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Discussion Starter #1 (Edited)
We have had discussions along these lines before. Should we invest in bonds or even GICs that offer zero or even negative real returns? Some who don't need income on their savings, say they do it because of guaranteed return OF capital. However, some of that capital will be eroded if real returns are negative. A bit like keeping cash under mattress.

So where should we put our money? Many go to real things that are likely to maintain value. Property, gold even some stocks. But as more an more funds are invested this way, these real things also tend to get inflated - Capital Inflation. So not a panacea.

This was in the Globe & Mail recently and may be something for retirees and perhaps even younger investors to think about?

Why one of Canada’s leading actuaries says it’s time for retirees to get out of bonds
Ian McGugan
19-24 minutes

It is high time for retirees and pension funds to dial back their exposure to “dead-weight” bonds, according to one of Canada’s leading actuaries.
Keith Ambachtsheer, the president of KPA Advisory Services in Toronto and director emeritus of the International Centre for Pension Management at the University of Toronto, argues that bonds at their current, dismal yields can no longer deliver the returns needed to fund retirements – not unless you assume savings rates well above what most of us would regard as practicable.
“Twenty years ago, inflation-indexed bonds offered a real yield of 4 per cent,” Mr. Ambachtsheer wrote in a report. “Today their yield is not just zero, but actually negative.”
The upshot is that bonds are “dead-weight investments” that “currently have no role” to play in the investment policies of continuing pension plans, he said.
In an interview, he suggested that similar logic applies to many personal portfolios. Bonds can no longer reliably generate much cash flow for retirees, so savers hoping to generate steady income from their holdings have to contemplate the notion of cutting back on their exposure to bonds.
His comments demonstrate how the long fall in interest rates in recent years is disrupting some of the most sacred tenets of investing.
Canada 10-year bond yield since 1960
For decades, pension funds and private investors regarded a portfolio composed of 60 per cent stocks and 40 per cent bonds as the sturdy all-terrain vehicle of the investing world. A 60-40 portfolio was supposed to deliver decent returns in just about any investing environment.
That proposition now seems in doubt. Benchmark 10-year Government of Canada bonds are yielding barely half a percentage point in annual payout. After adjusting for the corrosive effect of inflation on purchasing power, a typical bond is poised to deliver a negative return in real, or after-inflation, terms.
This challenges the logic underlying a 60-40 portfolio. When yields were substantially higher a decade or more ago, bonds acted both as a buffer against stock market weakness and as a source of real returns in their own right.
No longer. At their current yields, bonds are likely to actually subtract from a portfolio’s long-run buying power.
With interest rates already so low, bonds may not serve as much of a buffer, either. Yields have little room to move even lower because they are already bumping up against zero. As a result, bond prices (which move in the opposite direction to bond yields) have limited room to gain even if the world slumps back into economic turmoil.
So what should investors hold instead of bonds? Solid dividend-paying stocks, Mr. Ambachtsheer suggests.
Consider Unilever Group, he says. The giant British-Dutch consumer-products company pays a dividend yield of just over 3 per cent. History suggests it can grow that dividend at 1 per cent or more a year.
In theory, a stock’s long-term return should be equal to the sum of its dividend yield and its dividend growth rate. If so, Unilever should be able to deliver a real return of at least 4 per cent a year. This is far in excess of what most bonds are now paying.
Investors who select a cluster of similar dividend payers are likely to fare much better than people who stick to a traditional diversified portfolio, Mr. Ambachtsheer asserts. He suggests pension funds should shift to using a portfolio of dividend-paying stocks as their benchmark, or reference portfolio, in years to come.
“Rather than the traditional 60-40 stock-bond policy mix, such a well-diversified stock portfolio has become the reference portfolio for sustainable going-concern pension plans aspiring to deliver adequate inflation-linked pensions at affordable contribution rates into the indefinite future,” he wrote.
There are, to be sure, some objections to this viewpoint. One is whether pension funds and individuals are prepared to deal with the occasional but devastating paper losses that go along with holding an all-equity portfolio.
Mr. Ambachtsheer acknowledges that staying calm during crises requires strong nerves, both for investors and for pension plan sponsors. But the evidence is clear, he argues: Thanks to the Keynesian policies put in place since the Second World War, sustained economic depressions have become a thing of the past. In the long run, stocks as a whole don’t stay in the red.
Going back to the Unilever example, investors shouldn’t focus on the spikes and dips in its share price over the years. Instead, he said, they should celebrate “the fact that Unilever’s dividends have grown steadily decade after decade with very little volatility.”
 

