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Author: Valuemongeragain One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 77728  
Subject: Bonds more risky and volatile than stocks? Date: 2/9/2012 10:11 PM
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About a month ago I read a very interesting article in the Wall Street Journal. To me it is one of the most interesting things that I have read in a quite a while.

The article is entitled, “Stocks or Bonds? The Pros Say……” on page R1 of the January 9th WSJ.

The article advocates that equities are the better long-term investment in general and especially now based on current valuations.

The most interesting thing about the article is a graph showing 30 year returns starting in 1926 and ending December 31st, 2011 for both the S& P 500 and government bonds/treasuries. There are 56 30-year periods ending from 1956 to 2011.

From this chart I noticed the following.


1)Stocks outperformed bonds in 55 of 56 30-year periods. No surprise there.

2) Over long periods, such as 30 years, the return from stocks are less volatile than the returns from government bonds.

3)The 30-year period ending December 2011 was the only 30-year period where the return from government bonds outperformed equities. From 1981 to 2011, government bonds returned 11.03% and equities returned 10.98%.

Not much to comment about on the first observation, that is what most of us have been taught to believe.

The second observation is more interesting to me. A box in the graph states that the 30-year returns for stocks have varied from 8.5% to 13.7%. From looking at the chart the return for bonds, over long periods, has been much more volatile. They have returned less than 2% in 3 30-year periods ending in the late 60’s and early 70’s. In fact bonds did not return above 4% in a single 30-year period ending from 1956 to 1984. From 1985 t 2011, the bonds have returned more than 4% in every period. The variation in return for bonds over these longer periods is much more variable than that of stocks. If you subtracted inflation, the variation in real returns would be even greater.

In some 30-year periods the returns from equities were 5 to 6 times as great as bonds. In fact until 1986, the 30-year returns for stocks were at least twice that of the government bonds.

The third observation, that the 30-year period ending in 2011 was the only period where bonds outperformed stocks, makes me think that we are probably near the beginning of a long bond bear market.

A few days ago, I read where the head of Blackrock, one of the biggest investment management firms, advocated a 100% equities asset allocation based on valuations and the current rates on bonds and cash equivalents.

Then today I read an article on Bloomberg where Warren Buffett called bonds the most dangerous asset. According to the article this is a quote from Buffett’s annual letter to shareholders, “Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.”

In addition to the low rates offered on treasuries, I read this week that McDonalds was floating a 30 year bond at 3.75%.
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Author: ngcpa Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70616 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 8:25 AM
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In my opinion comparing long-term government bonds to stocks is apples to oranges. Since they are highly uncorrelated, it is wise to have a mix of both. If one wants to play the timing game, they should vary the mix from 30:70 to 70:30, but having all of one (or the other) seems foolish. Contrary to popular opinion, regardless of age, I believe one should still have a mix of both.
Norm

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70618 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 9:36 AM
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It's pretty meaningless to talk about "risk" without a modifier. If you buy a T bond, you will get the yield to maturity (nominal in the case of conventional, real in the case of TIPs) the arithmetic says you will get, with as close to zero risk of not getting that yield to maturity as we get on anything in this life.


These guys are thinking about other kinds of risk -- risk of not meeting your goals, risk of not doing as well as those who invest in something else, inflation risk in the case of conventional T-bonds, risk of temporary paper losses along the way to maturity, risk of loss if you sell rather than holding to maturity, risk of not getting quoted if you don't say something headline-worthy.

And it's a pretty good bet a portfolio with a mix of stocks and investment grade bonds will have lower volatility than an all-stock portfolio.

Stocks are supposed to outperform bonds over very long periods. This is what we expect. But we still hold some high quality bonds in portfolios designed for very long periods (a) because the future may not look like the past and (b) to help us sleep better and (c) to help us not sell out stocks when they are plunging, as they do from time to time.

