Bond Allocation

[TBS]

Run the numbers for the difference compounding 9.2% for 50 years vs 12% for 50 years......

Ok I get now what you were trying to say. It was just a lil strange to see it written like that, as it made it seem like dividends are more important than unit price growth, when actually it's dividends < unit price growth < unit price growth + dividends.

[TBS]

I'm having trouble understanding that video at 3:28mins here https://www.youtube.com/watch?v=oyzR7tMmj9o

In the bad sequence from 2000, they start of with:

450,000 pounds of savings (which continue to be reinvested, I think)
and draw down 22,500 pounds a year (he said 5% but then said 22,500 fixed each year, so I am guessing he didn't mean 5% of the remaining balance)

He said they would only have 196,150 pounds left by 2010

450,000 - (10 x 22,500 = 225,000) = 225,000 pounds = the amount left after draw-downs before factoring in the declines in investment value

So they "only" lost 28,850 pounds (225,000 - 196,150) due to the slump from 2000 until 2010?

He then said even if they did see the "phenomenal returns" from 2010 until 2020, they would never have been able to catch up, which seems a long time, but I guess the draw downs reduce the amount reinvested and therefore delay the recovery.

Presumably, this would have been even worse for a couple retiring in 1929 based on the deeper and longer troughs, and the time taken to reach the break-free point.

Am I understanding this correctly?

Hey all good questions. Yea basically you've got it. Just remember to completely separate in your mind the two scenarios we've been discussing.

The first one (BusinessInsider...) we were comparing the difference in value of an S&P500 investment between two time points only: a peak before a big crash, and either the time it took for the real terms value to recover to that, or the time it took to recover and never drop below the starting peak ever again (break free point). There's no new investments (other than dividends paid out by the shares) or withdrawals made.

The second scenario from the video is a completely separate one: a couple retiring at 55 with 450,000 GBP of equity investments want to know if this pot of money can sustain the lifestyle they want throughout retirement, which requires 22,500 GBP each year. Like you say I think that figure is fixed.

It's not just two time points on the BusinessInsider chart that matter in this second scenario, it's the trajectory the chart takes, as the withdrawals are occurring regularly (monthly I guess).

Because the couple experience an unlucky sequencing of returns initially, their starting investment pot isn't large enough to sustain their withdrawal requirement from it throughout retirement. The pot value drops too low, so even the bull run following the crash isn't enough to recover it. Eventually they will run out of money before they can expect the grim reaper to come knocking.

I wouldn't try and reproduce the numbers yourself as their isn't enough information in the video to actually do that. As an aside the graphs are made using this Timeline software which looks great.

But the main point to take away is the trajectory the stock market takes determines whether an investment goal can likely be met or not.

And indeed, things would have been worse for them retiring in 1929, because as we've seen the losses were deeper, more sustained and longer lasting than 2000. So it's likely the couple would have run out of money even earlier.

[TBS]

450,000 - (10 x 22,500 = 225,000) = 225,000 pounds = the amount left after draw-downs before factoring in the declines in investment value

So they "only" lost 28,850 pounds (225,000 - 196,150) due to the slump from 2000 until 2010?

And yes I think this is basically correct. Their investment pot is down 28,850 GBP at that point compared to if they had just kept cash*. Doesn't seem so bad maybe, but the point is their investment goal (22,500/y) requires that the investments grow for it to be achievable.

If they don't get enough growth early on (sequencing risk), they bust out of money.

This connects back to this thread topic, as there is no "correct" bond or cash allocation for a portfolio. It depends totally on the investment goal and the individual. Whether an investment goal is achieved depends on how large the goal is relative to the initial portfolio, then on what subsequently happens in the markets, the economy, inflation, and the individual's life circumstances & actions.

*I think the video calcs also account for inflation, so maybe not exactly comparable to holding cash.

[ToushiTime]

450,000 - (10 x 22,500 = 225,000) = 225,000 pounds = the amount left after draw-downs before factoring in the declines in investment value

So they "only" lost 28,850 pounds (225,000 - 196,150) due to the slump from 2000 until 2010?

And yes I think this is basically correct. Their investment pot is down 28,850 GBP at that point compared to if they had just kept cash*. Doesn't seem so bad maybe, but the point is their investment goal (22,500/y) requires that the investments grow for it to be achievable.

