With bonds returning less and less, what are some other volatility-reducing options?

[Butterball]

From my standpoint, the traditional purpose of bonds is to reduce portfolio volatility so that a market crash during retirement won't hurt your accounts too much.

Bonds are still low-volatility, but they aren't returning much these days, and aren't expected to turn around any time soon. Holding bonds is getting closer and closer to holding cash (for Japanese bonds it's worse!).

It seems many advisors are therefore recommending higher equities allocations -- I see phrases like "75% [equities] is the new 60%" and William Bengen (the 4% rule guy) who used to assume 50% bonds now recommending 75-85% equities IIRC. This is sensible advice but it obviously increases volatility.

I'm going to continue to hold bond funds in my portfolio, but I've been thinking about other strategies to reduce volatility. Some of my thoughts:

Hedging with commodities
- commodities are quite volatile but are generally uncorrelated or weakly negatively correlated with stocks. They're also considered a hedge against inflation, although I don't expect that to be a problem in Japan. I'd pretty much disregarded commodities as a boomer investment but I've added a commodities fund to my portfolio and, God help me, I've started sending 3% of my iDeco contribution to a gold fund.

Hedging with diversity
- of course a broad market-based index fund is already diverse by definition. Having some investment in more specialized funds should be expected to produce a lower return on average (most funds don't beat the market) but might provide some hedging. I have small allocations in a few industry-specific funds and a well-known blue chip-oriented fund. They did well in last week's small market dip. This is a difficult area because it's a slippery slope away from passive investing to high-fee managed funds, market timing & stock picking.

Dividend investing?
- there seems to be a split in opinion among people much smarter than me as to whether collecting dividends is actually any different than a scheduled forced selling of the equivalent value of of your holdings. I'm thinking that it probably isn't. I'm still having all my dividends automatically reinvested, but the idea of collecting dividends upon entering retirement just *feels* more stable. In terms of taxation, I don't *think* it makes any difference in Japan, does it?

Any thoughts?

[Ax6isB]

Any thoughts?

What’s the overall make up of the portfolio? 80/20 stocks to bond will be a wild ride.

Reducing your stock allocation and spreading to things like bonds, REITs, gold/commodities and cash will reduce volatility. I’m experimenting with a 20/20/20/20/20 make up with a portion of my portfolio and it’s not very exciting but not volatile.

[Established]

Any thoughts?

What’s the overall make up of the portfolio? 80/20 stocks to bond will be a wild ride.

Reducing your stock allocation and spreading to things like bonds, REITs, gold/commodities and cash will reduce volatility. I’m experimenting with a 20/20/20/20/20 make up with a portion of my portfolio and it’s not very exciting but not volatile.

Reduce Volatility? If anything that would make your portfolio more volatile!

Gold is essentially a volatile asset that returns little over time.
https://www.nytimes.com/2013/07/28/busi ... -gold.html

REITs are concentrated sector bets, their risk will depend on the specific type of real-estate but they are historically riskier class.

Weighting at 20% seems absolutely arbitrary.

...........

To Butterball's question 80% stocks/20% bonds is a great place to start. A bit conservative for those under 30.

You can move more into bonds if your risk tolerance decreases with age.

[Tony]

Holding bonds is getting closer and closer to holding cash (for Japanese bonds it's worse!).

I would guess a 0.09% return on 10 years for JGBs is better than holding cash in most banks in Japan (although I haven't gone searching for the best rates available for savings accounts).

[fools_gold]

Reduce Volatility? If anything that would make your portfolio more volatile!

Gold is essentially a volatile asset that returns little over time.
https://www.nytimes.com/2013/07/28/busi ... -gold.html

Isn't that author actually making the argument that holding a small amount of gold actually reduces overall risk?

Because gold is a small asset class with meager returns and high volatility, an investor may be tempted to avoid it altogether. But not so fast. One last fact may turn the tables.

IT MARCHES TO A DIFFERENT BEAT An important element of an investment portfolio is diversification, and here is where gold really shines — pun intended — because its price is largely uncorrelated with stocks and bonds. Despite gold’s volatility, adding a little to a standard portfolio can reduce its overall risk.

As for REITs...

Here are the historical risk/returns for global REITs and global stocks.

Yes, REITs are a little riskier but not much. Some people argue that they are a sector bet, others that they deserve to be treated as a separate asset class. I'm not sure either way, but I hold them mostly because they are less correlated with mid- and large-cap stocks.

[eyeswideshut]

Reducing your stock allocation and spreading to things like bonds, REITs, gold/commodities and cash will reduce volatility. I’m experimenting with a 20/20/20/20/20 make up with a portion of my portfolio and it’s not very exciting but not volatile.