I have just concluded a 2-month intensive personal study of annuities, which mostly involved wading through many many prospectuses for variable annuities with guaranteed lifetime withdrawal benefits ("VA/GLWB"). With these critters, the insurance company that offers them guarantees your portfolio will provide you with at least a certain stream of checks for the rest of your life, and that of your spouse if you set it up that way. If the portfolio goes to zero before the beneficiary(ies) die, then the insurance company keeps paying the stream of checks promised from its own pocket. If it doesn't go to zero before you die, your heirs get what's left in the portfolio. Some VA/GLWB promise as much as 10% annually, provided you wait 10 years after investing and are over 65 at the end of those 10 years. Here's my point: These guys require you to have some bonds in the portfolio if you want their guarantee. And in general, the companies with richer guarantees and lower fees want more bonds in the portfolio and the ones that let you have higher allocations to stocks are the ones with stingier guarantees and/or higher fees.

If the guys quoted in this article are right, we should expect insurance companies to start shifting in the opposite direction on guaranteed withdrawal benefits -- offering richer guarantees and/or lower fees, if you'll accept a higher allocation to stocks or even a 100% allocation to stocks. The insurance companies are putting their money on the line, as opposed to just giving quotes to journalists, and so far there is no sign of them moving in the direction of embracing higher allocations to stocks when they are guaranteeing lifetime income from the portfolio.

I found only one company that allowed 100% allocation to stocks in my research (Jackson National) and it has been doing that for a long time. The latest trend in the VA/GLWB world is lower guarantees and mandatory algorithms that pull you out of stocks when they have gone down. The large print tells you that you can have high allocations to stocks (some as high as 100%) and the small print tells you about the algorithm. Some even try to make the algorithm sound like it's a great feature for the investor. The salesmen talking about taking you to the safety of bonds "when stocks are falling " as if yesterday's market performance predicted tomorrow's. In reality, of course, they are locking in your losses and reducing your chances of participating fully in a bounce back. But it's interesting that this is what their high-paid experts have decided is the best way to minimize the insurance company's exposure on its guarantee of the income stream. As some are careful to tell you, deep in the high grass of the back pages of the prospectus, the algorithm is for their protection, not yours. Needless to say, I didn't buy any with such algorithms.

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70619 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 9:49 AM
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Agreed.

This board has for several years had a penchant for preferreds, which are essentially indefinite maturity bonds in the REIT's eyes. It's been a nice run, and I'm grateful. However, with the calls and with consumer inflation (you can see gasoline prices jumping 14 cents at several stations simultaneously as you drive the morning commute), I see them becoming riskier than common stocks once interest rates start to rise again.

I'm thinking it's getting to be the time to rotate back to commons, and maybe even into commodities.

Kat

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Author: bhpo One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70620 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 10:37 AM
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check out AREEP and RPTpD-both convertible Pfds best of both worlds. There maybe others too

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70623 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 11:14 AM
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I don't think any of these guys saying T-bonds will be terrible were recommending them over stocks during the past 30 years when they outperformed stocks. So, we should view their wisdom thru that lens.

That said, I have been a T-bond-overweight proponent during many periods of the past 30 years and am not now, unless you are rich enough to meet your goals that way.

Here is a plausible scenario for the future under which T-bonds will continue to outperform. I will couch each premise in the form of an "if" statement in the hope of avoiding an ideological discussion of political or macro issues. We can each have our own view of the probability of each "if."

First, bear in mind that the 30-year T-bond is at 3.14 yield to maturity and IF it went to 2% or 1% that would produce very nice capital gains for holders. Single-A-rated Japan is at 1.93%, so tip-toe past the graveyard if you are already scoffing at my scenario.

2) Suppose the Republicans gain the whitehouse. (And the dems do not gain a veto-proof majority in Congress).

3) Suppose the Republicans actually implement the economic program they advocate of huge cuts in government spending and putting more responsibility on households to save for their retirement income needs and medical needs now and in retirement. Cuts large enough to balance the budget while also cutting taxes. We could also throw in restraints on the Fed to reverse monetary stimulus.

4) Suppose this leads to a deep depression, as predicted by Keynsian economic models.

5) Suppose this depression leads to still lower long-term interest rates, as predicted by Keynsian economic models.

To dismiss this scenario you have to be either certain of Obama's re-election, or certain of Republicans' insincerity, or certain that austerity is expansionary rather than contractionary or certain that an economic downturn from today's low level would not further reduce t-bond rates.

