Bond Allocation

[ToushiTime]

Currently, my asset allocation is very distorted due to a recent inheritance. Under normal circumstances, if I was a USD-based investor, I would typically go for the good old 60% stocks and 40% bonds portfolio.

Interesting. Under normal circumstances, what would the ratio be for you as a JPY-based investor, without that inheritance?
Are you implying it would be different due to currency risk?

The way I see it is:

Currency risk affects both bonds and equities equally on a simple bond/share price conversion-to-yen basis (obviously).

Depreciation of a nation’s currency lifts the share prices of its exporters but lowers them for its importers. And the economy of the US, which accounts for a heavy chunk of many portfolios, is more balanced than Japan’s as far as export-dependence goes.

A currency could weaken due to low interest rates, which would actually lift bond prices.

I don’t think there is much in it.

[northSaver]

Using the period from July 2002 to May 2023, the 60/40 allocation returned an annualized 7.79% with a volatility of 8.75% and a Sharpe ratio of 0.75. In comparison, a 100% US stock allocation returned 9.65% with a volatility of 14.94% and a Sharpe ratio of 0.61. The allocation you mention, with a 25% bond allocation, returned 8.58% with a volatility of 10.89% and a Sharpe ratio of 0.69. These calculations use the SPY ETF for stocks and the IEF ETF for bonds (7/10-year Treasuries). The backtesting is from July 2002 to May 2023, which is when the IEF ETF was launched. These returns are in USD and have not been converted to JPY.

Although not directly comparable, here are the results of similar portfolios over the last 20 years (from May 2003 to May 2023) as calculated by myindex.jp. All these results are yen based:

100% US Stocks
Annual Return: 10.6%, Sharpe ratio: 0.59, Risk: 18.0%

75% US Stocks / 25% developed country bonds
Annual Return: 8.9%, Sharpe ratio: 0.60, Risk: 14.9%

60% US Stocks / 40% developed country bonds
Annual Return: 7.9%, Sharpe ratio: 0.60, Risk: 13.2%

I'm not exactly sure how "risk" is calculated but it's a measure of the volatility of short-term returns.

Note that if the 60/40 included Japanese stocks and bonds, the results are worse:
Annual Return: 6.6%, Sharpe ratio: 0.57, Risk: 11.7%

[TokyoBoglehead]

Disclaimer: I always approach these things with an open mind, so if I seem combative I am just exploring the other side of the argument.

........

I think someone already pointed out that bond funds don’t have fixed returns. They rise and fall in value, but the key point is that the downturns in their prices are less severe than for equities.

I think it is important not to get caught up in semantic linguistics.

Bond returns are fixed. They are literally called fixed income in the industry.

Funds are made up of different bonds, with different maturities and coupons. New bonds are added as old ones mature. But their returns are fixed.

......

The risk of panic-selling shouldn’t be understated, especially as the investor gets older and has less time to wait out the storm. Watching a 100% equity portfolio drop 65% in value during the GFC as VG1 did would certainly tempt me to panic and sell, unless I was your age. I know a couple of people older than me who did just that. One of them survived two crashes, but caved in the third one (at the start of the pandemic).
too!

Individual appetite for risk is relevant. But I would suggest holding more cash. At least a years worth of normal spending, that can be stretched into two if the worst comes to worse.

I am not a fan of structuring my own approach based of the theoretical emotional instability of others, past or present.

[VG1]

Currently, my asset allocation is very distorted due to a recent inheritance. Under normal circumstances, if I was a USD-based investor, I would typically go for the good old 60% stocks and 40% bonds portfolio.

Interesting. Under normal circumstances, what would the ratio be for you as a JPY-based investor, without that inheritance?
Are you implying it would be different due to currency risk?

The way I see it is:

Currency risk affects both bonds and equities equally on a simple bond/share price conversion-to-yen basis (obviously).

Depreciation of a nation’s currency lifts the share prices of its exporters but lowers them for its importers. And the economy of the US, which accounts for a heavy chunk of many portfolios, is more balanced than Japan’s as far as export-dependence goes.

A currency could weaken due to low interest rates, which would actually lift bond prices.

I don’t think there is much in it.

Yes, currency risk is important to and has a big impact on my allocation because most of my future spending is likely to be in JPY.

Let me provide some context about my situation otherwise, my allocation may be difficult to understand. I am in my mid-fifties and retired early 1.5 years ago, relying mainly on my investments for living expenses. Consequently, my risk appetite differs significantly from that of someone younger with a steady income. Given my circumstances and my personality, my primary objective is not to maximize my wealth but rather to ensure sufficient funding for my future consumption. As a result, I aim to hold around 5 years' worth of JPY cash (even though I may reconsider if inflation remains steadily above 2 % for the long run) whether if I was USD-based I would probably invest everything in the 60/40 without thinking.
But my JPY cash is currently more than these 5 years because I received a taishokukin and I am uncertain about what to do with it. Ideally, I would prefer to keep it in JPY since my portfolio already consists of 70% foreign currencies. But I already have enough Japanese stocks and investing in JGBs (at least at this stage) is a no-no for me. Recently, I made a small investment in J Reits, but I need to further study this asset class before committing more capital to it.

