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Author: GollumLives Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75700  
Subject: Bonds Date: 4/18/2004 2:57 PM
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At what point do you add bonds, savings accounts and the like to retirement investing and what do you buy? According to the retirement advice posted on the fool site stocks and possibly index funds are the most important thing for long term retirement investing. So that is just fine for while you are saving. At some point though you will want to have some protection against a downturn in the market when you are no longer earning an income. Do you put your money in a savings account, buy bonds, a bond fund, T bills or what?
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Author: wcfenton Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40559 of 75700
Subject: Re: Bonds Date: 4/18/2004 3:35 PM
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GollumLives...

At what point do you add bonds, savings accounts and the like to retirement investing and what do you buy? According to the retirement advice posted on the fool site stocks and possibly index funds are the most important thing for long term retirement investing. So that is just fine for while you are saving. At some point though you will want to have some protection against a downturn in the market when you are no longer earning an income. Do you put your money in a savings account, buy bonds, a bond fund, T bills or what?
-------------

You probably also read that in order to know how to proceed with your financial future, you need to take inventory of where you are now.

-How old you are
-Investment goal/s
-Current debt load
-Current investments
-Employment status
-Funds available for investing

These are the main things that someone giving advice on how you might approach your finacial goals would need to know. The order of priority that seems to be generally accepted is:

1)Eliminate bad debt (Primarily, credit card debt - mortgage, car, student loans are considered acceptable debts).
2)Establish an "E" Fund for emergencies like unemployment. (Savings Account, Laddered CDs, etc.)
3)If you have a 401k at your place of business - contribute up to the point where you maximize matching funds offered by your employer.
4)If you have additional funds that you can invest...now would be the point where you might want to consider a Roth IRA.
5)If you still have extra funds (lucky you) go back and max out your 401k.
6)Lastly, there are always taxable brokerage accounts.

As far as what to invest in - well, there you will get a multitude of answers. Personally, I like the idea of not taking too much risk and stand the likely possibility of losing my hard-earned money...so, for someone starting a retirement account/portfolio, I like (stand back because this is a long discription) a passively managed, no-load, low fee, broad-based Index Fund. Something like Vanguard's Total Stock Market Index Fund (VTSMX). That would be a good starting core fund. Where would you go from there? You need to take that inventory I was mentioning earlier in this post before I got carried away.

Regards,
Bill





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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40560 of 75700
Subject: Re: Bonds Date: 4/18/2004 3:48 PM
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GollumLives wrote"
At what point do you add bonds, savings accounts and the like to retirement investing and what do you buy? According to the retirement advice posted on the fool site stocks and possibly index funds are the most important thing for long term retirement investing. So that is just fine for while you are saving. At some point though you will want to have some protection against a downturn in the market when you are no longer earning an income. Do you put your money in a savings account, buy bonds, a bond fund, T bills or what?

Before you retire, volatility doesn't hurt you (except psychologically, but that's another discussion). Before retirement the goal is to maximize growth which implies a high percentage of equities and the attendant high volatility. In fact, many people invest nearly 100% in diversified equities prior to retirement, which offers the highest historical total return of all.

Then at about five years prior to retirement, most people start adding bonds to their portfolios to achieve an equity/bond ratio that suits their own personal tolerance for risk. Historical data suggests that a 75/25 equity/bond ratio will support the highest long term safe withdrawal rate (around 4%). However, the volatility of a 75/25 mix is substantial, so when I retired, I decided to use a 60/40 equity/bond mix which gives a lot less volatility and a slightly lower safe withdrawal rate.

During retirement, the portfolio should be rebalanced at least annually back to your chosen equity bond mix to assure your continued chosen withdrawal rate.

You also asked about what types of bonds to add. Well, most studies are based on a conservative bond porfolio that includes both treasuries and short term corporates. Of course, you can always add a little more potential income and a little more risk by using longer term bonds.

I recommend you read the Retire Early Home Page at

http://www.RetireEarlyHomePage.com .

You'll find all sorts of great studies and ideas for portfolio asset allocation in retirement.