Can you say you are certain of at least one of these things?


Now, I know that #3 is supposed to lead to a boom, not a bust, by Republican ideology. And I don't want to get into whose model of the macro economy is right. That's what this board is for. But let me just point out that anti-Keynsian, pro-austerity types are in control in the UK and the Eurozone and so far, "Expansionary Austerity" has been contractionary, as predicted by Keynsian models, not expansionary as predicted by their models.

(Germany got off to a rapid start in recovering from the recession, perhaps because it actually had more fiscal stimulus than the US, taking into account all levels of government spending; then it pivoted to austerity, particularly for its Eurozone trading partners, and the ECB raised rates, and now its recovery has stopped. http://www.spiegel.de/international/business/0,1518,808582,0.... . The UK jumped on austerity from the start, but its central bank kept its foot on the monetary gas, unlike the ECB. Still, the recovery has been weaker than in the US and Q4 2011 was negative. http://www.bbc.co.uk/news/business-16715080 )

And I would also point out that the Expansionary Austerity crowd predicted higher interest rates, declining private investment and soaring inflation in the US from the Obama-Bernanke set of policies and what we have gotten has been the opposite, as predicted by Keynsians. I say this not to try to convert anyone to the Keynsian view, and not to influence anyone's vote, but just to get skeptics to entertain the possibility that "if #2 and #3, then #4 and #5" MIGHT be the way things would happen, and therefore a diversified portfolio that includes some high quality bonds would be prudent.

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70625 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 1:36 PM
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JimLuckett wrote <<I have just concluded a 2-month intensive personal study of annuities, which mostly involved wading through many many prospectuses for variable annuities with guaranteed lifetime withdrawal benefits ("VA/GLWB")>> Oh my gosh, I could never do that.

I looked at a couple of plans (SPIA, VA) and tried to figure out how they stayed in business. I look at insurance companies as casinos; the odds (they think) are with them. I'm willing to play with the insurance company but I want to understand the game ... I don't want to read the fine print or the the print in the "high grass of the back pages of the prosective" (I'm a lousy reader).

I think I understand how insurance companies make (or don't lose) money on SPIAs, but I'm not sure about other plans. SPIAs handle longevity risk only. The VA's and some other plans may try to mitigate inflation and market risk as well as longevity risk. In order to do that, I think they have to be adaptive, that is change allocation with time. That introduces, IMHO, another risk (from the point of view of the holder of the policy); an algorithm risk. Further the actual algorithm used may be to protect the insurance company.


Comments, corrections, bricks welcome

klee12

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70626 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 2:35 PM
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JimLuckett wrote <<Here is a plausible scenario for the future under which T-bonds will continue to outperform. I will couch each premise in the form of an "if" statement ...
To dismiss this scenario you have to be either certain of Obama's re-election, or certain of Republicans' insincerity, or certain that austerity is expansionary rather than contractionary or certain that an economic downturn from today's low level would not further reduce t-bond rates.>>

Lets look at the probability distribution for the T-bill yields in the future, say 3 years out. The 2nd condition, that the Republicans gain the white house, is a binary event ... they either do or don't. The probility distribution for the 2'nd condition is discrete. If I plug that into my crystal ball (other people have models, I only have a crystal ball) I get a bimodal distribution. Furthermore the variables are not independent. Condition 3 considers the case of Republicans implementing their economic programs. If Republicans do not capture the white house, they probably will not be able to capture both houses. That makes a more pronounced bimodal distribution.

I do not dismiss your scenario. I Just don't worry about it much. If your scenario comes true preferreds will just fine. But I do worry that your scenario doesn't come true.

By the way my crystal ball warns me that the bimodal distribution might begin to converge after November.

Comments, corrections and bricks welcome

klee12

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Author: ytm One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70627 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 3:37 PM
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I think when they come out with an article like this comparing stock to bonds they really need to change two specific parameters.

First off in terms of evolution, just think for a moment what was accomplished between 1900-2000. Everything was a first with unlimited potential. Think of all the industry and technological break throughs.

I was reading a book on the exponential and absolute explosive growth of big companies like Coca Cola, IBM, Microsoft, etc. in terms of how their market caps went from peanuts to billions upon billions of dollars as the growth cycles played out over the course of decades between the 1950's - the end of the century or millenium.