Anyway, I am still thinking about my assets and currency allocation and there is a lot of food for thought on this forum. Many thanks to all the contributors!

[ToushiTime]

Bond returns are fixed. They are literally called fixed income in the industry.

Bond fund returns = income (fixed coupon payments from underlying bonds) and capital gains (rises in the prices of the underlying bonds), which are not fixed and reflect demand, which in turn reflects inflation and prevailing interest rates, plus inflation expectations etc.

In a crash, when interest rates are often cut sharply, that would put upward pressure on the prices of those underlying bonds and help lift the value of the bond fund. More importantly history shows that their prices fall less precipitously than equities during a crash.

Individual appetite for risk is relevant. But I would suggest holding more cash. At least a years worth of normal spending, that can be stretched into two if the worst comes to worse.

I plan to have that amount of cash too, but I think a year's worth of cash won't cut it, if you experience a bad sequencing risk with a 10-13 year stock slump. This is irrelevant to you as you are in your mid-30s.

I am not a fan of structuring my own approach based of the theoretical emotional instability of others, past or present.

Being distressed when your entire portfolio plummets 65% during the GFC is not a sign of "emotional instability". I don't imagine VG1 is neurotic And the guy I knew who sold during the pandemic after making it through previous crashes is one of the most level-headed guys I know. I think proximity to retirement affects risk tolerance though, for obvious reasons.

[ToushiTime]

Currently, my asset allocation is very distorted due to a recent inheritance. Under normal circumstances, if I was a USD-based investor, I would typically go for the good old 60% stocks and 40% bonds portfolio.

Interesting. Under normal circumstances, what would the ratio be for you as a JPY-based investor, without that inheritance?
Are you implying it would be different due to currency risk?

The way I see it is:

Currency risk affects both bonds and equities equally on a simple bond/share price conversion-to-yen basis (obviously).

Depreciation of a nation’s currency lifts the share prices of its exporters but lowers them for its importers. And the economy of the US, which accounts for a heavy chunk of many portfolios, is more balanced than Japan’s as far as export-dependence goes.

A currency could weaken due to low interest rates, which would actually lift bond prices.

I don’t think there is much in it.

Yes, currency risk is important to and has a big impact on my allocation because most of my future spending is likely to be in JPY.

Let me provide some context about my situation otherwise, my allocation may be difficult to understand. I am in my mid-fifties and retired early 1.5 years ago, relying mainly on my investments for living expenses. Consequently, my risk appetite differs significantly from that of someone younger with a steady income. Given my circumstances and my personality, my primary objective is not to maximize my wealth but rather to ensure sufficient funding for my future consumption. As a result, I aim to hold around 5 years' worth of JPY cash (even though I may reconsider if inflation remains steadily above 2 % for the long run) whether if I was USD-based I would probably invest everything in the 60/40 without thinking.
But my JPY cash is currently more than these 5 years because I received a taishokukin and I am uncertain about what to do with it. Ideally, I would prefer to keep it in JPY since my portfolio already consists of 70% foreign currencies. But I already have enough Japanese stocks and investing in JGBs (at least at this stage) is a no-no for me. Recently, I made a small investment in J Reits, but I need to further study this asset class before committing more capital to it.

Anyway, I am still thinking about my assets and currency allocation and there is a lot of food for thought on this forum. Many thanks to all the contributors!

Thanks. By "my portfolio already consists of 70% foreign currencies". Wow. Do you actually mean dollars and euro deposits etc. or do you mean foreign currency-denominated investments?

[VG1]

Interesting. Under normal circumstances, what would the ratio be for you as a JPY-based investor, without that inheritance?
Are you implying it would be different due to currency risk?

The way I see it is:

Currency risk affects both bonds and equities equally on a simple bond/share price conversion-to-yen basis (obviously).

Depreciation of a nation’s currency lifts the share prices of its exporters but lowers them for its importers. And the economy of the US, which accounts for a heavy chunk of many portfolios, is more balanced than Japan’s as far as export-dependence goes.

A currency could weaken due to low interest rates, which would actually lift bond prices.

I don’t think there is much in it.

Yes, currency risk is important to and has a big impact on my allocation because most of my future spending is likely to be in JPY.

Let me provide some context about my situation otherwise, my allocation may be difficult to understand. I am in my mid-fifties and retired early 1.5 years ago, relying mainly on my investments for living expenses. Consequently, my risk appetite differs significantly from that of someone younger with a steady income. Given my circumstances and my personality, my primary objective is not to maximize my wealth but rather to ensure sufficient funding for my future consumption. As a result, I aim to hold around 5 years' worth of JPY cash (even though I may reconsider if inflation remains steadily above 2 % for the long run) whether if I was USD-based I would probably invest everything in the 60/40 without thinking.
But my JPY cash is currently more than these 5 years because I received a taishokukin and I am uncertain about what to do with it. Ideally, I would prefer to keep it in JPY since my portfolio already consists of 70% foreign currencies. But I already have enough Japanese stocks and investing in JGBs (at least at this stage) is a no-no for me. Recently, I made a small investment in J Reits, but I need to further study this asset class before committing more capital to it.