Russ

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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40561 of 75700
Subject: Re: Bonds Date: 4/18/2004 3:53 PM
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When you are 15 years from retirement, begin shifting a little of your wealth a time to fixed income (I'd go with bond funds and a CD ladder), until, at retirement, FI (plus a 5-10% REIT allocation) represents 50% of your savings. Maintain the 50% ratio through retirement.

Nick

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Author: billjam Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40562 of 75700
Subject: Re: Bonds Date: 4/18/2004 4:04 PM
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I've always carried some fixed income investments. In the early 80's you could earn double digit rates even on money market funds and mortgage securities. Over time my equities grew to 85% but I still held mortgage securites and a high yield bond fund. Today I've reduced equities to 75% but I didn't do it soon enough to avoid a substantial hit in 2001 and 2002. My plan now is to gradually reduce equities to 70% or less. I'll do this by taking some profits each year and re-investing in fixed income securities.

One thing I have learned from the last 3 years is to set specific portfolio allocation objectives and re-balance on a regular schedule. I may vary the allocations by 5% depending on which way I think markets are trending but I'll never let the portfolio get that lop sided again.

As for what bonds to buy, right now I'm staying with short term corporates because I expect interest rates to rise through 2005. Also some CD's. And I have 5% in REITS, which I buy for income and treat as fixed income rather than equity for allocation purposes.


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Author: MadCapitalist Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40563 of 75700
Subject: Re: Bonds Date: 4/18/2004 5:58 PM
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When you are 15 years from retirement, begin shifting a little of your wealth a time to fixed income (I'd go with bond funds and a CD ladder), until, at retirement, FI (plus a 5-10% REIT allocation) represents 50% of your savings. Maintain the 50% ratio through retirement.

Nick


Why 50%?

I don't agree with your recommendation, but I am curious on how you settled on 50%.

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40564 of 75700
Subject: Re: Bonds Date: 4/18/2004 11:32 PM
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The traditional Foolish philosophy is that stocks will continue upward in the long term and you need to hold as much equities as you can to keep up with inflation. Corrections in the stock market happen from time to time, but usually recover in under three years. Therefore, you put 5 years of living expenses into laddered maturity fixed incomes--usually T-bills. You live off the interest from the bonds and the one that matures. Each year you sell stocks to cover one year of expenses and buy a new five year bond to replace the one that matured. If stocks crash, you continue to live off the bonds and then replace them later.

For those who retire on a minimal 25 years of living expenses invested, this gives you a very low bond allocation. 20% is typical, but it could be lower if your investments are larger so expenditures are less then 4%. Or it can be higher if you are more conservative.

Although T-bills were the original vehicles recommended, many now use corporate bonds, or CDs because you get adequate safety with better yields.

I do not agree that bond funds is a good way to begin--especially right now. Interest rates are likely to rise some more. REITs just fell about 20% in the last 4 weeks. Long term rates have skipped upward. Bond fund owners have already taken a hit and will likely take a drubbing before interest rates settle down. So if you are thinking of investing in fixed incomes now, be very careful. Wait if you can. A year or two from now things could be more settled. Meanwhile pick CDs, the bonds themselves, or other similar instruments with fixed maturity dates. They will be safer than bond funds for the forseeable future.

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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40566 of 75700
Subject: Re: Bonds Date: 4/19/2004 1:27 AM
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Why 50%?

If you're retired, I think a 50% stock, 10% REIT, 40% bond is the right mix of stability and growth.

The problem with stocks is, from time to time, they decide to drop by 50% or more, and sometimes remain at depressed levels for decades.

The idea that stocks always bounce back to their all time highs after a couple of years is Pollyanaish. Look at the Nikkie or NASDAQ.

The average retiree who will withdrawing 5% of his portfolio per year to pay his living expenses, and will never have new money to invest to catch cheap post-crash stock prices isn't going to sleep very well with an all stock portfolio. Imagine you retired in in mid 2000 with a $1,000,000 portfolio in an S&P 500 fund, and were withdrawing $50,000 per year to meet your living expenses. In mid 2002, you had around $400,000 after withdrawals.

It's also a myth that only bonds will drop as interest rates rise. Stocks and bonds are competing investments, so if the return of one increases, investors will demand a similar increase in returns from the other. Look at stock prices 20 years ago when bonds were paying 18%. I kept seeing the headline "Stocks drop on rate fears" in the news last week. Stocks, not bonds. Will investors tolerate a stock market with a PE of 25 if bonds are yielding a real 10%? Not in a rational world.