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Central bank policy is now set on 'ensuring' cash is 'invested' which cannot help but cause asset inflation, both in capital and real markets. Ultimately this cannot end well long term BUT what does one do in the meantime? I empathize with those who are having to make asset allocation decisions and more specifically whether to abandon the classic 60/40 balanced portfolio. Various financial types are now saying that 70/30 or 75/25 is the new 60/40 but that, in itself, can be dangerous if folks are not paying attention to longer term trends.

The article is off tangent in my opinion regarding equities. The return performance of a stock (total return) is the sum of capital appreciation and dividend yield, which in itself is ultimately growth in earnings per share (EPS) over the long term (near term stock market volatility notwithstanding). I think there will be (already is) herd shifting to dividend stocks and that will cause asset inflation (inflated P/E valuations). The risk is getting too far into excessive valuation territory. I don't have an answer except to suggest that investors shifting to dividend equities be cognizant of EPS growth, D/E ratio, and ROC (more than ROE) to avoid leveraged balance sheets. Corporate managements are going to be teased into dividend growth at the potential expense of insufficient re-investment in the business and leveraging of balance sheets. Increasing debt loads will eventually become devastating to those who over-leverage.

For old farts like me, I can just continue to do what I have been doing. Hold X years of fixed income in reserve to counter bear equity markets from time to time and ensure that fixed income is indeed readily accessible and essentially risk free. I don't care about return ON that capital. I want return OF that capital. I simply look at my FI component as a X year emergency fund consisting of a 5 year ladder of bonds/GICs and HiSA accounts. If it only gives me a 1-2% nominal return (negative in real and AT terms), so be it. It is simply my 'lifeline' to what is otherwise an 'all equity' portfolio*.

* Basically, I can look at my portfolio as an 85/15 portfolio in the classic sense, OR I can look at it as an 'all equity' portfolio with an X year cash equivalent emergency fund. I think some investors should start looking more and more at the latter view but that may be risky for someone mid-career when they will still experience multiple business cycles in their lifetime.
 

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I totally agree agent99. Retirees need to get out of bonds.

I think the same as you AltaRed. I've been retired 15 years and I always was, and still am, invested 100% in equities or equity funds. I don't hold any bonds or bond funds, however I do hold a cash reserve in HISAs. I think of it as if I were a fund manager with a cash portion in my personal fund. Nothing wrong with holding some cash, and any responsible fund manager would do so.
 

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Those of us discussing this subject, and who have DB pensions covering some/all of our basic living expenses, should qualify our responses accordingly because annuity payments are really guaranteed fixed income. I have a relatively small DB pension which helps cover much of our basis living expenses and my cash reserve to cover X years of living expenses takes that into consideration, i.e. it would have to be larger if I didn't have that DB pension component.

Another way of saying the same thing is one "protects" on the downside with the cards one has in their hand. It may contain an Ace, a Jack and a deuce... or
 

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As rates are approaching zero I have been making some changes...we'll see hows thing go in a few years... no pension here.

2% is as low a return as I will go on my GIC ladder. I'll be likely swapping them over to REIT's as they mature .

I have been vacuuming up some rate resets for additional fixed income in my investment account but it seems that train has left the station the last few months and prices have moved much higher.

I am holding a pretty large cash position (for me) that I intend to buy some real estate with should stuff go on sale when people can't pay their mortgages but I do think that may be a crowded trade.

I get OAS next year...I can live large on that cash should things go awry haha.
 

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The initial post says "retirees" and I completely agree that retirees should reduce duration and stick to shorter maturities. A retiree who is currently withdrawing money should probably not be in a typical bond fund at 10 year average maturity. Maybe 5 years is more appropriate.

So while I agree with reducing maturity, I don't agree with getting out of bonds entirely. Two big reasons

1. Possibility of deflation

I did not see the word "deflation" mentioned a single time above. Many economists warn it could be coming (in fact Canada currently does read negative inflation).

Japan had a scenario like the one we're in, and quite a long period of deflation. A yield like 1% in fixed income is not necessarily a poor real return in a deflation scenario. Japanese bond funds provided quite reasonable returns ever since the 90s. Starting in the late 90s, Japanese bonds dropped sub 2% and then sub 1% yields. This provided something in the 1% to 1.5% nominal CAGR for bond funds, which with inflation between 0% and 1%, was a reasonable real yield, possibly even a positive real return.

In other words, fixed income investment in Japan worked out quite well. And it provided rock solid stability, even while stocks performed terribly.