To give some perspective, in 1939, the DJIA was approximately 150 points. In 1999 the DJIA closed approximately in the 11,500 range. I just do not see this type of change happening between 2000 - 2100. So I am more concerned about the period of 2000+ than looking at in hind sight to the greatest period of capitalism in the history of western civilization.

On top of that, instead of running a comparative illustration between government bonds vs. stocks, why not run individual corporate bonds vs. their underlying common stocks. It would be much more relevant and also much more applicable given the risk profile.

Someone who buys a government bond has a completely different objective than someone buying an index themed mutual fund or individual stock.

Say for instance, take microsoft. Beginning 2000 through present day, the annual rate of return on a Microsoft 5.5% corporate bond absolutely smoked the rate of return on microsoft common stock including dividend. One more; a Lowes bond with a 6% coupon has smoked the performance of the common stock going back to 2005 as a starting reference point.

This would be a comparative type study much more relevant IMHO.

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70628 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 4:05 PM
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And I would also point out that the Expansionary Austerity crowd predicted higher interest rates, declining private investment and soaring inflation in the US from the Obama-Bernanke set of policies and what we have gotten has been the opposite, as predicted by Keynsians. I say this not to try to convert anyone to the Keynsian view, and not to influence anyone's vote, but just to get skeptics to entertain the possibility that "if #2 and #3, then #4 and #5" MIGHT be the way things would happen, and therefore a diversified portfolio that includes some high quality bonds would be prudent.

Jim, I agree that this has been the correct play until now, and I happily wipe the egg off my face for thinking otherwise. And I have profited to some extent from doing so.

However, how does the 90% debt to GDP point of diminishing returns from stimulus factor in? How about the slow pace of recovery: How does that fit the Keynsian model?

And are we really in Keynsian mode right now? Perhaps at the Federal level, but G in aggregate is going down. How about red state/blue state differences?

In other words, I doubt we are in Keynsian times even now, and if we are, we may be at the point where additional stimulus at the cost of higher debt to GDP actually has a negative effect.

Thanks,

Kat

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70629 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 4:24 PM
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The VA's and some other plans may try to mitigate inflation and market risk as well as longevity risk. In order to do that, I think they have to be adaptive, that is change allocation with time. That introduces, IMHO, another risk (from the point of view of the holder of the policy); an algorithm risk. Further the actual algorithm used may be to protect the insurance company.

And that's not all. You don't even need to wade through that kind of detail. I went through one of these a couple of years ago, and just highlighted all the X% fees that were scattered in the footnotes and disclaimers all over the 100+ page document. Then I went back and added them all up, and they totaled something like 7%.

Pretty easy to see how they could "guarantee" 5% when they are charging 7%.

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70630 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 4:56 PM
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Klee, they don't all impose algorithms that mess with your asset allocation. For example, 100% of my Jackson National VA/GLWB is in a small cap index fund and they can't change it even if it tanks. My Vanguard is in their "moderate allocation portfolio" which is 60-40 stocks-bonds and they're not going to mess with that.

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70631 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 5:39 PM
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Katinga,

Thanks for egg comment.

I have the uneasy feeling I'm slipping into a macro & politics discussion, but I'm about the leave for 2 weeks of sailing in the Caribbean so, no risk of it being protracted.

Debt to GDP ratio is a long term problem, not an emergency. High unemployment is an emergency. The long term problem has solutions that are neither Keynsian nor anti-keynsian. GDP has to grow. Tax revenue has to grow. Spending has to grow not as much. We've been at much higher ratios in the past. So has UK. Japan is now. It's not going to melt the polar ice caps. If we are worred about future generations' welfare we should worry at least as much about the future condition of the earth we hand them, the quality of education we give them, and the state of the infra-structure we bequeath them. Debt that is held by the Fed is a wash. Debt that is held by the US public is a wash as far as our national wealth is concerned, and that's most of the debt. Debt that is held by foreigners can ultimately only either be (a) held to make them feel richer, (b) converted to dollars buy our goods and services, thereby creating US jobs and income, or (c) converted to dollars to buy our assets, such as real estate, old movies, US stocks, etc., thereby giving them a stake in our future success. We have not issued debt in someone else's currency or a currency we don't control, like Greece, or Ecuador or Agentina. There is a huge difference. The days when creditors sent gunboats to invade debtor deadbeat countries are long gone, and it wouldn't work in our case.

