VBND vs VAF vs VGB

@pippen

A bit over 10% in VAF at the moment, then VAS and VGS. I count my older VTS/VEU funds, that I've not sold due to CGT as international within the pie chart nowadays, similarly my old STW funds make up part of my Aussie allocation.

I do get tempted from time to time with VGE, DJRE, IFRA etc

 

No cash holdings on the side? Fully invested?!

 

Some may or may not be interested but overtime I’ve kept numerous quotes from Bill Bernstein some that relate to the above. The relevance of the comment “If you’ve Won the game stop playing” is very much dependent on “level of wealth” and “RISK TOLERANCE”.

If wealthy enough things like Sequencing Risk, need for Bonds etc are irrelevant. It simply comes back to the investor’s Risk Tolerance albeit a very important attribute.

I’ve also included a few quotes from Bernstein on Bonds hence why I prefer to stay with “short duration” Term Deposits / high interest cash accounts for the defensive part of the portfolio. One could choose Treasuries / short term Bond Funds but why lose 20 or so basis points in Fees when a High Interest Cash Account and Short Duration Term Deposits have ZERO fees. Return of ALL capital, zero fees and a bit of protection against inflation (it’ll rise eventually) by staying short is far more important to me than taking on the risk of investing in intermediate / long duration Bond Funds.

Note when referring to dividends Bernstein is using the S&P500 as an example where the dividend yield is low.

 

Why are bonds outperforming stocks over long term?

Some prudent comments within though, especially at the end



The below is more telling in my mind though

Portfolio allocation models

 

Thanks @Redwing, greatly appreciate and respect your views as always. You’re the most disciplined investor I know of here on PC.

The realty as you know is there is no right or wrong approach with this stuff, it’s very specific to each investors circumstances. I think this is something we can all agree on. However broad discussion and a variety of views might help others identify with an approach that could be useful for their circumstances.

 

Another snippet from my collection of Bernstein quotes. Of course in Australia our Bond market is small relative to the US so one could argue the diversification card? But given that near all Bond index funds locally are “Hedged” essentially when foreign bonds are Hedged you’ve basically got Australian Bonds. Simplistic view I know but food for thought. Maybe that’s why @Redwing is content in just owning VAF and doesn’t feel the need for foreign bonds? If one is confident the Australian Gov’t won’t go bankrupt why bother with foreign Bonds?

 

Not sure how that logically follows ;

- global bond fund has very strong diversification mitigating issuer risk, VAF has very low diversification

- global bond fund when hedged will still return underlying coupon and price movement plus / minus hedge effects. This is not that same as Australian bond fund.

 

In my scrutiny of the data I have not found much robust support for bonds helping with sequence risk. Yes there are times but it cuts both ways. Bonds had the biggest positive impact on safe withdrawal rates in historical data during the great depression. A physical economic depression largely caused by monetary response constrained by adherence to the gold standard, a situation that sovereign currency issuers have since freed themselves from. Too easy to create monetary inflation with pure fiat currency to believe serious economic deflation to the physical economy from monetary policy will re-occur. (monetary constraints are now isolated to EU country type scenario’s where single currency issues can trump deflating the currency to support an individual country physical economy)

Even looking back over gold standard data – SWR rates are enhanced by bonds only a small amount and on limited occurrences. Bonds are most helpful when you have a limited timeframe to fund – the longer the timeframe the less bonds improve SWR.

These are the sort of typical findings I was making on various data set I could get my hands on.

Taking something like a 30 year time frame – and applying SWR calculations to periods that had gold standard constraints to monetary policy, you will find a 40% bond allocation might give you a SWR of say 4% and all equity say 3.8%. But the cost to extract that extra .2% increase in withdrawal rate on the worst sequence might typically cost you a halving of the total capital that could be safely consumed in all other periods. The longer the time frame the worse this benefit / cost become.

My conclusion on sequence risk seems to differ from the authoritative opinions mentioned above. My unwavering opinion from studying the data now is that the best form of defence is attack. Increase your capital to lower your withdrawal rate. An all equity portfolio that only needs to sustain a withdrawal rate of say 3% is vastly safer than a portfolio with a bond component that needs to sustain a 4% withdrawal. And you can safely withdraw (or for the collectors, accumulate) millions more in all other circumstances.