2. Bond funds are portfolios which adapt to rates

The initial argument completely misses the fact that bond funds (just like GIC ladders) are portfolios which continually adapt to interest rates of the day. I do agree that retirees should stick to closer maturities. Let's say the retiree is at 5 year avg maturity using a mix of XBB + XSH. We have no idea where interest rates will go. What if interest rates start rising? The bond funds adapt to this, and before you know it your bond fund(s) or GICs are generating a higher rate of return. Maybe rates creep upwards from here towards 4% or something reasonable.

Rising interest rates, plus shorter maturity bond funds, is a great scenario. You will suffer some volatility and drawdown, but by the time you hit X years (say 5 years) the volatility is ancient history, and you're getting higher rates of return.

IMO ditching bonds now is an attempt to time the bond market and time interest rates. It's very hard to time markets. Better thing to do is reduce maturity, but don't go too short. Remember, a lot of people think interest rates are going to rise any moment. And if they do ... at something like 3 year, or 5 years, or 7 years avg maturity, you'll be in a great position.
 

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I don't hold any bonds or bond funds, however I do hold a cash reserve in HISAs.
Right, you need cash, probably enough to pay several years of expenses. But would you also not satisfy your cash needs if you had it laddered in 1 year GICs? Each GIC would mature and provide cash that you need, so it wouldn't matter if you kept some of it locked away. It's a viable replacement for cash and provides higher returns.

Now extend that line of thinking...

What if you were in a ladder of 5 year GICs? It could satisfy your liquidity and you get a higher yield due to going to longer maturities. I realize the yield curve is very flat, but in general you will get higher yields at 5 years than cash. e.g. Outlook GICs yield 2.0% whereas HISAs yield 1.6% if you're lucky.

Now what if you nudge that to 7 year instruments, laddered? Well buddy, this is a bond fund.

My point is that bond funds or GIC ladders ARE substitutes for cash. There is very little difference between a ladder of 1 year GICs and a bond fund, other than the term lengths.


Myself: I'm semi-retired and have a fixed income portfolio with a weighted average maturity at 7 years. This includes GICs and some bonds as long as 30 years to maturity. But they are all laddered and staggered, so that in any given year, something is always maturing. This will provide all the cash I need, and on average over time, I will get higher returns than cash.
 

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FWIW, I did not mention preferreds because that is a highly active subject unto itself as we well know from the numerous discussions on this forum. That said, James mentioned deflation. Well, there is nothing better than a perpetual preferred in a deflationary environment. The dilemma, of course, for retirees with perpetuals is long term interest rate sensitivity AND being caught on the wrong side of the yield curve when any such perpetuals must be sold to fund expenses OR by the Executor upon death.

However, for retirees who might be able to ride out the rest of their lives with a 4-5% yield alone in their portfolios, perpetual prefs are a legitimate component of that portfolio.
 

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The classic 60/40 portfolio is not necessarily the most appropriate portfolio for most retirees. "Age in bonds" or something close to that would be more appropriate, although there are exceptions. The 60/40 portfolio has historically had the best risk-adjusted return. It is possible that going forward there will be a shift, and for example 80/20 or even 95/5 would have the best risk-adjusted return. But most retirees should not try maximizing profit, but rather manage risk. For an 80 year old today, it does not matter much if stocks crush it in the 2040s. It is all about this and the next decade.

Maybe going from 20/80 to 40/60 would help with returns and mitigating some risks (such as inflation), but that does not have to be done using Unilever or any other dividend stock. A stock index fund would do the job too. No point in advocating dividend stocks as bond substitutes, which could suggest it is okay to have a 100% stock portfolio (tilted to dividend payers).
 

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Discussion Starter #10 (Edited)
Those of us discussing this subject, and who have DB pensions covering some/all of our basic living expenses, should qualify our responses accordingly because annuity payments are really guaranteed fixed income.
This is true and always a problem when discussing general subjects on these forums.

Personally, I have no real pension income. Just some beer money from a company I worked for early on. But most of us do have CPP and OAS. For a couple, this can be about $35k. This is like an indexed annuity, so perhaps that should be built into those equity/FI ratios.

For a couple aged 65, present value of CPP/OAS could be in the $500-$600k range. Say $500k. They could have $750k in equities and that would provide the 60/40 ratio for a total portfolio of $1250k. Income $35k + return on equity portion. I wouldn't advise that!

We used to be told that we should have our age in fixed income - 65% FI at age 65. For that same $1250k portfolio, FI should then be $812.5k. Deduct the $500k CPP/OAS value, so $312.5k FI. Equity $1250k-$812.5k= $437.5k. Total savings needed same $750k, Income $35k + return on roughly 60/40 Equity/FI investments (like many balanced funds)

So perhaps for a couple with almost full CPP/OAS benefits and no DB pension, using the current 60/40 ratio at retirement age is about right? Maybe revisit every few years and reduce equity exposure?