I think some people who shun bonds tend to think of them simplistically as treasuries that won't keep up with inflation. And if treasuries were your only choice, I'd lower my bond allocation. But there are many types of bonds, which is why bond funds are so handy. Some bonds are more similar to stocks than treasuries. William Bernstein, for example, expects large cap stocks and corporate bonds to perform equally (5% real return) going forward based on current dividends, interest rates, default rates, and earnings growth rates.

Of course you still want a healthy stock allocation, since they've been historically the best long term investment, which means, at least in theory, you're being compensated for some greater risk (volatility?) beyond the greater default risk of stocks.

The idea that stocks always rise steadily, and always bounce back quickly from crashes is best case scenario thinking. Best case scenarios do happen. Sometimes.

Nick



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Author: MadCapitalist Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40567 of 75700
Subject: Re: Bonds Date: 4/19/2004 7:28 AM
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Why 50%?

If you're retired, I think a 50% stock, 10% REIT, 40% bond is the right mix of stability and growth.


So basically you pull a number out of a hat.

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Author: 2old4bs Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40568 of 75700
Subject: Re: Bonds Date: 4/19/2004 10:24 AM
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At what point do you add bonds, savings accounts and the like to retirement investing and what do you buy?

As Bill said:
As far as what to invest in - well, there you will get a multitude of answers.

Your own individual situation must determine 'what and when'. Just as an example, Jonathan Pond recommends that a person currently in their 50's, who has saved very little toward retirement, and is trying to do 'catch-up', shouldn't invest in bonds at all. His reasoning is that people in this situation need as much upside potential as possible so that their money might be able to grow quickly, hence 100% equities.

On the other side of the coin: Someone I know personally invested solely in fixed income securities (CDs), until he was 86, at which time he took a small portion of his money and invested in equities. He didn't feel comfortable with anything but fixed income while he was younger. At 86, he felt his portfolio wouldn't have to last him much longer, hence he was willing to take on more risk.

It really is a very individual decision, which should be made after reading lots of recommendations from many quarters and then deciding which suits your investment-style/worry-level best.

2old




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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40569 of 75700
Subject: Re: Bonds Date: 4/19/2004 10:35 AM
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yobria wrote:
When you are 15 years from retirement, begin shifting a little of your wealth a time to fixed income (I'd go with bond funds and a CD ladder), until, at retirement, FI (plus a 5-10% REIT allocation) represents 50% of your savings. Maintain the 50% ratio through retirement.

Nick, this seems a little too conservative for most retirees. A 50/50 equity/bond mix would only be acceptable if a person has a large enough portfolio that he/she will only withdraw about 2.5% a year to live on.

Russ

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40570 of 75700
Subject: Re: Bonds Date: 4/19/2004 10:54 AM
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pauleckler wrote:
I do not agree that bond funds is a good way to begin--especially right now. Interest rates are likely to rise some more. REITs just fell about 20% in the last 4 weeks. Long term rates have skipped upward. Bond fund owners have already taken a hit and will likely take a drubbing before interest rates settle down. So if you are thinking of investing in fixed incomes now, be very careful. Wait if you can. A year or two from now things could be more settled. Meanwhile pick CDs, the bonds themselves, or other similar instruments with fixed maturity dates. They will be safer than bond funds for the forseeable future.

While I agree that a CD or bond ladder is best, I think that bond funds with short maturities should be OK. As interest rates rise, the share price of the short term bond funds will take a small hit initially, but the higher interest rates will compensate with a higher dividend. The ones that will be hit hard by rising rates are the long term corporate(aka 'junk') bond funds. One type of long term fund that may have minimal damage is long term municipal funds.

Russ

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40571 of 75700
Subject: Re: Bonds Date: 4/19/2004 11:03 AM
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yobria wrote:
The average retiree who will withdrawing 5% of his portfolio per year to pay his living expenses, and will never have new money to invest to catch cheap post-crash stock prices isn't going to sleep very well with an all stock portfolio.

I hope the 'average retiree' will NOT be withdrawing 5% from his/her portfolio each year.

