is empirically true: bonds suck.

[BernardShakey]

1929-1959. Stocks can stay down for a whole retirement.

This is not a "why not 100% stocks" thread. I don't want 100% stocks. But I'm not sure I want BND either

To me, asking if you should get rid of (or stay away from) bonds is kind of like asking if you should get rid of seat belts in your car. You may not always need them, but you'll be glad you had them in a crash!

Seriously though, for young and mid-career folks with a stomach for volatility, I can understand the resistance to bonds. But when your human capital is diminishing (or your motivation to use that capital is dropping) and you're near or in retirement, I think you have to consider bonds.

[jvini]

I didn't make any changes to our portfolio.

It's currently 85/15 (at just about 25x), with about half of that 15% in BND equivalents and another half in I Bonds.

It's just that buying I Bonds is no longer enough to keep us on the glide path, and I can't hold my nose long enough to pull the trigger on buying more BND than I currently do.

Different situation since I am still in growth / accumulation phase, but I struggle with the same dilemma. I feel so disappointed buying bonds and always want to reach for stocks instead.

I can handle 40% drops in the market without losing any sleep, so I decided to use a very small % of bonds primarily for two purposes
(1) as my emergency fund
(2) as a small backup store of cash to dump into the market when the big dips happen

Ultimately I couldn't convince myself to do the "hold your age in bonds" rule because it was too conservative. So I considered 90/10, and felt it was also too conservative. I decided to come up with my own (more aggressive) formula which takes into account my age, how much of an emergency fund I need, and whether the market is at a high or low. I use a google spreadsheet which pulls in the current VTI price and re-computes the desired bond percentage dynamically based on how old I am that day, how far off VTI is from its current high, and my monthly expenses. Right now it wants me at 4% bonds, but when the market was down last year it had me redeploy a lot of my bonds into stocks and I was down below 2% in bonds.

I think most people have a higher level of anxiety and loss aversion, and hence the standard recommendations for bonds suggest a higher amount to stabilize the portfolio. But I do think additional adjustment makes sense if you can live with the chaos.

“Everyone has a plan until they get punched in the mouth.” -Mike Tyson

Up to 2008, I didn't think I needed bonds either. I was young and regularly investing in stock index funds. I had amassed a nice sized portfolio and was saving for young kids' colleges too, along with paying off a mortgage. Then came the GFC. I got punched in the mouth. I lost a job. My portfolio got cut in half. Watching my portfolio evaporate and having (thankfully) a very brief period of no income, I discovered why people owned bonds. I actually kept buying only equity indexes until I got back to my high in 2013, then started buying bonds with the formula age-20 in my 40s. At 50 I switched to age-15 and when I reached a financial goal I switched to 55/45, where I am now, about to retire at 56. Everyone is different, but when you get to be 40+, bonds may be something to consider.

[2pedals]

Well let's chart 2D-1 and see if bonds lose money then. D = 6.4 years so let's chart 11.8 years. Let's call it 12 years.

Can you guarantee that bond funds will not lose money for the next 10 years?

If saving/investing toward a date-certain obligation for which losing money is unacceptable, a fixed-duration bond fund is an inappropriate tool, as is a bond fund holding bonds with credit risk. A significant-enough rise in market yields or defaults too close to your planned liquidation date may cause fund NAV losses that exceed the total accumulated+remaining yield.

Alternatives more appropriate for that requirement include individual Treasury bonds/notes/bills, target-maturity Treasury funds, CDs (all of the preceding with maturity before your obligation), I bonds (if you have at least a year), or periodically shifting to lower-duration Treasury funds (and eventually a Treasury money market fund / equivalent) to keep the fund duration under half of the time until planned liquidation.

Losing money means different things to different folks. I will say that if you have a target duration, you can reasonably ensure a positive real return (currently ~2%) for a targeted date you want have to this money. Money can be invested in two or three different TIP funds (short, intermediate, and long - e.g. VTIP, SCHP, and LTPZ) to create a weighted average duration that changes over time by rebalancing and reducing the weighted average duration over time as one approaches the target date.

[dbr]

Losing money means different things to different folks. I will say that if you have a target duration, you can reasonably ensure a positive real return (currently ~2%) for a targeted date you want have to this money. Money can be invested in two or three different TIP funds (short, intermediate, and long - e.g. VTIP, SCHP, and LTPZ) to create a weighted average duration that changes over time by rebalancing and reducing the weighted average duration over time as one approaches the target date.