Not addressed here, is where the investment classes should be and how to minimize affect of taxes.. Funds in RRSPs and RRIFs are taxed on withdrawal. Each case different because of varying amounts that are in registered accounts.

Also not addressed, are DB pensions. But similar math could be done to include present value of those.

For those of us not using a balanced ETF or Mutual Fund, we still need to decide on just what the FI component should be. No low yield gov bonds? Maybe higher yielding GICs? Otherwise Corporates of Prefereds with added risk?
 

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The classic 60/40 portfolio is not necessarily the most appropriate portfolio for most retirees. "Age in bonds" or something close to that would be more appropriate, although there are exceptions. The 60/40 portfolio has historically had the best risk-adjusted return. It is possible that going forward there will be a shift, and for example 80/20 or even 95/5 would have the best risk-adjusted return. But most retirees should not try maximizing profit, but rather manage risk. For an 80 year old today, it does not matter much if stocks crush it in the 2040s. It is all about this and the next decade.

Maybe going from 20/80 to 40/60 would help with returns and mitigating some risks (such as inflation), but that does not have to be done using Unilever or any other dividend stock. A stock index fund would do the job too. No point in advocating dividend stocks as bond substitutes, which could suggest it is okay to have a 100% stock portfolio (tilted to dividend payers).
All that 'age in bonds' stuff was born in an age much different than we are in today...when bonds delivered real returns and the equity risk premium was just 1-2% or so. Attempts to tweak it with 110-age in equities, or in later years with 120-age, was/is just a lazy, lame attempt to justify slightly higher equity percentages due to the widening of the gap between bonds and equity risk premiums.

My view is there is no one right answer these days. It is highly situational on what the portfolio needs to deliver to meet cash flow needs. IF that is 4% as in SWR, that isn't likely going to happen in the near term at least with a 60/40 portfolio.

Justin Bender did some recent work in a YouTube video and put it in the context of Vanguard AA ETFs: Using 1.4% inflation, the expected nominal (and real) returns are: VCIP 1.9% (0.5%), VCNS 2.7% (1.3%), VBAL 3.6% (2.2%), VGRO 4.5% (3.1%), VEQT 5.4% (4.0%). Or if you don't like the apparent accuracy of such an exercise, just call it 2%, 3%, 4%, 5% and 6%.
 

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The bond weighting is also important for the psychological effect of volatility reduction, which will never enter into the quantitative analyses.

VGRO's 3% real return sounds pretty great until you freak out one day and liquidate it all, which is what people tend to do during turmoil. So while I agree that the more aggressive asset allocations (less bonds) provide theoretically better returns ... reality can be quite different once you consider human behaviour. Volatility and drawdowns matter to most people, and causes people to touch, trade, shift in & out, and do other harmful things.

Two of my close friends (one in his 30s, another in 40s) with equity-based portfolios liquidated and sold everything during the COVID crash due to, essentially, panic of the magnitude of the catastrophe. And this wasn't even a giant drawdown, only about 30%. A bad crash can easily be 50% or 70%, much worse than we got this year.

I did not sell. My high fixed income allocation really smoothed things over.

So who is better off? There's more going on than just projected real returns. Especially if a retiree has ALL their capital in their own hands (no pension) I think it's even more important to design the portfolio conservatively because you can't afford to screw things up based on emotion and fear. I'm 50% in fixed income and would not dream of going any lower.
 

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So who is better off? There's more going on than just projected real returns. Especially if a retiree has ALL their capital in their own hands (no pension) I think it's even more important to design the portfolio conservatively because you can't afford to screw things up based on emotion and fear. I'm 50% in fixed income and would not dream of going any lower.
That is why a retiree might annuitize a portion of their portfolio at age 75 or 80 as well. To get both a steady monthly paycheck plus longevity insurance. Though now is not an ideal time for annuitizing with interest rates so low.
 

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All that 'age in bonds' stuff was born in an age much different than we are in today...when bonds delivered real returns and the equity risk premium was just 1-2% or so. Attempts to tweak it with 110-age in equities, or in later years with 120-age, was/is just a lazy, lame attempt to justify slightly higher equity percentages due to the widening of the gap between bonds and equity risk premiums.

My view is there is no one right answer these days. It is highly situational on what the portfolio needs to deliver to meet cash flow needs. IF that is 4% as in SWR, that isn't likely going to happen in the near term at least with a 60/40 portfolio.