Keynsian economics says the stimulus was not large enough to fill the aggregate demand gap opened up by the housing market crash and the general deleveraging of business and households that ensued. See for example Krugman saying so at the beginning of Obama's term: ( http://www.nytimes.com/2009/01/09/opinion/09krugman.html and more recently http://krugman.blogs.nytimes.com/2011/09/05/on-the-inadequac... ) As you have pointed out, the aggregate impact of government spending has to be measured after adding together federal with state and local spending changes. The $500 billion over 2 years of the stimulus was not much larger in absolute value than the cuts at the state and local level, leaving very little net stimulus.

So, no we are not really in Keynsian mode right now if by that you mean are we doing what Keynsian economics would say to do to hasten the recovery. We are in Keynsian mode however if you mean are we resisting the impulse to slash spending deeply now, now, now to balance the budget and resisting the call to raise interest rates now, now, now to fight inflation that is supposedly about to turn to hyper inflation. Republicans are calling for these things and so my point was that if you believe they would actually do them given the chance, and if you believe they might win the whitehouse and therefore get that chance, you might still want to hold some bonds, unless you are certain the Keynsians are wrong that doing these things would be very contractionary. And I pointed out the Keynsians have been right so far in this recession about what leads to what and what doesn't lead to what, while the anti-Keynsians have been exactly wrong, so you might not want to place all your bets portfoliowise on them being wrong on this point. Vote your ideology, but diversify your portfolio.

You close by saying
"In other words, I doubt we are in Keynsian times even now, and if we are, we may be at the point where additional stimulus at the cost of higher debt to GDP actually has a negative effect. "

Hmmm. Moment of Zen, Katinga?

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70632 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 5:59 PM
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Rayvt,

The 7% (if it is that high -- most aren't) is only for as long as the money lasts. After that, they get nothing, but have to keep paying the 5% if either you or your spouse is still alive.

And it's not 5% of nothing that you get. It is 5% of the high water mark on the account (can't be less than 5% of what you initially invested and might be much more). Most of their fees are calculated as a percent of the account value, not of the high water mark, so their fees go down with the account value while your income stream does not.

Lets say one of you lives 40 years more. And lets say the market does poorly and your withdrawals plus their fees plus market performance exhaust the account in 15 years. You get 5% x initial value of account x 40 years = 200% x initial value . They get 7% x 15 years x average value of the account = $105% x about half the initial value. (Yes, part of their fee is a percent of the initial value, but not most of it).



So, explain to me how this is such a bad deal for the investor and such a good deal for the insurance company?

It's true it's a bad deal if you both die relatively soon or if the market does well enough to keep the account positive. But then, fire insurance is a bad deal if your house doesn't burn down. Do you scorn fire insurance?

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Author: sailrmac Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70633 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 7:11 PM
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Bonds are a great deal... for the issuer!

Don't I wish I could borrow sub 4% fixed. I'd take out as much as they would let me.

The only reason bonds have done better than stocks over the last few decades is we interest rates have been continuously declining. Remeber double digit mortgage rates? But you got to ask yourself, how much farther can bond interest rates fall? If they don't fall then either they stay the same (earning you the interest rate) or they go up (losing you money).

Bonds, particularly treasuries, are very dangerous!

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70634 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 7:13 PM
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JimLuckett wrote <<100% of my Jackson National VA/GLWB is in a small cap index fund and they can't change it even if it tanks.>>
If they are 100% invested in stocks they have market risk. Can you buy the small cap index fund directly?


