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  • Bond Philosophy

    Is there a school of thought in investing that bond allocation should be more of an absolute number rather than a percentage of the portfolio?

    If you have a million dollar 80/20 portfolio, $200k in bonds seems like a nice safety net. But if it’s a $5million portfolio then $1m in bonds seems overkill.

    I have only been watching investments for the past few years where my bonds have gone essentially nothing so I am definitely jaded. But, it almost feels like I’d be doing well to convert my bonds to cash and bury the money in an old pickle jar in the back yard for the tough times.

  • #2
    you’re not dumb. lots of folks advise having x number years of expenses in bonds and remainder risk on. famously taylor larimore

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    • #3
      It depends on what you see the purpose of bonds is in your portfolio.

      If you just see it as a safety net, then a fixed allocation irrespective of NW doesn’t make a lot of sense.

      With current valuations, I keep bonds to hedge against the possibility of stocks underperforming against bonds long term. That seems ridiculous now, but it’s happened in the past, and stocks are at astronomically high valuations at the moment. As my NW has gotten larger, to the point that it is more important not to lose money, I feel better hedging my bets. I especially like I bonds. I might even buy some EE bonds to lock in the 3.5% guaranteed returns for 20 years. However the annual contribution limits for both of these are pretty low.

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      • #4
        I hate to answer a question with a question, so I apologize.
        Why do you have bonds?

        Equities have market risk.
        Bonds have interest rate risks.

        Frame your thought that stocks are invested for returns and bonds are parked outside of the market for safe keeping, not an investment. They are safer than the pickle jar! You are right, they basically breakeven.

        Your risk capacity and tolerance determines how much risk you want to take and need to take in stocks. They will have a rollercoaster ride. The will have significant drops. With a $5m portfolio, can you handle a $2m-$2.5m drop? Drops of 20%-30% are expected. You need to drop back and assess your individual risk profile. Most cannot handle a 100% roller coaster once the get any significant investment in the accumulation phase. Capital preservation then kicks in. Later, it becomes how much do you want to even put at risk for the long term. Thus the 3-5 years of expense.
        Don’t get overconfident, selling when you are at the bottom hurts you financially. Bonds are ballast, not for ROI.


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        • #5
          I don’t like asking questions on this forum. The responses force me to take a deep look inside and inevitably come to the conclusion that I have no idea why I do what I do with my investments.

          I think the only reason I have bonds is because I’ve always heard you need diversified split in your portfolio without actually considering why.

          I would say my risk tolerance is high. I’m in my prime earning years and still have about 20 total working years left. To continue the $5m NW example, I don’t see that much benefit to having a 80/20 split if the market takes a 50% dive. Having $2.5m left in stocks vs. $2m/$1m in a split portfolio seems roughly the same to me. I’d rather have that extra $500k in equities for when the market goes back up rather than sell half my safety net to get back into the market that just burned me. But maybe history says something different.

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          • #6
            The only problem with that logic is most people sell when the market goes down for an extended period of time. A 30% drop which improves in one year is a lot different than a 50% drop that takes 10 years to make up what you lost , while bonds are out performing the entire time. There is no right answer. The longer time horizon points more towards a higher percent of equities. But if you have "won" the game, why take the risk if you don't have to. The market has been going strong for over 10 years, so looking back , having bonds was a poor choice, but I will take a bet that the next 10 years will not be the same, no one knows.

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            • #7
              When pre-retired I use bonds to lessen volatility based on my risk tolerance. Still 15-20 years away from retirement now so my AA is between 95/5 and 90/10. As I get within 5 years of retirement I will trend towards 60/40. Then at retirement I think my plan will be to have ~5-7 years of expenses in bonds, 3 years in cash, and the rest in equities.

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              • #8
                I look at bonds for liquidity, diversification, and some stability. Bonds are more liquid because they typically don’t experience the dramatic price fluctuations that equities do. They are not polar opposites to equities in terms of diversity, although they have been since 2000. They aren’t without risk and many forget we’ve been in a 20-30 year bond bull market with interest rates falling. I think things may change soon and bonds will carry more risk, especially longer terms.

                History, which is not obligated to repeat itself, suggests equities are your best chance for growth and beating inflation. I’m 15 years out, but my approach will be a bucket strategy, using a CD ladder as my pickle jar, bonds as my middle bucket and the rest in equities. I will not focus on %, but rather $ amounts reflective of years of income needed. I will likely keep enough in the CD and bond buckets to cover 7-10 years of needed income. In today’s environment, I’d be much more heavily weighted towards CDs, maybe 5 years in CDs and 2 in bonds. I am also a fan of gold (IAU) and may hold 2 years worth of income there as part of my first 2 buckets. I currently do not own bonds and am 85-90% equities.

                Back to your question, bond holdings should reflect your risk tolerance, amount of money in your portfolio, and liquidity/income needs.

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                • #9
                  I like the philosophy of “when you’ve won the game stop playing”.