Justin Bender did some recent work in a YouTube video and put it in the context of Vanguard AA ETFs: Using 1.4% inflation, the expected nominal (and real) returns are: VCIP 1.9% (0.5%), VCNS 2.7% (1.3%), VBAL 3.6% (2.2%), VGRO 4.5% (3.1%), VEQT 5.4% (4.0%). Or if you don't like the apparent accuracy of such an exercise, just call it 2%, 3%, 4%, 5% and 6%.
I don't dispute that stocks have a higher expected return than bonds. But for a retiree, what matters is the SWR of their portfolio. The SWR is influenced as much by volatility than returns. Using Portfolio Visualizer's Monte Carlo simulations, in the past one could have taken a 4% withdrawal for 30 years from a bond only or 60/40 portfolio with a success rate of more than 95%. With a 100% stock portfolio, the SWR would have to drop to 3% for a similar success rate.

It is likely that the SWR will be lower in the future, but it is safe to assume a more volatile portfolio will have a lower success rate. The role of bonds is to dampen volatility.





 

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I don't dispute that stocks have a higher expected return than bonds. But for a retiree, what matters is the SWR of their portfolio. The SWR is influenced as much by volatility than returns.
. . .
It is likely that the SWR will be lower in the future, but it is safe to assume a more volatile portfolio will have a lower success rate. The role of bonds is to dampen volatility.
Volatility is more harmful than most people think. It's harmful both from an emotional angle, but also -- as you point out -- for sequence risk and the impact on SWR.

I strongly believe that retirees (with no pension/annuity) need a healthy allocation to bonds. This can mean lower maturity bonds and/or GICs.
 

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I don't dispute that stocks have a higher expected return than bonds. But for a retiree, what matters is the SWR of their portfolio. The SWR is influenced as much by volatility than returns. Using Portfolio Visualizer's Monte Carlo simulations, in the past one could have taken a 4% withdrawal for 30 years from a bond only or 60/40 portfolio with a success rate of more than 95%. With a 100% stock portfolio, the SWR would have to drop to 3% for a similar success rate.

It is likely that the SWR will be lower in the future, but it is safe to assume a more volatile portfolio will have a lower success rate. The role of bonds is to dampen volatility.
That is why one goes with a modified 4% SWR (based on portfolio value at the beginning of each year). Better yet, adopt Variable Percentage Withdrawal methodology, enjoy higher withdrawal rates and never run out of money. Course one has to accept variable annual amounts with either modified SWR or VPW methodologies. Just like 'Age in Bonds' is dumb, so is the inflexible 4% SWR. Old habits die hard.
 

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That is why one goes with a modified 4% SWR (based on portfolio value at the beginning of each year). Better yet, adopt Variable Percentage Withdrawal methodology, enjoy higher withdrawal rates and never run out of money. Course one has to accept variable annual amounts with either modified SWR or VPW methodologies. Just like 'Age in Bonds' is dumb, so is the inflexible 4% SWR. Old habits die hard.
I like VPW myself, but it is no panacea for volatility either; in practice it allows one to take more from the portfolio than SWR. This of course leaves less unspent funds in the portfolio if one lives long enough.

If you have a 1m stock portfolio you can take 50k this year (for example). If stocks drop 50% next year due to COVID-21, under VPW, you will have to take only 25k. You have to be comfortable with that kind of volatility in withdrawals.
 

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Indeed. One trades variablity in withdrawals with a general higher overall withdrawal rate. Just like RRIF minimum annual withdrawals Both based on similar methodology. Recognize this methodology assumes one dies broke at 100. Want a buffer? Keep some cash aside in a 'cash reserves' account or use the percentages for a higher FI allocation, e.g. 40/60 instead of 60/40.
 

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j4b makes a good point, that bonds are not only an investment vehicle where you expect a real return that is positive. It acts as ballast during turbulence, much like a keel on a sail boat !

Maybe this whole time our expectation of a positive real return from bonds was partially flawed, should the return be only 1/3 of the value and 2/3 be the stability offered by bonds ? Seeing it as not highly corolated with stocks....

If over the next few years bonds are low to neg real return and markets are very turbulent, is the bond roll more to offset turbulence at the cost of 1% ? If at the end you can’t stomache a 50% draw down, and sell or bubbles pop, either way markets could be less in 5 years for high equity investors. The bond investor would have lost too but the losses would have been less and getting there would have been less volatile too.... we have not had such a long draw down but one can never say never.....

I do wish bonds were more promising but......
 

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I like perpetual prefs. Just did a Quicken report which shows they constitute ~ 12% of my investment portfolio.

Mostly GWO, Royal Bank, Power Corp, & Power Financial.
 
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