Reduce Volatility? If anything that would make your portfolio more volatile!

Probably not actually as those asset classes have historically low correlation (and maybe negatively correlated). So while each asset class individually may experience high volatility, the portfolio as a whole will likely have less volatility than an 80/20 portfolio. No comment as to how much growth such portfolio would see; a portfolio can have low volatility and nonetheless still perform badly.

[Butterball]

Thanks for the input so far!

I guess I should emphasize that what I'm really looking at is the risk of a badly-timed serious hit to equities markets right around the start of my retirement. That's what can really hurt a portfolio. So either low-volatility investments or uncorrelated investments can help here. It's really risk reduction rather than volatility reduction that I'm looking for despite my title. I'm not really spooked by volatility or bear markets over the long term, only the risk of being forced to buy the bear.

In my case I'm in my mid-40s and currently a bit over 80% equities. My current thinking is that it would be best for me to be about 85% equities until around age 50, and then start ramping up the portion of "safety" assets. I hope to retire at age 60 if I'm at my target.

To be clear, I don't think it would be a good idea to get out of bonds entirely; I was thinking something more along the lines of 85% equities / 10% bonds / 5% "other".

I think having REITs as a modest portion of a portfolio is a reasonable way to go but personally I'm just not very confident in them for some reason, and most of my equity index funds (eMaxis all country, etc) already contain a small portion of REIT holdings so I don't really feel the need to increase my exposure more than that.

I'm still leaning towards commodity indices for most of the "other." I have a tiny portion of gold in my iDeco because that's the only commodity fund Rakuten offers for iDeco; if they had a broader commodity fund I'd have gone with that if the fees weren't too bad (the gold fund is already pretty expensive).

Some other options that I don't think have been mentioned:

- Foreign currencies -- traditionally USD, JPY and CHF (Swiss Franc) are "safe haven" currencies that tend to be bought up during economic crises. This isn't really an investment; it's hedging. I believe, however, that currency exchange rates are to some degree baked into market prices, so there's a limited currency hedging effect that comes just by holding Japanese assets and US assets. I might be wrong about that, but anyway, buying foreign currency just to sit on isn't really appealing to me right now.
- volatility-tracking funds -- VIX is the one I know about. Again, a hedge not an investment; over the long term you will probably lose money, but in the event of a market disruption like in March 2020, it will shoot up. Again, not interested right now. Maybe a small stake when I'm 59.

I don't want to fall into the trap of trying to be too clever about this; just interested in any ideas floating around.

[RetireJapan]

To deal with the issue you seem to be concerned about (stock crash just when you were planning to retire) I am thinking of having a cash fund with 3-5 years living expenses in, then using that for daily needs and selling investments once a year to top it up. If there were to be a crash I would just use the cash instead of selling. I think Michael Kitces writes about this with the glide path stuff: https://www.kitces.com/blog/should-equi ... ly-better/

[Ax6isB]

Probably not actually as those asset classes have historically low correlation (and maybe negatively correlated). So while each asset class individually may experience high volatility, the portfolio as a whole will likely have less volatility than an 80/20 portfolio. No comment as to how much growth such portfolio would see; a portfolio can have low volatility and nonetheless still perform badly.
[/quote]

Correct, that’s what I’m finding and it’s performing alright in the limited time I’ve had it in place. Time will tell of course.

To the overall question, I guess it comes down to your long term view. I’m a bit hedged these days and I also have a thesis regarding inflation. We’ve also had a boom for a long, long time (50 years or so) punctuated with the occasional crisis. Could we have an equally long bust? I sure don’t know but the business cycle appears a bit untraditional and off (or just flat out eliminated) and my saving/investing strategy is starting to incorporate these thoughts.

I like the idea of a 3-5 year cash reserve. That’ll reduce risk and volatility. What currency I put that in is something I’m not actively considering and I need to address.

[TokyoWart]

Just by chance over the weekend I listened to a podcast interview by ETF Alpha with Nancy Davis where she discussed the IVOL ETF.

https://www.google.co.jp/url?sa=t&rct=j ... -DKhy_EP1w

https://www.ivoletf.com/wp-content/uplo ... tsheet.pdf

What IVOL is designed to do is be long interest rate volatility so it should be poorly correlated with equities and incidentally yield more than many fixed income instruments do now. It's mostly long TIPS with the remainder in fixed income options. I don't own any (and I'm not sure about it's availability through Japanese brokerages) but this is something I am going to look into more closely as a possible hedge to my high equity allocations.