                  But I think in practice, the quote that really applies is, “How much money does it take to make a man happy? Just one more dollar.”

                  With changing tax laws, rising inflation, and social security on shaky ground, can anyone really feel confident that they have “won the game”? Feels like the goal posts are moving too much if my retirement is still 20 years away.

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                  • #10
                    Originally posted by BryanMD View Post
                    I don’t like asking questions on this forum. The responses force me to take a deep look inside and inevitably come to the conclusion that I have no idea why I do what I do with my investments.

                    I think the only reason I have bonds is because I’ve always heard you need diversified split in your portfolio without actually considering why.

                    I would say my risk tolerance is high. I’m in my prime earning years and still have about 20 total working years left. To continue the $5m NW example, I don’t see that much benefit to having a 80/20 split if the market takes a 50% dive. Having $2.5m left in stocks vs. $2m/$1m in a split portfolio seems roughly the same to me. I’d rather have that extra $500k in equities for when the market goes back up rather than sell half my safety net to get back into the market that just burned me. But maybe history says something different.
                    Consider the math:
                    If you are 80/20 and a 50% drop occors, rebalancing at the bottom puts you ahead with a short recovery. Your new portfolio is worth more and the you rebalance back to 80/20.

                    That is the value added by having a written plan.
                    The key is to stay with your plan. Long term the the results are superior. You reallocated from risk off to risk on. What behavioral finance tends to lean to is first ceasing continued contributions and then potentially some selling. Why? Trying to pick market tops and bottoms, which I think you understand is luck.
                    If you have the tolerance (personal capital vs financial capital) for 100% equities, that will work. Just realize at 50-70 your behavioral reactions won’t be the same. Just write your plan down. Don’t make allocation decisions based on the market, that you cannot control.
                    You can control contributions and AA.

                    If you choose 100% until you hit 50, realize you will have some gut wrenching years. No one can tell you when and if it will recover. I guarantee you will again be seeking better returns (real estate or private investment). Nope, 100% equity. Chasing yield is mostly an emotional choice. You just need to come up with your plan.
                    ROT consider risk before return. Contributions are the engine that gets you to $5m, time takes care of the rest.

                    Every person goes through this.
                    https://www.whitecoatinvestor.com/ho...nal-statement/

                    Keep it simple, it’s easier.

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                    • #11
                      As a recent retiree I have 3-5 years of living costs - in absolute $$ - in cash/cash-equivalents/bonds. All of our remainder is in stocks.
                      I agree with BryanMD, at high NW, the % stocks/% bonds model is no longer relevant.

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                      • #12
                        I am also a recent retiree. I keep more cash and no longer add to bonds. Cash plus bonds = 30%.

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                        • #13
                          BTW, I have buried $3000 cash in our backyard. I've indulged an apocalyptic scenario whereby a widespread midwest electrical outage leaves us without banking services, crypto services, and loss of credit card functioning. EV cars are left for dead. Gas station pumps are stymied.
                          My cash allows me to bribe the fuel truck drivers arriving from outside the region.
                          My electrician nephew nods approvingly.

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                          • #14
                            Originally posted by BryanMD View Post
                            I like the philosophy of “when you’ve won the game stop playing”.

                            But I think in practice, the quote that really applies is, “How much money does it take to make a man happy? Just one more dollar.”

                            With changing tax laws, rising inflation, and social security on shaky ground, can anyone really feel confident that they have “won the game”? Feels like the goal posts are moving too much if my retirement is still 20 years away.
                            You only know when you get there in 15-30 years. Notice, I added 10 years in retirement.
                            The only comfort is you are a lot better off than most. At that point your cushion is your heirs might get less. Ponder that. Who knows if you will be allowed to have heirs.

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                            • #15
                              Originally posted by BryanMD View Post
                              I don’t like asking questions on this forum. The responses force me to take a deep look inside and inevitably come to the conclusion that I have no idea why I do what I do with my investments.

                              I think the only reason I have bonds is because I’ve always heard you need diversified split in your portfolio without actually considering why.

                              I would say my risk tolerance is high. I’m in my prime earning years and still have about 20 total working years left. To continue the $5m NW example, I don’t see that much benefit to having a 80/20 split if the market takes a 50% dive. Having $2.5m left in stocks vs. $2m/$1m in a split portfolio seems roughly the same to me. I’d rather have that extra $500k in equities for when the market goes back up rather than sell half my safety net to get back into the market that just burned me. But maybe history says something different.
                              have to consider the relative upside as well. i am not a huge bond advocate, but it one of bernstein’s books he shows data that there have been substantially declining marginal gains when equities get above 80%. there are gains on average, but in his opinion at the time not worth being more aggressive.
                              “. . . And the LORD spake, saying “First shalt thou take out the Holy 401k. Then shalt thou save to 20%, no more, no less. 20% shall be the number thou shalt save, and the number of the saving shall be 20%. 25% shalt thou not save, neither save thou 15%, excepting that thou then proceed to 20%. 30% is right out . . .””

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