If they don't get enough growth early on (sequencing risk), they bust out of money.

This connects back to this thread topic, as there is no "correct" bond or cash allocation for a portfolio. It depends totally on the investment goal and the individual. Whether an investment goal is achieved depends on how large the goal is relative to the initial portfolio, then on what subsequently happens in the markets, the economy, inflation, and the individual's life circumstances & actions.

*I think the video calcs also account for inflation, so maybe not exactly comparable to holding cash.

Thanks for both or your replies.
Yes, thanks for reminding me there were no new investments (other than the dividends) in the BusinessInsider article.
I am relying largely on DCA, so even those 20 years and 13 years for total real returns to reach the “break free” point (i.e., stay above the starting points in 1929 and 2000 respectively for sustained periods) would not have applied to all of my portfolio.

Just before I checked this forum, I was watching another video by James Shack - he’s very good. Thank you for recommending him. I'd advise others to check him out.
https://www.youtube.com/watch?v=3Vk8DuqwsyA

Based on everything, I’ve learnt, I think I will be conservative and assume 10-15 years for my portfolio to recover from a crash. Retirement is still some way off, but I’m not fresh out of college either. I realize it’s not just about the time and the data, though. It’s also about the risk of losing your nerve and panic-selling. I admire people who are 100%-equity, but until someone has been through the fire, like VG1 has, it’s hard to tell how each of us would react. Rationalizing and looking at past trends helps, but I guess you never know until you’ve actually experienced a crash. Also being able to draw down funds when you need it is another key reason to have bonds in the event of a crash.

As I mentioned, at the moment, I’m thinking of going for 25% bonds, 75% equity.

For what it’s worth, I’m planning to have a mix of the following in the bond portion:

iShares TIP ETF (Inflation Protected Treasuries 2-20yrs),
Vanguard VTIP ETF (Inflation Protected Treasuries under 5 yrs),
i-Share IEF ETF (Treasuries 7-10 yrs) and
eMaxis Developed Nations Bond fund.

I’m still not sure whether to bother with the inflation protection or not, given that the ETFs have taxable distributions whereas the eMaxis doesn't.
It is not very scientific but when in doubt, I go for a bit of both of something, just for diversification

[ToushiTime]

I want the diversification in maturities, countries and some protection against inflation, hence the mix above
You could make your own portfolio of various maturities etc and keep laddering/rolling over various bonds but I’d find that a hassle, and Japanese brokerages don’t sell individual Treasury TIPS, AFAIK.

[TokyoBoglehead]

Is there any advantage going for a bond fund instead of directly buy bonds?
Bond funds seem to be much rather volatile, and I’d feel more comfortable knowing I can just wait out the bond till maturity…

I've come to realize that holding to maturity, and holding via a bond fund essentially guarantee the same returns.

I was enlightened by this article.

https://institutional.vanguard.com/insi ... funds.html

This again ignores the issue of currency and assumes you are dealing in USD.

[ToushiTime]

I was enlightened by this article.

https://institutional.vanguard.com/insi ... funds.html

That link is excellent. Thank you. I remembered you or somebody else pointed that out but I couldn't recall the exact argument.

This again ignores the issue of currency and assumes you are dealing in USD.

NorthSaver took the time to crunch the numbers on page 5 of this topic, but they seemed pretty inconclusive to me as to whether foreign bonds are more sensitive to currency changes than foreign equities.

The dollar weakened during the period below, but falling interest rates lift existing bond prices (I think these were bond mutual fund prices), which only fell 14%, versus 36% for stocks. You could argue that without falling interest rates, bond prices would have fallen further in dollar value, contributing to a lower end result, but lower interest rates often affect the value of the currency, i.e. higher interest rates may have lifted the dollar (see the current disparity between the dollar and yen due to central bank rate differences).
You could also argue that stocks would have fallen even further in yen value if they hadn't rallied later on.
My point is there are probably too many inter-connected variables and also separate variables to tell, IMHO.