As I said, I try to understand the rules of the game, i.e. how taking into account your expected life expectancy, they can not lose money insuring your age cohort assuming large swings in the markets. Once upon a time I spoke to a VA salesperson who kept talking about the historical record ... but past performance cannot be guaranteed in the future. I think TIAA guarantees a small amount but every year they pay a special dividend. I can guess (but don't know for sure) how that works. I think it's a static allocation algorithm between fixed income and stocks with the fixed income being responsible for most of the minimum distribution. But the VA salesperson I spoke to seemed to try to emphasize past performance but was vague about the minimum distribution. I wasn't sure how that VA handled inflation.

Anyway, if that's what some VAs do, can I can synthesize that strategy by buying bond and stock funds, saving the fees? Having the insurance company insure the minimum amount is safer but If I synthesize the that strategy I can put off to the future how much inflation protection I want. Once I write the insurance company a check I'm committed to a payout rate and to an algorithm based on current interest rates. The interest rates are dependent on expected inflation rates at the time the check is written. If inflation is in the cards then I might be better off writing the check when inflation is evident. This is a form of market timing that I willing to engage in.

Comments, corrections bricks welcome

klee12

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70635 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 7:14 PM
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Katinga,

Response to your comment I labelled "moment of zen":

You don't have to be "in Kaynsian mode" to play out the scenario I sketched out. I agree we're not. Let's say we're in neutral to mildly austere mode. The stimulus was 2 years and it ended a while back, plus state and local G continues to go down, as you point out. So we're not doing Keynsian stimulus, that's correct. Now suppose a Republican gets elected and swings us to deep austerity mode as promised, coupled with monetary tightening, as some of them advocate, against a backdrop of recession in Europe and a still-broken housing market here. If Keynsians are right that cutting spending without offsetting monetary stimulus is contractionary, and if the Republican spending cuts are as deep as promised, the result is a deep downturn. This could be very good for T-bonds, even starting from 3.14%, using the same analysis that correctly predicted falling rates in 2008 - 2011 due to deep recession and inadequate stimulus and given monetary policy largely hamstrung by the zero bound.

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70636 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 7:29 PM
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How much further can rates fall? They can fall from 3.14% on the 30 year to 1.57% which is 50%. Now go calculate the capital gain on a 30-year bond when yield-to-maturity falls 50%. Or if you're really greedy, calculate it for a 30-year zero.

Bonds are not dangerous at all if you are satisfied with the nominal yield-to-maturity and you hold them to maturity. And they are not dangerous for a shorter holding period if the economy tanks (T-bonds, that is) or performs as expected.

Stocks will be very dangerous if the economy tanks and there is no guaranteed nominal return over any holding period.

But I agree bonds are not as good a bet as they were. I placed a huge bet on bonds in 2008 - 2011 and I would not do that now. And I agree it was falling yields that made them so profitable, obviously. I just don't see how you can be so sure yields will not fall farther. Were you surprised when the 30 year fell below 3%? I was. I got out at 3.4%. If 3% why not 2%? If 2%, why not 1%? You never thought you'd see the 10-year under 2%. Why not the 30 year? Why can't you be surprised again?

If we fall back into recession I'll predict 2% on the 30 year and if we respond to recession with austerity this time, instead of stimulus, I'll predict 1.5%.

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Author: JimLuckett Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70637 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 7:43 PM
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Klee,

It's an index fund. They tell you what index they emulate. You can't buy that particular index fund directly, but you can buy another index fund that holds exactly the same stocks in exactly the same proportions because it tracks the same index. And it will have lower fees, if you are any good at fund shopping. So, your portfolio will perform better than mine.

However, if you withdraw from your portfolio at the same rate I'm going to withdraw from mine, you might drive yours to zero and then your withdrawals will stop. Mine will go to zero faster than yours, but my withdrawals will continue undiminished for the rest of my life and my wife's life despite the account having been exhausted.

That pleases me to know, and will enhance my enjoyment of my retirement. (Not that I beat you in this regard -- I wish you every success -- but that my withdrawals can go on at the same rate,or higher rate, no matter what happens to the stock market.) I'm willing to have my heirs pay a small price for that peace of mind.

You can't synthesize that and save their fees.

You may be lucky and you may be able to sustain the same withdrawal rate that I do. But you will worry from time to time about that sustainability and I will not. That freedom from worry is one of the things I want to buy with my retirement money pile. You can't synthesize that except with drugs or senility.