Historical backtesting shows that taking a 5% withdrawal (adjusted upwards for inflation each year) will drastically lower the chances that the portfolio will survive 30 years. The highest acceptable withdrawal rate for long term portfolio survival is usually accepted to be 4% (adjusted upwards by inflation each year), and ONLY if the mix is about 75/25 equities/bonds.

I believe that REITs added to the mix will increase the safe withdrawal rate to about 4.3%, but there is not enough REIT data yet to statistically verify this.

Russ

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40572 of 75700
Subject: Re: Bonds Date: 4/19/2004 1:09 PM
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"One type of long term fund that may have minimal damage is long term municipal funds."

A closed end fund of this type is Nuvene Select, NQS, traded NYSE. In the last four weeks it has dropped from $15.6 to 14.2/share. It is now paying 7% fed tax free--based on $1/sh div which is "a" footnoted indicating paid last 12 mo or paid so far.

REITs which pay high dividends and are interest rate sensitive have crashed similarly.

The long awaited interest rate correction is here. Whatever caused it happened on about April 2.


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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40573 of 75700
Subject: Re: Bonds Date: 4/19/2004 1:13 PM
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this seems a little too conservative for most retirees. A 50/50 equity/bond mix would only be acceptable if a person has a large enough portfolio that he/she will only withdraw about 2.5% a year to live on.

Russ,

Two questions for you:

1. Does this 2.5% assume a healthy mix of higher yielding corporates, or just bonds at the extreme end of the risk/return spectrum?

2. Was this number the result of cherry picking a date range where stocks shown? Does it include the 2000-2002 period when stocks dropped by 50%?

Nick

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Author: MadCapitalist Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40574 of 75700
Subject: Re: Bonds Date: 4/19/2004 2:22 PM
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2. Was this number the result of cherry picking a date range where stocks shown? Does it include the 2000-2002 period when stocks dropped by 50%?

Nick


If anybody is guilty of cherrypicking returns, it's you (or cherrypicking indexes, like the NASDAQ, when it suits you, even though no one is recommending investing solely in the NASDAQ). For example, despite the stock drop, you fail to mention that the compound annual return for the S&P 500 for the 5-year period ending 3/31/04 is -1.20%, which is hardly catastrophic, especially if one were to take my advice, where I suggested not investing money you will need within 5 years in the stock market.

You also fail to point out that people almost never invest *all* their money precisely at a market peak, so investors in the stock market will enjoy superior returns as stocks climb to a peak, after which returns will be disappointing. However, long-run returns averaged over the bull market and bear market will still generally be pretty good. For the 10 years ending 3/31/04, the compound annual return for the S&P 500 was 11.68%, which I feel is more than adequate, and this despite lackluster returns over the last 5 years.

You seem very concerned about risk, but I think you neglect to consider the risk that a portfolio will not have a positive real (i.e. inflation -adjusted) after-tax return -- i.e. the risk that you will lose purchasing power over the long-run. Stocks give you the greatest probability of staying ahead of inflation, especially after taxes, over the long run.

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40575 of 75700
Subject: Re: Bonds Date: 4/19/2004 4:30 PM
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Nick,

The facts I cited were from studies of the data from 1926 - 1998 (the Trinity Study). It includes the 1929 crash where the market lost over 80% of its value, but not the 2000 - 2002 crash. I'm not sure how much the new data would change the results, but I don't think it would be significant.

Russ

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40576 of 75700
Subject: Re: Bonds Date: 4/19/2004 4:34 PM
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Nick,

The 2.5% assumes the Lehman Bros short term bond index.

A higher return can be achieved by using medium term bonds, but it adds risk.

Russ

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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40577 of 75700
Subject: Re: Bonds Date: 4/19/2004 8:01 PM
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If anybody is guilty of cherrypicking returns, it's you

I have every right to cherry pick when demonstrating cases when stocks perform far differently from what steady growth models predict.

no one is recommending investing solely in the NASDAQ

So let me get this straight- you don't believe past performance of a single stock will predict future results, or that the past performance of a single index will predict the future. But you do believe that the past performance of a single asset class, stocks, will predict future performance. Sounds like selective faith to me.

the compound annual return for the S&P 500 for the 5-year period ending 3/31/04 is -1.20%, which is hardly catastrophic,

It wasn't -1.2% for the retiree withdrawing 4%-5% per year. He would have lost 30% or so of his wealth during that period.