April 2007 to April 2012 (5 years)
USD.JPY: falling (from 119.5 to 79.8 = -33%)
S&P500: falling then rising (from 1483 to 666 to 1398)
US interest rates: falling (from about 5% to 0%)

Foreign bond cumulative return: (114 - 133) / 133 = -14%
Foreign stock cumulative return: (136 - 211) / 211 = -36%

[TokyoBoglehead]

I was enlightened by this article.

https://institutional.vanguard.com/insi ... funds.html

That link is excellent. Thank you. I remembered you or somebody else pointed that out but I couldn't recall the exact argument.

This again ignores the issue of currency and assumes you are dealing in USD.

NorthSaver took the time to crunch the numbers on page 5 of this topic, but they seemed pretty inconclusive to me as to whether foreign bonds are more sensitive to currency changes than foreign equities.

The dollar weakened during the period below, but falling interest rates lift existing bond prices (I think these were bond mutual fund prices), which only fell 14%, versus 36% for stocks. You could argue that without falling interest rates, bond prices would have fallen further in dollar value, contributing to a lower end result, but lower interest rates often affect the value of the currency, i.e. higher interest rates may have lifted the dollar (see the current disparity between the dollar and yen due to central bank rate differences).
You could also argue that stocks would have fallen even further in yen value if they hadn't rallied later on.
My point is there are probably too many inter-connected variables and also separate variables to tell, IMHO.

April 2007 to April 2012 (5 years)
USD.JPY: falling (from 119.5 to 79.8 = -33%)
S&P500: falling then rising (from 1483 to 666 to 1398)
US interest rates: falling (from about 5% to 0%)

Foreign bond cumulative return: (114 - 133) / 133 = -14%
Foreign stock cumulative return: (136 - 211) / 211 = -36%

I think you can can get too into the weeds with this sort of calculation.

If I am going to take on currency risk, I expect that risk to be rewarded. The fixed return bonds offer are not sufficient to match that downside risk.

The unfixed reward offered by global equities is sufficient to equal the potential currency risk.

That is my calculation. I also am in my mid-30s. So my outlook is 35+ years before I start to drawdown.

[VG1]

I believe one important criterion for determining bond allocation is the maximum drawdown that an individual can tolerate.

During the time of the Lehman shock, my portfolio, which was 100% invested in global stocks, experienced a 65% drawdown when valued in JPY from its peak in October 2007 to its low point in March 2009. In hindsight, it is easy to say that there was no reason to worry because the portfolio fully recovered. However, it was not so easy to remain calm during the drawdown itself.
The difficulty lies in the fact that it is hard to determine one's risk tolerance without experiencing a real situation that tests it.

During that period, the ETF IEF, which invested in 7 to 10-year US Treasuries, gained 20% over the same period.
Since then, I have always allocated a portion of my portfolio to bonds.

Hi, thanks. This is proof it is not just about the numbers.
Could I ask; what is your bond allocation now, and have you adjusted it as time passes?

Hello,

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.

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.

As a JPY-based investor, most likely residing in Japan for the long term, my biggest headache is determining the appropriate amount of JPY cash to hold.

[ToushiTime]

I think you can can get too into the weeds with this sort of calculation.

I agree, that’s why I said the data is inconclusive in my opinion.
Until I see otherwise, I will assume bonds and equities have roughly the same currency risk.

If I am going to take on currency risk, I expect that risk to be rewarded. The fixed return bonds offer are not sufficient to match that downside risk.

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.

If equities had no downside, I would agree with you. The problem is that the volatility of equities often leads to panic-selling, and can leave you stranded when old age approaches due to sequencing risk/being unable to draw down funds during a lengthy equity market crash. Yes, bonds could well be lower in a crash too, but historically they fall to lower levels. It is that relative stability that keeps you sane in a crash and makes it easier to draw down funds with smaller losses.

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).

Essential point: it is not so much the lows of equities, as it is the actual depth of the plunge from the high point to the low point that freaks people out. At your age, you may think this is daft but you may feel different when you are older.
This video by James Shack, whom TBS on this forum mentioned, sums it up perfectly here (from 8:45mins in).
https://www.youtube.com/watch?v=Eac2jZcelQw&t=2s

I also am in my mid-30s. So my outlook is 35+ years before I start to drawdown.

By "retirement is still some way off", I didn't mean I was in my mid-30s.
How long is a piece of string, I guess
Anyway, I didn’t realize you were so young!
It puts your approach into a whole new perspective.
In your shoes, I’d probably be close to 100%-equities too!