Anyway, I am still thinking about my assets and currency allocation and there is a lot of food for thought on this forum. Many thanks to all the contributors!

Thanks. By "my portfolio already consists of 70% foreign currencies". Wow. Do you actually mean dollars and euro deposits etc. or do you mean foreign currency-denominated investments?

Sorry for the confusion. I meant foreign currency denominated investment. I guess roughly half stocks half bonds.

[TokyoBoglehead]

Bond returns are fixed. They are literally called fixed income in the industry.

Bond fund returns = income (fixed coupon payments from underlying bonds) and capital gains (rises in the prices of the underlying bonds), which are not fixed and reflect demand, which in turn reflects inflation and prevailing interest rates, plus inflation expectations etc.

In a crash, when interest rates are often cut sharply, that would put upward pressure on the prices of those underlying bonds and help lift the value of the bond fund. More importantly history shows that their prices fall less precipitously than equities during a crash.

Individual appetite for risk is relevant. But I would suggest holding more cash. At least a years worth of normal spending, that can be stretched into two if the worst comes to worse.

I plan to have that amount of cash too, but I think a year's worth of cash won't cut it, if you experience a bad sequencing risk with a 10-13 year stock slump. This is irrelevant to you as you are in your mid-30s.

I am not a fan of structuring my own approach based of the theoretical emotional instability of others, past or present.

Being distressed when your entire portfolio plummets 65% during the GFC is not a sign of "emotional instability". I don't imagine VG1 is neurotic And the guy I knew who sold during the pandemic after making it through previous crashes is one of the most level-headed guys I know. I think proximity to retirement affects risk tolerance though, for obvious reasons.

An investor typical buys a bond fund (example - ETF: BND as we all seem to be ignoring $/¥ risk) for the dividend. There is capital yield from the buying and selling of bonds, and investor sentiment,but capital yield should never be a reason to own a bond fund.

That's not why someone would by an individual bond either.

(Discounting CABs, corporates, etc as we all seem to be discussing sovereign developed bonds)

.....

Being distressed is not a sign of instability, selling during these periods is the unstable action.

My portfolio doesn't need bubble wrap and corner protectors.

[VG1]

Using the period from July 2002 to May 2023, the 60/40 allocation returned an annualized 7.79% with a volatility of 8.75% and a Sharpe ratio of 0.75. In comparison, a 100% US stock allocation returned 9.65% with a volatility of 14.94% and a Sharpe ratio of 0.61. The allocation you mention, with a 25% bond allocation, returned 8.58% with a volatility of 10.89% and a Sharpe ratio of 0.69. These calculations use the SPY ETF for stocks and the IEF ETF for bonds (7/10-year Treasuries). The backtesting is from July 2002 to May 2023, which is when the IEF ETF was launched. These returns are in USD and have not been converted to JPY.

Although not directly comparable, here are the results of similar portfolios over the last 20 years (from May 2003 to May 2023) as calculated by myindex.jp. All these results are yen based:

100% US Stocks
Annual Return: 10.6%, Sharpe ratio: 0.59, Risk: 18.0%

75% US Stocks / 25% developed country bonds
Annual Return: 8.9%, Sharpe ratio: 0.60, Risk: 14.9%

60% US Stocks / 40% developed country bonds
Annual Return: 7.9%, Sharpe ratio: 0.60, Risk: 13.2%

I'm not exactly sure how "risk" is calculated but it's a measure of the volatility of short-term returns.

Note that if the 60/40 included Japanese stocks and bonds, the results are worse:
Annual Return: 6.6%, Sharpe ratio: 0.57, Risk: 11.7%

Thanks for this. Interesting to observe that USD returns converted in JPY are quite similar to returns in USD indicating that over the long term, the FX exposure had little impact except making returns more volatile. But again 22 years is quite a long period for some of us!

[ToushiTime]

An investor typical buys a bond fund (example - ETF: BND as we all seem to be ignoring $/¥ risk) for the dividend. There is capital yield from the buying and selling of bonds, and investor sentiment,but capital yield should never be a reason to own a bond fund.

That's not why someone would by an individual bond either.

The reason to own a government bond fund is the reduced volatility, putting aside the unresolved question of $/¥ risk. That scenario I gave was mainly to illustrate how mutual (government) bond returns could fluctuate, i.e. upward in that scenario, if central bank rates were cut in response to a crash, which would be an added benefit.

Being distressed is not a sign of instability, selling during these periods is the unstable action.

Selling during such periods is not a sign of emotional instability either.

Millions of retail investors panic sold on the way down during the GFC. It’s easy to dismiss them all with hindsight.

My portfolio doesn't need bubble wrap and corner protectors.

I agree, given your current situation.
Could you ever imagine yourself adjusting the ratio, assuming you retire in Japan? (not a rhetorical question, just curious).