However, long-run returns averaged over the bull market and bear market will still generally be pretty good. For the 10 years ending 3/31/04, the compound annual return for the S&P 500 was 11.68%

Again you're mixing past and future tense, assuming what's happened in the past must reoccur in the future. What has the Nikkei's 10 year return ending 3/31/04 been? Japan's demographics are leading ours by about 20 years, so this may be a better predictor than the S&P. Or do we get to ignore stock market returns that don't fit your model?

You seem very concerned about risk, but I think you neglect to consider the risk that a portfolio will not have a positive real (i.e. inflation -adjusted) after-tax return -- i.e. the risk that you will lose purchasing power over the long-run

Inflation is certainly a risk- and a portfolio with 50% stocks 10% REITs, and 40% bonds (some inflation protected) as well as home equity gives you quite a bit of protection against inflation. But you're not keeping up with inflation when the stock market drops by 50% either.

Stocks give you the greatest probability of staying ahead of inflation, especially after taxes, over the long run.

No, TIPS and I-Bonds do.

Nick

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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40578 of 75700
Subject: Re: Bonds Date: 4/19/2004 8:26 PM
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Russ,

The 2.5% assumes the Lehman Bros short term bond index. A higher return can be achieved by using medium term bonds, but it adds risk.

Good lord, that's like choosing only biotech startups as the stock portion for a stock/bond comparison! I wonder if we can commission a study on asset allocation using current (post 2000) data, as well as a real bond portfolio.

There's more to life than T-Bills: I was interested in investing in Calpine Corp (Ticker:CPN) recently and was trying to decide between their 11.5% 2011 notes and their stock. I went with the stock, since it was easier to buy, but either would have been fine.

CPN stock is a little further along the risk/return spectrum, so I expect it to return a point or two more than the notes, but with additional risk as well.

Nick

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Author: buzman Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40579 of 75700
Subject: Re: Bonds Date: 4/19/2004 8:55 PM
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Russ wrote

The 2.5% assumes the Lehman Bros short term bond index. A higher return can be achieved by using medium term bonds, but it adds risk.

Nick wrote

Good lord, that's like choosing only biotech startups as the stock portion for a stock/bond comparison

Reply: Dimensional Fund Advisors (DFA) recommending keeping bond durations relatively short. Five years max. What I think is missing from this discussion is the fact that adding fixed income generally reduces volatility.

buzman

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Author: babyfrog Big red star, 1000 posts Old School Fool Home Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40580 of 75700
Subject: Re: Bonds Date: 4/19/2004 8:57 PM
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Stocks give you the greatest probability of staying ahead of inflation, especially after taxes, over the long run.

No, TIPS and I-Bonds do.


Nick,

There are some flaws with that assertion.

First of all, TIPS and I-Bonds use the CPI for an inflation gauthe CPI is a lousy indicator of personal inflation. CPI measures economic inflation, but does not adjust for age effects of expenses like health care. So unless a person does not age and suffer the age-related, non-inflationary increases in health care costs, a person relying on TIPS and I-BONDS will not keep up with inflation.

Additionally, CPI adjusts for things like "technological advances." While a car may cost $12,000 when the equivalent car cost $11,500 last year, 'technological improvements' may have added $400 to the cost of the car, leaving inflation to only cause $100. Income that's tied to an index that only accounts a fraction of a price increase as 'inflation' does not keep up with the true-to-the-individual increasing cost of that item. Negotiating skills nonwithstanding, $11,600 does not buy a $12,000 car.

Furthermore, CPI adjusts for the 'substitution' effect, which is the actions by consumers as a whole to substitute less expensive alternatives and bulk purchases when the price of a good rises. These substitutions may not be practical for every individual. For example, an individual will likely not purchase bulk perishables, because those perishables may go bad before that individual can consume them. A family, on the other hand, may make those purchases. So a fraction of the substitution effect will again underrepresent an individual's personal inflation.