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Author: Valuemongeragain One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70638 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 9:34 PM
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“These guys are thinking about other kinds of risk -- risk of not meeting your goals, risk of not doing as well as those who invest in something else, inflation risk in the case of conventional T-bonds, risk of temporary paper losses along the way to maturity,”


Jim Fink, the CEO of Blackrock, was writing of not meeting goals or doing reasonably well on your investments as compared to other investments. Below is a link to a different article than the one I read, but it covers his idea reasonably well. Note the last paragraph talking about record inflows into bond funds. Sounds like nearing a top to me.

http://finance.yahoo.com/news/ceo-etf-manager-blackrock-tout...

Buffett’s argument is mainly toward purchasing power, something that should concern all of us. Here is a link to the Buffett article. It is longer and better explains his rationale. The Jim Fink article on Bloomberg was longer than the above link, but I can’t find it. Below is the Buffett link, a good read!

http://finance.fortune.cnn.com/2012/02/09/warren-buffett-ber...

The risks I am concerned with in owning bonds ( I haven’t owned any bonds since Jan 2010 and no REIT preferreds since mid-2010.) are:

1) That most fixed income investments do not presently return enough to cover taxes and inflation. I think I have to get 3.85% in short-term issues before I would get interested again.

2) That interest rates rise, probably not significantly in the next 1-2 years, and bonds get clobbered. I would take an even money bet, that we will see 4% long bond treasury rates before I see the Dow below 10,000 again.

3) That there is an exodus out of bonds as too many head to the door at once trying to get out before others do. Now treasuries are a pretty big asset class, so the door to get out is pretty big.

I remember back in 2008, some Chinese official made a comment that they were going to diversify their holdings more to own less USD and U.S. Treasuries. Long bond rates rose pretty close to .75% in about six to eight weeks. I would not have been sleeping that well holding a bunch of bonds back then. And that was only one guy making one statement, what if he had spoke and they had made a small liquidation of some treasury holdings. If that drop had been enough could it have brought on even more sales from others.

Panics are normally associated with stocks, but it could happen to bonds even treasuries. Ask John Corzine how far sovereign debt can fall in a panic, more than he thought! I know we are not the Greeks, I read that the Greeks had the worse debt to GDP ratio and I think we were fourth worse. I know that we have our own currency so the printing presses are there to bail us out once! The second time the foreign creditors would probably not lend to us solely in the USD. As far as ramping up the printing presses, I would not want to be holding bonds if and when that happens.

Yes, you’re almost guaranteed to receive the 2-3% to maturity, but at 3% on a 30 year bond, you would only receive 90 cents on every dollar invested over the 30 year life of the bond. What if you need the money before maturity? What is you could only get 75 cents on the dollar? I am not interested in an investment that will probably not cover inflation and taxes.

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70639 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/10/2012 11:02 PM
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JimLucett wrote << if you withdraw from your portfolio at the same rate I'm going to withdraw from mine, you might drive yours to zero and then your withdrawals will stop. Mine will go to zero faster than yours, but my withdrawals will continue undiminished for the rest of my life and my wife's life despite the account having been exhausted.>>

I want to understand how they do it. If your fund goes to zero before my portfolio, and my fund mimics the same fund, then they lose money on you when they write the next check after our funds hits zero. Where do they get the money from? They seem to be taking a risk. Can they assume enough people died before the fund runs to zero? But all annuities have the same mortality tables (more or less) and I assume their returns are competitive with other annuities. Maybe they hire a hit man to accelerate mortality. By the way how does Best rate them.

I won't have peace of mind until I understand. I think I understand SPIAs.

Comments, corrections bricks welcome

klee12

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70645 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/11/2012 1:15 PM
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Hmmm. Moment of Zen, Katinga?

Nope. Running out of other people's money and unending QEn programs. I'm balancing your posts with the Mauldingrams I get.

I'm also thinking of slow recoveries/stagnation that came during the G expansions of Wilson, Hoover-Roosevelt, Nixon-Carter, and Bush-Obama...and the fast ones of Coolidge, Eisenhower, and Reagan.

Fair winds and following seas, Jim.