The pure equity ride will be more volatile under many circumstance, but not always, an exception for example could be hyper-inflation scenarios where currencies/countries are decimated by devastation (war, natural disaster, pandemic, poor leadership etc) but some foundation of physical production and ownership recognition remain.

Fiat currency freed from gold standard is good for transacting – its not good as a store of wealth or for denominating an investment in. Long-term after-tax return on it is never likely to exceed real inflation levels, the very mechanism of fiat money creation and its role to facilitate the physical economy basically ensures it. Capital gains from bonds price changes as currency lose their value are cyclical and not a true sustainable underlying return. Nearing zero nominal return, future capital gains must be viewed sceptically unless you believe negative interest rate are sustainable.

The impact of 0.5% interest rate changes on bond prices are much larger when interest rate are 1% than when interest rates are 5%. Going forward if interest rates stay low, bond volatility may not hold the same correlations as the last 30 years of high and falling rates.

That will about do for my highly biased views on bonds. Bottom line – I just don’t like the risks I see involved in holding cash or cash denominated investments such as bonds. Cash for transacting, ownership of productive capacity for wealth accumulation and maintenance.

 

Yes fair points, it makes sense from a US perspective of course given the sheer size and diversification of the Bond market there. Still I can see what Bernstein is getting at.

I suppose given Australia’s credit rating, when it comes to Gov’t Bonds is there really much reason to hold Hedged foreign bonds? However in regard to corporate bonds the diversification aspect would apply more. But we don’t need Bernstein to remind us of the risks of Corp bonds when protection against equity risk is needed most.

It would be interesting to know for example why Six Park don’t include Foreign Bonds in their portfolios?

Personally I like the simplicity of high interest cash / term deposits. Although unlikely to even need that given our circumstances. But having some cash available doesn’t hurt particularly in the SMSF given mandatory pension payments.

Occasionally I’ve felt that Buffet’s 90% equities / 10% short treasuries (high interest cash / short duration term deposits are a good substitute) might be a nice simple allocation for us. That still equates to a lot of cash in dollar terms and would provide quite a buffer if ever needed. Still much more cash than I’d want to hold. Then again very recently Buffet said the following which suggests that very little cash is needed even for retirees with modest equity holdings (equity holdings a bit low for my liking however). I think Thornhill must have hacked Buffet’s email account:

@The Falcon you’re still a young bloke now having won the game with lots of human capital left if in the unlikely event something extremely nasty arose. Bonds are for the old and fearful not a young wealthy fella like you
.

 

Fantastic post thanks @dunno. I was starting to feel outnumbered. Happy to agree with everything you said, my confirmation bias is working well today.

 

As a thought experiment. I took the average return for each allocation in the Vangaurd article that @Redwing attached and assumed each option earned that return until the final year and then hit the worst drawdown.

Ie for 100% equity if X axis is year 5 then that allocation starting at $1,000 earned 10.1% for 4 years and then hit worst draw down of 43.1% in year 5. For 100% bonds 4 years at 5.3% and then worst draw down of 8.1% in year 5 etc.

Series 2 to 8 represent 20% to 80% equity allocations.

Aim is to give a feel for how prior growth can mitigate future drawdown as measured by equity lows. Unfortunately, if you anchor to equity highs (which most do) then this sort of example will do little to help with your fears of draw down.

But if you got a long term perspective, this first graph shows the first 20 years where the cross overs occur and the growth in the risky asset (on average) mitigates its maximum drawdown. The Important word is "on average" and hence why this sort of example can only be a thought experiment.



Any thought experiment that challenges fear or over-confidence is worth considering in my book.

Speaking of over-confidence (my weakness) - this is the same graph extended to 60 years.


seems my bias can't help reinforcing my belief that cash denominated investments are risky in the long run on a purchasing power basis. Over the 92 years vanguard uses for their data. "On average" (there's that phrase again) 100% bonds returns $115,720 on initial $1000. That return needs to cover , Inflation and any duration and credit risk implied in their bond universe. 100% equities "on average" returns $6,989,294. that is an additional ~6.8Million for bearing equity risk. Diversification and time are the tools to make equity risk manageable to anybody that can invest consistently in equities for the long haul.

 

This is very important in my view. I’ve never liked Bonds at the best of times but given current interest rates they make no sense at all to me. Equity volatility doesn’t scare me at all but the thought of investing in Bonds at this time especially those with medium to long term duration damn near terrify me.