Now, let's talk about the TIPS securities themselves... TIPS are taxable instruments, and they have a special feature that only a government could love. TIPS are taxed on the 'inflation protection' addition to principal in the year it is added, in spite of the fact that it is nothing more than an accounting entry until the TIPS security is sold. As such, an income seeking individual is taxed on TIPS income and basis adjustment, in spite of receiving only the TIPS income as actual cash. It's a tax on money an investor can't spend yet. It's the antithesis of Return of Capital income from REITs, and an ugly 'gotcha' for an unprepared investor.

TIPS and I-Bonds do not really protect against individual inflation. And unless they start getting tied to a different indicator than CPI, they never will.

-Chuck

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Author: babyfrog Big red star, 1000 posts Old School Fool Home Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40581 of 75700
Subject: Re: Bonds Date: 4/19/2004 8:59 PM
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Oops...

...use the CPI for an inflation gauthe
should read
...use the CPI for an inflation guide.

My bad.
-Chuck

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Author: sunrayman Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40582 of 75700
Subject: Re: Bonds Date: 4/19/2004 9:13 PM
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What has the Nikkei's 10 year return ending 3/31/04 been? Japan's demographics are leading ours by about 20 years, so this may be a better predictor than the S&P.


+++
+++


airboy,

I can't really believe you are using this as an argument! Demographics do not determine societies, cultures, governments, nor investment results.

Would you care to make any inferences from Japan's banking system and the US Govt's establishment of the Resolution Trust Corporation?

Nope, I didn't think that would interest you.

sunray




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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40583 of 75700
Subject: Re: Bonds Date: 4/19/2004 9:58 PM
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Chuck,

OK, ok, I know TIPS aren't perfect at matching personal inflation, and that no product ever will, however I think your statement:

"TIPS and I-Bonds do not really protect against individual inflation"

Is a little strong. The CPI isn't perfect at measuring inflation, but it isn't worthless either.

Nick

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Author: babyfrog Big red star, 1000 posts Old School Fool Home Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40584 of 75700
Subject: Re: Bonds Date: 4/19/2004 11:01 PM
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Nick,
OK, ok, I know TIPS aren't perfect at matching personal inflation, and that no product ever will, however I think your statement:

"TIPS and I-Bonds do not really protect against individual inflation"

Is a little strong. The CPI isn't perfect at measuring inflation, but it isn't worthless either.


CPI does not, nor is it intended to measure personal inflation. Most individuals must purchase goods at higher prices regardless of whether the higher prices are caused by that individual's aging, by 'technological improvements', by the lack of a legitimately available substitution, or by good old fashioned "inflation". In any event, the individual sees the higher prices, not merely the "inflation" portion of those higher prices. The CPI, however, only attempts to measure the "inflation" portion of those higher prices and therefore structurally and consistently underestimates an individual's cost of living increases.

Even a small underestimation over time will compound the problem dramatically. Since TIPS and I-Bonds are indexed to the CPI, and the CPI structurally underestimates an individual's cost increases over time, TIPS and I-Bonds provide lousy protection against an individual's inflation. Their 'inflation protection' growth cannot exceed CPI, and therefore, their 'rounding error' will always make the gap wider, never shallower.

Add to the structural problem the cash flow problem of getting taxed on money before it can be spent, and TIPS stop looking merely like a bad inflation hedge and start looking like attempts to defraud a financially ignorant population.

To be honest with you, I don't think my original statement was strong enough. :-)

-Chuck

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40585 of 75700
Subject: Re: Bonds Date: 4/19/2004 11:14 PM
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<<rkmacdonald: this seems a little too conservative for most retirees. A 50/50 equity/bond mix would only be acceptable if a person has a large enough portfolio that he/she will only withdraw about 2.5% a year to live on.

Russ,

Two questions for you:

1. Does this 2.5% assume a healthy mix of higher yielding corporates, or just bonds at the extreme end of the risk/return spectrum?

2. Was this number the result of cherry picking a date range where stocks shown? Does it include the 2000-2002 period when stocks dropped by 50%?