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70647 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/12/2012 4:41 PM
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katanga

Actually the U.S. government contracted a bit during both Nixon and Carter (and Ford). And the Federal deficit during Carter decreased in three of his four years as president.* Between Johnson and Obama, only Reagan expanded the Federal government. Bush-41 and Clinton together contracted Federal employment by about 700 million with Clinton doing about 2/3rds of it (including me). Bush-43 Federal employment remained essentially constant and Obama's expansion has not been great and is retracting somewhat.

* Please do not think I am a great supporter of Carter as President, I'm, not, but I do believe in being fair.

brucedoe

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Author: Reitnut Big red star, 1000 posts Top Favorite Fools Feste Award Nominee! Feste Award Winner! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70652 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/12/2012 7:28 PM
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Jim says, I just don't see how you can be so sure yields will not fall farther.

I very much agree; indeed, I don't see how, in the current environment particularly, anyone can be sure about the direction of interest rates. We need to remember that the economist who has accurately and consistently called interest rates correctly over the past 5 or 10 years seems to be impossible to locate at the moment; perhaps he (or she) is hanging out at some ashram in Nepal.

R.

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70655 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/12/2012 10:37 PM
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Bush-43 Federal employment remained essentially constant and Obama's expansion has not been great and is retracting somewhat.

Thanks for the data. However, have you factored in regulation costs?

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70656 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/13/2012 8:22 AM
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Actually the U.S. government contracted a bit during both Nixon and Carter (and Ford). And the Federal deficit during Carter decreased in three of his four years as president.* Between Johnson and Obama, only Reagan expanded the Federal government. Bush-41 and Clinton together contracted Federal employment by about 700 million with Clinton doing about 2/3rds of it (including me). Bush-43 Federal employment remained essentially constant and Obama's expansion has not been great and is retracting somewhat.

Does anyone know when in US history total G at all levels lagged GDP growth?

Thanks,

Kat

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Author: klee12 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70658 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/13/2012 12:18 PM
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Katinga wrote <<Does anyone know when in US history total G at all levels lagged GDP growth? >>

I don't know but if you're talking about government employment which I think includes size of the military, I would look at years after WWW II and Vietnam, and the cold war.

klee12

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70659 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/13/2012 4:10 PM
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katanga

I don't know the answer to your question, but I would look at Clinton's second term as a guess.* GDP expanded greatly and free cash flow of the government was positive; yet, he cut Federal employment a lot. Actually it was Al Gore's Reinventing Government project.

* No, I don't give Clinton all the credit as we had divided government at the time and Newt baby likes to take the credit.

brucedoe

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Author: katinga Big funky green star, 20000 posts Old School Fool Ticker Guide Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70660 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/13/2012 5:40 PM
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Well, I think I found a chart that looks at G as a percentage of GDP since 1900.

http://www.usgovernmentspending.com/spending_brief.php

There are two clearly discernible lengthy periods of flat to lowering G in the smallish chart in the link: the 20s and the 90s. Both were GDP expansions.

And then there's the overall upward trend, with the WWII blip. So there's also the exit question of when G gets so high that raising it does no good, or even harm?

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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70667 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/13/2012 10:18 PM
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Katanga

Very interesting plot. Since Federal spending is a part of GDP, GDP is complicated. For example if business and personal spending remains constant and government spending increases, GDP will be positive. And if business and personal spending even decrease and the government spending increase more than the decreases, GDP will be positive. In fact, this is the heart of Keynsian economics. In a recession, government spending borrows to make the GDP positive, but he wanted the government to pay back the borrowed money in good times and this, um, we haven't done have we.

I wonder how many people would be better off if they lived at the turn of the 18th century to the 19th century.

brucedoe

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Author: sailrmac Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 70677 of 77728
Subject: Re: Bonds more risky and volatile than stocks? Date: 2/16/2012 11:48 AM
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Well argued and you are correct I was very surprised when the 30 year fell below 3% and am very surprised at the currently yield. I have no arguement that yields couldn't go down more, I guess they could. My gut says it's unlikely and there's a much greater risk of them going up than benefit in them going down. I pay attention to my gut (it's less ruled by emotion than many) but there's absolutely no reason why anyone else should.

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