That is for sure. Some investors hedge that around with requirements that are so severe that no investment exists that meets all the criteria. In other cases some investments simply don't work for that purpose and everyone can just admit that up front. Strangely a criterion that is almost always overlooked by those who do not want to lose money is that the accounting logically should be done in real dollars after inflation. That puts a severe limit on what is available to meet the need. Of course we can also demand that the accounting be after taxes.

But the point above is that there are lots of practical options that limit losses or make them very unlikely. That is called risk management and is part of investing. The idea that there is investing with no risk is an unattainable pipe dream.

[southernlucky]

Hi op. If I was nearing or in retirement at the start of the century I would have felt more comfortable with a mix of stocks and bonds vs all stocks during the 20 yrs from 2000 to 2019 that it took stocks to match a simple 50/50 mix (not sure how to post the image but here is the link from portfolio visualizer website). And, yes I am cherry picking dates but one never knows when such times could occur again so best to be ready for them.

https://www.portfoliovisualizer.com/bac ... tion2_2=50

[er999]

Hi op. If I was nearing or in retirement at the start of the century I would have felt more comfortable with a mix of stocks and bonds vs all stocks during the 20 yrs from 2000 to 2019 that it took stocks to match a simple 50/50 mix (not sure how to post the image but here is the link from portfolio visualizer website). And, yes I am cherry picking dates but one never knows when such times could occur again so best to be ready for them.

https://www.portfoliovisualizer.com/bac ... tion2_2=50

If you add a 4% withdrawal rate starting in 2000 (3333 monthly withdrawals, inflation adjusted) it is even worse where 100% stocks never catches up.

[Valuethinker]

Well, there aren't many of us but I hate bonds, too.

Maybe it's that I didn't take my cod liver oil as a kid but in nearly 40 years of investing, I've never made a dime on bonds.

Bought in the secondary market, pricing is opaque. Buying and selling them in a brokerage account requires guessing interest rates, credit risk and a boatload of other factors that make it impossible for anyone except the middlemen to profit. At auction or via a brokered CD, they're uninteresting.

I'm tired of experts telling me...imploring me...to do something I stink at and, in contrast to equities, I've never been successful at doing. Too much risk for you in equities? Keep five years of cash on hand. (I can't wait for the responses to that idea, even though now you can probably do better with T-bills than you could with "safe" bonds.)

This is a case of the Bogelheads world rationalizing what it wants to be true vs. what is empirically true: bonds suck.

You will have noted the OP's original illustrations avoid years when bonds had a markedly different correlation from equities. (Weird things happened in the US Treasury bond market during the Covid crash March-April 2020).

If one has a fixed or CPI indexed pension this makes a big difference to one's retirement strategy. One can afford to run a high level of equities in retirement.

If one holds bonds to maturity (or CDs) the transparency problems are much reduced. It is the buying and selling in 2ndary markets which eats up returns -- because there's a spread, and there's opacity. Or if one holds ETFs &/or mutual funds.

If you plan to keep 5 years of cash on hand, a "barbell" portfolio, then I suggest using a CD ladder - on the principle that it's very unlikely you will need all that money at once.

The last 40 years in equities? Probably the best period of that length on record *ever*. Although there are not so many periods. Even including the "10 lost years" 2000-2010. International investors have not enjoyed as good a ride as US investors from bottom of dot com Crash (2003) to now.

Bonds of course also had a pretty amazing 40 years, but then a torrid 2022. The higher yields now available suggest that returns will be better in the future.

John Bogle's rules of thumb:

- long run equity returns 1/PE so for the US right now about 3% real? I would make a pretty strong case that the 6% real (since 1900) was a one off and is very unlikely to be repeated
- long run bond returns about the bond yield. So for US Treasury bonds about 4%?

Importantly, TIPS are offering substantial real yields for the first time in a long time. Making them quite attractive for those contemplating retirement in less than 10 years, or just generally for investors.

[yobyot]

Well, there aren't many of us but I hate bonds, too.

Maybe it's that I didn't take my cod liver oil as a kid but in nearly 40 years of investing, I've never made a dime on bonds.

Bought in the secondary market, pricing is opaque. Buying and selling them in a brokerage account requires guessing interest rates, credit risk and a boatload of other factors that make it impossible for anyone except the middlemen to profit. At auction or via a brokered CD, they're uninteresting.

I'm tired of experts telling me...imploring me...to do something I stink at and, in contrast to equities, I've never been successful at doing. Too much risk for you in equities? Keep five years of cash on hand. (I can't wait for the responses to that idea, even though now you can probably do better with T-bills than you could with "safe" bonds.)