An inflation-adjusted withdrawal rate of 2.50% seems very low for a 50/50 mix of fixed income and S&P500. I get more like 3.5% to 4.0% for a 30-year pay out period using Shiller's 1871-2002 database.

http://www.retireearlyhomepage.com/re60.html

Even if you wanted to maintain your initial principal, that only reduces it to 3.25%.

intercst

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Author: MadCapitalist Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40586 of 75700
Subject: Re: Bonds Date: 4/19/2004 11:20 PM
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If anybody is guilty of cherrypicking returns, it's you

I have every right to cherry pick when demonstrating cases when stocks perform far differently from what steady growth models predict.


You don't need to use steady growth models. You can use actual results, like many have done before.

But you do believe that the past performance of a single asset class, stocks, will predict future performance. Sounds like selective faith to me.

Yes, I have faith in *diversified* stocks behaving reasonably similar to how they have behaved over more than a century.

I don't understand you. You don't believe in using the past to predict the future, but you keep bringing up the past in order to determine an appropriate course of action. That is completely irrational.

I am done with this conversation. I have wasted enough time talking to you .

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Author: rkmacdonald Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40587 of 75700
Subject: Re: Bonds Date: 4/19/2004 11:49 PM
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intercst
An inflation-adjusted withdrawal rate of 2.50% seems very low for a 50/50 mix of fixed income and S&P500. I get more like 3.5% to 4.0% for a 30-year pay out period using Shiller's 1871-2002 database.

I went back and looked, and you are right. I don't know where I got 2.5%. It should have been 3.25%, since I always assume preservation of original principal. I can never be sure enough of the date of my demise to do other <grin>.

Thanks for catching that.

Russ

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40588 of 75700
Subject: Re: Bonds Date: 4/20/2004 12:01 AM
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rkmacdonald writes,

intercst
An inflation-adjusted withdrawal rate of 2.50% seems very low for a 50/50 mix of fixed income and S&P500. I get more like 3.5% to 4.0% for a 30-year pay out period using Shiller's 1871-2002 database.

I went back and looked, and you are right. I don't know where I got 2.5%. It should have been 3.25%, since I always assume preservation of original principal. I can never be sure enough of the date of my demise to do other <grin>.

Thanks for catching that.


The SWR is a bit less than 2.5% for a 100% fixed income portfolio (assuming account exhaustion at the end of a 30-year pay out.) Perhaps that's the number you misremembered?

intercst



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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40589 of 75700
Subject: Re: Bonds Date: 4/20/2004 12:43 AM
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intercst,

Interesting study, though in my opinion if you're only using bonds with 4-6 month maturities, you're analyzing stocks and cash, not stocks and bonds.

In any case, nice to see you have post 2000 data in the study. To be clear, you're talking about a real (inflation adjusted) 3.5%-4% withdrawal rate, correct?

It would be interesting to do an analysis not just on PEs and market timing (your Improvement #4), but remaining fully invested while owning only low PE stocks.

Nick

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40590 of 75700
Subject: Re: Bonds Date: 4/20/2004 12:56 AM
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yobria writes,

Interesting study, though in my opinion if you're only using bonds with 4-6 month maturities, you're analyzing stocks and cash, not stocks and bonds.

That's true. Commercial paper was the only fixed income data series available for the full 1871-2002 time period.

Here's another interesting study on optimizing the fixed income component of a retirement portfolio from Jaye Jarrett.

http://www.retireearlyhomepage.com/fixedinc.html

In any case, nice to see you have post 2000 data in the study. To be clear, you're talking about a real (inflation adjusted) 3.5%-4% withdrawal rate, correct?

Yes. In the study, a 4% inflation-adjusted withdrawal means taking a $40,000 first year withdrawal from a $1 million portfolio, then inflating that $40,000 by the change in the CPI in each subsequent year until the end of the pay out period.

intercst


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Author: yobria Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 40598 of 75700
Subject: Re: Bonds Date: 4/21/2004 2:07 AM
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That's true. Commercial paper was the only fixed income data series available for the full 1871-2002 time period.

Ok...To make it more realistic (at least in my opinion) I added 1.5% to your commercial paper rate to approximate something like a 5 year CD ladder. In this case, with a 50/50 stock/bond split and a withdrawal rate of 5% went from 69% to 83%. Not too significant.

By the way, you might get a more predictive result by doing a Monte Carlo simulation on the data...right now you're only looking at sequential returns.

Nick


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