Getting back to Sequence Risk I fell victim to being too conservative when our circumstances didn’t warrant it. The opportunity cost of holding an excessive safety net in cash relative to having been invested in equities has been significant albeit thankfully our lifestyle wasn’t impacted. In fact it was Bernstein’s books that led me astray with the so called “won the game ...”. It wasn’t till later when Bernstein went into greater depth during discussions on Bogleheads and in other interviews etc that it became clearer that it was very circumstance dependent. Further in hindsight despite my limited intellect I feel Bernstein’s Liability Matching approach is very flawed. That is a topic in itself and one too difficult for me to contemplate after a few refreshments.

The quote below by @dunno and drummed into my head over the decades by Thornhill and others was what I believed investing is all about. I allowed myself to be led astray by much of the research out there on Sequence Risk. Thankfully I’m back on track with minimal harm done:

 

The way I look at it (and per @SatayKing it's all about me ) Stocks will always outperform over the long term and similarly, over extended time periods there are benefits to holding an 100% equities position, there are also short term benefits to bonds when stock markets fall, holding some Bonds will ensure your portfolio doesn't fall as far as the rest of the market, but will also give you capital to deploy when required

From January 2000 to Dec 2018 $10'000 invested into portfolio's using the below allocations

Portfolio 1 100% US Stocks
Portfolio 2 70% US Stocks 30% Bonds
Portfolio 3 60% US Stocks 40% Bonds




Resulted in the below



Note Portfolio 2 and 3 results





Start and end dates always matter, changing the end year from 2018 to 2019 gave the below result

 

But my biggest concern as also mentioned earlier by @dunno (see below) is the assumption that the negative correlation between equities and bonds will behave as in recent decades being a declining high interest rate environment.

I’m confident and positive in regard to what equities will do in coming decades. Bonds on the other hand are a complete unknown which I’m not willing to risk my capital on.

But of course as you say “it’s all about me” so one needs to go with whatever they believe in.

Out of curiousity are there any actual RETIREES here who invest in Bonds as part of their “long term” asset allocation? Being retired especially when human capital has been depleted is a very different situation compared to younger retirees / accumulators. Generally our investment income is all we have to live off, returning to work is not usually an option available to us. Yet surprisingly the likes of me, @SatayKing, @truong who I know are retired have avoided Bonds favouring high exposure to equities. @SatayKing being one of the most senior here in my mind is a legend being 100% equities. Maybe with age we toughen up.

 

Love to be at the stage of the three dividend growth kings @Nodrog where there's more coming in than going out

I wish I'd read some of your posts and @SatayKing 's on the share forum you've previously mentioned



I think as @DoggaPP mentioned though this LIC strategy maybe a bit harder if left until later years before you get a move on and you may need some growth to play catch up?

 

I've never directly held bonds as an investment. Maybe did indirectly when I foolishly put money into unlisted managed funds many moons ago. Once an FP did suggest some but I rejected the idea. Didn't feel all that comfortable about it.

Anyway the LICs I hold have heaps of cash I gather so that's my proxy for bonds. They also have borrowings, at least some do, so there is my gearing as well.

 

Overall we were as boring as bat poo. I still am.

There is nothing exciting about what I do. Taken years to understand investing doesn't have to be flashy. No 10 baggers or Wow I got a 50% gain and ain't I so smart.

Just keep going doing whatever suits you best and if that includes bonds all to the good. And no looking over the fence could be a worthwhile approach too.

 

Yes, I often lose sight of late that. Then again Thornhill is of the view that those less well off need equity dividends even more so than the wealthy.

@dunno of course has generously provided excellent data analysis supporting high exposure to equities.

The problem though arises in the Sequence Risk danger zone. It’s a complete jungle out there trying to determine the best approach for each investors given circumstances. No easy answer unfortunately. Personally I still favour high equity exposure regardless but if skating close to the edge then a modest cash cushion would be worthwhile to cover dividend shortfall and / or to avoid forced asset sales at the worst possible time.

 

Ah the old Shares Guru forum back in early to mid 2000. I would get excited every time I saw a new post by @SatayKing. Mind you from what I read elsewhere the vast majority of forum members being traders considered us boring old buy and hold LIC investors a laughing stock. I’m pretty sure I know who have had the far better outcome near 20 years later. Boring is best.