User:Martincmartin/Bonds

= Which Bonds Should I Hold? =

This depends on why you're holding bonds. There are two schools of thought: the old from emotions, drama and Shakespeare, and the new, from logic, rationality and Mr. Spock.

Short version
Why do you hold bonds?


 * When the stock market goes down, you get anxious? Then hold Short Term Treasuries, as they go down the least.  This is Bill Bernstein's point.
 * You want to minimize the chance of running out of money in retirement? Then hold Total Bond Market (in tax sheltered) or Intermediate Term Treasuries (in taxable).
 * You've won the game and want to stop playing, to use Bill Bernstein's words? Then get a liability matching portfolio of a TIPS ladder.

Can't sleep well at night
Some people think, when they have $1M in the stock market, that they have a million dollars. When stocks go down, they think they're losing money. When stocks go down to $800k, they think it's the same as if they had lit $200k on fire. If your nest egg, that you're hoping to use to retire, then goes down to $700k, then later to $600k, then to $500k, then goes down EVEN MORE, they worry. They believe they will have to work many more years at their job. Will they even be allowed to keep their job that long? Will anybody hire them if they get laid off? And anyway, weren't they a fool to make such a poor investment, to trust these companies whose shares they bought?

If that's your problem, you need something that will cause your total savings to go down the least. This is Bill Bernstein's thinking, and he suggests short term Treasuries, since they'll go down the least. It's about emotions, drama, Shakespeare.

For a long time, that was the dominant way of thinking about AA: stocks for the long run, bonds to soothe emotions. Need, ability and willingness to take risk. "Risk" defined as daily/monthly volatility, or max drawdown, or scary headlines in newspapers. If your emotions wouldn't get in the way, it was ok to be 100% stocks.

Running out of money in retirement
Then Bengen and the Trinity study said "let's look at historical performance of different asset allocations and withdrawal rates." It turns out, when you're withdrawing funds during retirement, 100% stocks is no longer the best. Now risk is defined differently, in terms of impact to your life, as the chance of running out of money in retirement. 100% stocks does poorly if you retire just before the great depression, or just before the stagflation of the 1970s, or just before the bank panic of 1907, or just before the dot com crash. If you look at actual returns during those years, along with actual inflation, it turns out around 70/30 minimizes this new, objective kind of risk. 100% bonds is actually riskier if you retire with 25x annual expenses, because you need the returns from stocks. Bonds are simply unlikely to appreciate enough to cover your future expenses.

So what kind of bonds should you hold? During the Great Depression, there was significant deflation, so long term bonds were best and short term worst. During the 1970s, there as a lot of inflation, so short term did best and long term worst. Intermediate did ok in both scenarios. Total bond is a little more diversified, so could be argued to do a little better. This is logic, rationality, Mr. Spock.

Which one is correct?
So are bonds safer? That depends on how you define risk. If you define it using emotions and "sleep well at night," then more bonds are safer. If you define it through objective criteria and not running out of money in retirement, 70/30 is safer than all bonds or all stocks. Top