[Boondock]

Thanks for your help in my previous thread. I'm going to start buying e-series index funds directly through TD Waterhouse until my portfolio gets large enough to justify online discount brokerage expenses.

I have seen a lot of proposed portfolios, but I would like to hear a good explanation for bonds in my portfolio, other than it is the accepted wisdom.

I realized fixed income assets are an important part of a balanced portfolio, but considering that:

a) I am 30-40 years from retirement
and
b) interest rates have nowhere to go but up in the short-term

Would I be completely out of my tree to forego having any bonds in my portfolio for the next 5 or so years?

 

[CanadianCapitalist]

I realized fixed income assets are an important part of a balanced portfolio, but considering that:

a) I am 30-40 years from retirement
and
b) interest rates have nowhere to go but up in the short-term

Would I be completely out of my tree to forego having any bonds in my portfolio for the next 5 or so years?

The purpose of bonds for an investor with a very long time horizon is to reduce portfolio volatility. If you are okay with a very volatile portfolio, it is perfectly reasonable to forego bonds altogether. But consider:

1. By putting a small portion in bonds, you are not giving up a lot of returns. For instance, if you expect 5% from stocks and 2% from bonds, a 20% weighting in bonds reduces portfolio returns by 0.6% but you'll get some of that back through rebalancing.

2. I believe the market's guess of where interest rates should be is usually correct. I've been hearing the "interest rates have nowhere to go but up" argument for more than 5 years now. Still, I think it is best to keep bond duration short.

3. Volatility scares a lot of people. It is very nice that stocks are up 30 or 40 percent but they also fell dramatically fast. Unless investors can make a considered decision that volatility won't bother them, a 100% stock portfolio might not be suitable.

Just my 2 cents.

 

[Boondock]

The purpose of bonds for an investor with a very long time horizon is to reduce portfolio volatility. If you are okay with a very volatile portfolio, it is perfectly reasonable to forego bonds altogether. But consider:

1. By putting a small portion in bonds, you are not giving up a lot of returns. For instance, if you expect 5% from stocks and 2% from bonds, a 20% weighting in bonds reduces portfolio returns by 0.6% but you'll get some of that back through rebalancing.

2. I believe the market's guess of where interest rates should be is usually correct. I've been hearing the "interest rates have nowhere to go but up" argument for more than 5 years now. Still, I think it is best to keep bond duration short.

3. Volatility scares a lot of people. It is very nice that stocks are up 30 or 40 percent but they also fell dramatically fast. Unless investors can make a considered decision that volatility won't bother them, a 100% stock portfolio might not be suitable.

Just my 2 cents.

I agree with your points. Since I am starting with small amounts and am very young, I feel I can afford more volatility than most.

I also see your point about interest rates. I even took a variable rate mortgage just over a year ago, which has worked out amazingly for me.

But since the BOC prime rate is practically already at zero, is it not obvious that rates are on their way up in the next handful of years. The BOC could only even lower them what, another 1/4%? I just don't see how rates won't possibly be higher than they are now in 5 years, even though people have been saying that incorrectly for years.

 

[CanadianCapitalist]

But since the BOC prime rate is practically already at zero, is it not obvious that rates are on their way up in the next handful of years. The BOC could only even lower them what, another 1/4%? I just don't see how rates won't possibly be higher than they are now in 5 years, even though people have been saying that incorrectly for years.

Bond yields are different from BoC interest rates. BoC interest rates affects only bills -- the rate on the cash component of your portfolio.

Bonds are typically of longer term. 5-year bonds are currently yielding 2.5%.

http://www.bankofcanada.ca/en/rates/bonds.html

 

[Robillard]

Boondock,
In relation to the earlier thread, you should think carefully about what you are saving money for and determine your asset allocation appropriately. Retirement is a long way off, so you can afford to put 80%+ of your allocation for your RRSP into equities. By comparison, if you are trying to save up a downpayment for a house in say 5 years, you might want to have a lower allocation of equities and a higher allocation of bonds (maybe 60/40, 50/50, or 40/60). Likewise, an emergency fund shouldn't be tied up in volatile stocks. For that, it's probably best to stick to bond fund units, money market instruments or to sock it away in a high interest savings account.

Basically, the shorter the time horizon for which you are saving, the lower the allocation of stocks.

 

[Rickson9]

3. Volatility scares a lot of people. It is very nice that stocks are up 30 or 40 percent but they also fell dramatically fast. Unless investors can make a considered decision that volatility won't bother them, a 100% stock portfolio might not be suitable.

This is important to consider.

 

[leslie]

Your comment "interest rates have nowhere to go but up in the short-term" considers only government treasuries. There is also corporate debt which has had a HUGE risk premium since last June.

Even if you think there will be inflation (I don't), any increase in treasury yields may well be more than offset by reductions in the risk spreads for corporates.

I always invest 100% in whatever I think will earn the biggest return. That was GICs in the 1970s, strip bonds in the early 1980s, and common equity for the past 20 years, but last year I sold all, sat in cash, and bought preferred shares (NOT the new issues) in Dec.

If you think common stocks will give you the biggest returns I see no problem with your investing 100%. But it has to be because you have made an informed decision, NOT because you are simply regurgitating historical average returns statistics.

(Not including cash you need for e.g. real-estate downpayment, or wedding, etc, as noted above).