This is a case of the Bogelheads world rationalizing what it wants to be true vs. what is empirically true: bonds suck.

You will have noted the OP's original illustrations avoid years when bonds had a markedly different correlation from equities. (Weird things happened in the US Treasury bond market during the Covid crash March-April 2020).

If one has a fixed or CPI indexed pension this makes a big difference to one's retirement strategy. One can afford to run a high level of equities in retirement.

If one holds bonds to maturity (or CDs) the transparency problems are much reduced. It is the buying and selling in 2ndary markets which eats up returns -- because there's a spread, and there's opacity. Or if one holds ETFs &/or mutual funds.

If you plan to keep 5 years of cash on hand, a "barbell" portfolio, then I suggest using a CD ladder - on the principle that it's very unlikely you will need all that money at once.

The last 40 years in equities? Probably the best period of that length on record *ever*. Although there are not so many periods. Even including the "10 lost years" 2000-2010. International investors have not enjoyed as good a ride as US investors from bottom of dot com Crash (2003) to now.

Bonds of course also had a pretty amazing 40 years, but then a torrid 2022. The higher yields now available suggest that returns will be better in the future.

John Bogle's rules of thumb:

- long run equity returns 1/PE so for the US right now about 3% real? I would make a pretty strong case that the 6% real (since 1900) was a one off and is very unlikely to be repeated
- long run bond returns about the bond yield. So for US Treasury bonds about 4%?

Importantly, TIPS are offering substantial real yields for the first time in a long time. Making them quite attractive for those contemplating retirement in less than 10 years, or just generally for investors.

You make some interesting points, @Valuethinker.

But:

- 3% real in equities is enough for me.
- I prefer T-bills to brokered CDs for the barbell.
- Interest rates now are about where they were (should be?) before the Fed sold its soul in the Great Recession and kept rates a near zero for a decade. It makes one wonder if the bond market will ever be what it was before it became policy to turn on the gusher at any economic provocation.

[slicendice]

The OP should look up the actual yields for these bond investments at the start of 2013. For the sake of argument, I recall BND was offering a whopping ~3% nominal yield and around 7 years of duration, and intermediate TIPS may have been offering negative real yields aka the certainty of losing money for a similar duration. Things turned out pretty close to expectation for both I think which is the point of bonds that is not offered by stocks.

It may be more worthwhile for the OP to pick a historical time frame where the two instruments start at similar yields to today and look at the ensuing 10 years. ~4.8% on VBTLX and ~2% on intermediate TIPS.

[hudson]

Losing money means different things to different folks. I will say that if you have a target duration, you can reasonably ensure a positive real return (currently ~2%) for a targeted date you want have to this money. Money can be invested in two or three different TIP funds (short, intermediate, and long - e.g. VTIP, SCHP, and LTPZ) to create a weighted average duration that changes over time by rebalancing and reducing the weighted average duration over time as one approaches the target date.

That is for sure. Some investors hedge that around with requirements that are so severe that no investment exists that meets all the criteria. In other cases some investments simply don't work for that purpose and everyone can just admit that up front. Strangely a criterion that is almost always overlooked by those who do not want to lose money is that the accounting logically should be done in real dollars after inflation. That puts a severe limit on what is available to meet the need. Of course we can also demand that the accounting be after taxes.

But the point above is that there are lots of practical options that limit losses or make them very unlikely. That is called risk management and is part of investing. The idea that there is investing with no risk is an unattainable pipe dream.

Some investors just hedge: 50% nominals/50% TIPS?
Focus on "real": I warm up to nominals for guaranteed income. Sometimes TIPS don't pay much except maybe in the long run. Inflation marches on....but you never know.
Investing with no risk? There's always risk, but fixed income helps with a good night's sleep.

Bottom Line: What does one do? hedge your bets

[Whitefalcon]

Perhaps consider using a managed fund and treating it like the bond portion of your portfolio. There are some pretty smart people that consider bonds a great diversifier in a portfolio
funds like: VWINX , VWELX, DODGX or even a target date fund

[dbr]

Perhaps consider using a managed fund and treating it like the bond portion of your portfolio. There are some pretty smart people that consider bonds a great diversifier in a portfolio
funds like: VWINX , VWELX, DODGX or even a target date fund

Blended funds of bonds and stocks, managed or not, do not have the risk characteristics of bonds alone. Your suggestion does make sense as a practical tool, but you still want to acknowledge that such funds have an allocation to stocks and to bonds. If you own Wellesley VWINX you own a fund that is roughly 40/60 stocks/bonds and behaves like it.