Monday, January 7, 2008

Grace, Vindicated

I don't like bonds. I never have.

While I am not much of a risk-taker, I just don't understand why I should settle for the low returns of a bond fund when, by waiting awhile, I can ensure a greater return sticking with stock funds. Jonathan, at My Money Blog attempts to show me why. He uses plenty of eyecatching charts and graphs, which I can almost understand.

But then, along comes Consumer Reports, one of the more reliable sources of information. Consumer Reports does not allow access to its site without a subscription, but issues are widely available at the public library. Check out February.

One article talks about common money mistakes made in retirement. And there, as # 1, is putting too much (not to mention, any) retirement money into bonds or bond funds.

Consumer Reports analyzed a range of stock-and-bond portfolios to see how they would have performed from 1940 through 2006. In one hypothetical, they assumed a 65 year old retiree would have $500,000 to invest; in the other scenario, they reduced the retirement funds to $250,000. They also assumed a withdrawal rate of 3% per year, and adjusted returns for inflation. Finally they assumed both a 20 year and a 35 year retirement.

What they found was that an all-stock portfolio provided $750,000 more than an all-bond one over the course of retirement. For the retiree who had saved less, the all-stock portfolio returned about $360,000 more.

Their final recommendation was to weight one's asset mix as heavily toward stocks as one's comfort level allows, certainly no more than 30% in bonds ever.

While I recognize that there will always be periods when my stock funds lose money (like, say, NOW!)it still makes sense to me to avoid bonds.


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Bob McD said...

This is a topic where the "conventional wisdom" is changing, and the main reason is that people are living longer. If stocks averaged 9-10% over the last decade, you are correct not to get too excited about locking up money at 5-6%... except when you have a strong belief that rates will drop.

Remember the wonderful days of the Carter administration and souble digit mortgage rates? There was a brief period when long term Treasury bonds were at 13%. In investment in one of those in say 1980 not only gave you that 13% but a big capital gain when rates came down.

4Life said...

Grace: Good read. Over the long haul, stocks have out-performed bonds.

Best Wishes,

Living Almost Large said...

You need bonds. Bonds stabilize a portfolio. Read this, it's simple.

Paul Merriman is brilliant.

Second read the four pillars of investing by William Bernstein. Again why you need bonds. You do not need tons of bonds, but 30-40% is adequate.

Bonds/cash equivalents stabilize a portfolio.

How so? Well if you read fundadvice, historically you only return 1% more for a 100% equities portfolio over a 80/20 mix. Yet the 80/20 has less volatility.

So even in my 20s, I keep bonds/cash equivalents. This year DH and I are thinking of taking some time off the market to buy bonds/cash because we think it's going down.

I'm Grace. said...

I know that you're giving me the conventional wisdom on bonds, but I actually don't think it's correct except for the very short term. If one has enough in retirement to ride out the "down" periods, I still think it is smarter and more financially prudent not to have much invested in bonds. That's why the Consumer Reports article intrigued me--that was their conclusion as well.

At your age, I wouldn't have any bonds at all. At my current age, I don't either, though I may when I actually retire.

BTW--about Bernstein? I grew up with him--he was a brilliant but cranky physician in my hometown. No one really knew about his financial interests until the last decade.

Living Almost Large said...

Read Bersteins books. They are purely mathematical and why bonds stabilize the porfolio. As for Merriman he shows numberswise as well why you need bonds.

I don't think you need a lot of bonds, but please explain to me why you think even a 20 something shouldn't keep at 10-20% bonds/cash equivalents?

I would like to see how 1% better returns for almost 2x much risk is worth it?

I have looked extensively at numbers from both authors, money magazine, fortun, and warren buffet, reading investment books. So I've seen tables and calculated returns.

With the increased beta (risk) of stocks, why would you take such a risk when you can stabilize your portfolio with a bit of bonds?

What is the financial gain? Please explain? I'd like hard numbers, not feelings, but actual numbers? Give me % of risk increased and how much return? I've seen not a lot of increased risk over not much increased gain and it's certainly not proportional.

What's the math? No harsh feelings, but where's the real numbers?

Recall in the 1980s, there were bonds paying 9-13%. I know people who held such bonds. So it's not necessarily a bad idea to buy bonds. Plus some bonds are not taxed Munis.

I've also discussed with financial advisor, bonds can help decrease taxes depending on how you hold them.

I'm Grace. said...

This discussion is very interesting, and I give this some more thought (and read the articles you've recommended). Right now, I'm still looking at the Consumer Reports findings, which would greatly disupute the "1% better returns for 2x greater risk. The return was far better than 1% and the risk (over time--which is why one must have enough money on hand to ride out a year or two of downturn) was not two times greater.

I don't understand the math well enough to follow all the arguments. But, at your age, I would not bother with bonds because you've got a very long time to regain any losses. At my age? Well, it will be interesting seeing how I handle the next year or so, because I purely hate putting money into my 401 (k) and seeing it immediately disappear!

BTW, Bonds will not provide me with any tax advantage because all of my retirement savings are within my 401 (k).

Living Almost Large said...

Gotcha about the tax advanatages.

Look at the tables in the Merriman articles. That will show the extrapolation of rate of Return specifically and the risk involved.

I found the consumer reports article, they did not say do not have bonds. Instead they only compared a 100% stocks portfolio with a 100% bonds portfolio. Incorrect assumption, when they write at the bottom people should be holding 80/20 or 70/30. Those portfolios are not suggested by Bernstein or Merriman or most financial advisors.

The article only shows the absolutes of the portfolios.

Merriman's table is 100% stocks 14.4% ROR, 90% 13.7% ROR, 80% 13.1%ROR. Std Dev 100% 16.0, 90% 14.4, 80% 12.8. Worse 60 months 100% -6.9%, 90% -2.3% (half as bad), 80% 2.3% gain. So bonds are stabilizing for a gain.

Merriman explains the table shows how much risk you must tolerate for your gains.

I just don't think you can say you need to be 100% in stocks. Nor should you ignore the benefits of bonds, and tell me that I don't need bonds/cash. I picked to have a more balanced portfolio, not because I can't stomach the risk, but I don't think it's worth the extra 1.5% gain/annually for a potential 3x the loss. That's mathematically not a good rate.

And with the stock market tanking right now it's not looking so crazy.