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Can someone help me with a question about the value of bonds in a long-term portfolio?

Since we know that bonds will underperform stocks over the long term, why bother with them if you have an investment horizon of 20+ years? Isn't it possible to achieve sufficient diversification using only investments like equities, which, we know from a long history, are very certain to have vastly superior returns? Thanks,

jeff
 

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Can someone help me with a question about the value of bonds in a long-term portfolio?

Since we know that bonds will underperform stocks over the long term, why bother with them if you have an investment horizon of 20+ years? Isn't it possible to achieve sufficient diversification using only investments like equities, which, we know from a long history, are very certain to have vastly superior returns? Thanks,

jeff
Bonds provide better diversification from stocks. Typically their performance has a negative or zero correlation. It is a lot of work to identify a basket of stocks even with with low positive correlation.

Bonds provide an excellent opportunity for skittish investors, or those with shorter time horizons.

As for myself, I have at least fifteen years to go, and I have not owned bonds since CSBs paid 19%. I am looking for a way to diversify with stocks only. I am working towards:

1. overweighting defensive stocks like utilities, pipelines, telecommunications and consumer staples
2. underweighting cyclical stocks like financials and energy which dominate TSX
3. overweighting tech, which has low correlation to financial and energy
4. investing in non-Canadian small cap ETFs because small caps in different countries should correlate less than large caps
5. holding about 10% in REITs
 

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Can someone help me with a question about the value of bonds in a long-term portfolio?

Since we know that bonds will underperform stocks over the long term, why bother with them if you have an investment horizon of 20+ years? Isn't it possible to achieve sufficient diversification using only investments like equities, which, we know from a long history, are very certain to have vastly superior returns? Thanks,

jeff
Bonds often move in the opposite direction of stocks (ie negative correlation), therefore they reduce the risk in a portfolio.

If you have an investment horizon of 20+ years, you can buy bonds and hold until maturity. That way, you know what your nominal gain will be. Some investors like that certainty.

Securities issued by the Government of Canada are generally regarded as the safest investments in Canada, because they set their revenues. If the government can't afford the coupon payments, they can just raise taxes. Non-government entities cannot set their revenues.
 

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Can someone help me with a question about the value of bonds in a long-term portfolio?

Since we know that bonds will underperform stocks over the long term, why bother with them if you have an investment horizon of 20+ years? Isn't it possible to achieve sufficient diversification using only investments like equities, which, we know from a long history, are very certain to have vastly superior returns? Thanks,

jeff
Let's say you expect a 4% real return from stocks and a 2% real return from bonds. You may expect a portfolio that has a 80/20 stock-bond split may be expected to return 3.6%. Since stocks are more volatile than bonds, by rebalancing diligently you can boost your returns somewhat, say just shy of 4%.

By adding bonds, you've also lowered the risk of your portfolio. Quick example. Say you have $80 in stocks and $20 in bonds going into a brutal bear market that takes stocks down by 50%. At the bottom of the bear market, you'll likely have $40 in stocks and $20 in bonds for a total of $60. A bad loss? Yes. But an all-stock investor has lost even more. His portfolio is valued at just $50.

But here's the key difference. The diversified investor, can sell some of his bonds and buy stocks. If he rebalances back to his original allocation, he'll have $48 in stocks and $12 in bonds.

Now say stocks go back to $100. The diversified investor has $108, or 8% more than the all-stock investor. Admittedly, I've cherry picked my numbers for illustration but it shows why you want to add bonds to a portfolio.
 

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Since we know that bonds will underperform stocks over the long term, why bother with them if you have an investment horizon of 20+ years?
You're assuming that the past can be used to predict the future, and that stocks will replicate previous runs. There's no good evidence that the next 20 year cycle will follow this line of thinking.

Imagine being invested in the Nikkei in 1990, buying in and holding during the run to 40,000- It's 20 years later now, time to retire eh? :eek:
 

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there is at least one investment counsel that i'm aware of - and probably many more that i'm not aware of - that practices a highly-disciplined, draconian form of stock/cash/bond balancing using etfs only. It's venable park of barrie, ontario.

as i understand it, venable park swings from equity etfs and a gold etf or 2 to all cash, and then back, in slow cycles that can last a few years. The technicals driving the timing were, apparently, developed by venable. Or at least they are in-house fine-tunings of others' work.

what's unusual is that venable park tends to be almost entirely out of stocks for periods as long as several years. For example, as far as i can make out, they were out of stocks in 2008, well in advance of the meltdown. I believe they have been back in as of roughly mid-2009, but it may have been an on-again-off-again trajectory.

reason i can't say for sure is that i'm not a client, therefore i can't see their financial reports.

CC you seem to be doing something similar. From the post above:

" ... Say you have $80 in stocks and $20 in bonds going into a brutal bear market that takes stocks down by 50%. At the bottom of the bear market, you'll likely have $40 in stocks and $20 in bonds for a total of $60. A bad loss? Yes. But an all-stock investor has lost even more. His portfolio is valued at just $50.

But here's the key difference. The diversified investor, can sell some of his bonds and buy stocks. If he rebalances back to his original allocation, he'll have $48 in stocks and $12 in bonds.

Now say stocks go back to $100. The diversified investor has $108, or 8% more than the all-stock investor."


when you say that "the ... investor can sell some of his bonds and buy stocks ... [and rebalance] back to his original allocation," i am wondering how you make that timing decision. Such a decision is being made at the nadir of the bear market. Do you wait until markets appear to have turned definitely up - for example in june or july 2009 - and then return to stocks. Or would you be buying at the height of the panic, for example in march or april 2009. What are the triggers that initiate your rebalancing. Would you not say that rebalancing is market timing.

any thoughts would be most appreciated.
 

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what's unusual is that venable park tends to be almost entirely out of stocks for periods as long as several years. For example, as far as i can make out, they were out of stocks in 2008, well in advance of the meltdown. I believe they have been back in as of roughly mid-2009, but it may have been an on-again-off-again trajectory.
It is hard to say whether Venable Park has beaten the markets in the past. I haven't seen them publish their past returns compared to the benchmarks. For all, I know they may be beating the pants off the markets, or not. I don't know.

http://www.canadiancapitalist.com/book-review-juggling-dynamite/

when you say that "the ... investor can sell some of his bonds and buy stocks ... [and rebalance] back to his original allocation," i am wondering how you make that timing decision. Such a decision is being made at the nadir of the bear market. Do you wait until markets appear to have turned definitely up - for example in june or july 2009 - and then return to stocks. Or would you be buying at the height of the panic, for example in march or april 2009. What are the triggers that initiate your rebalancing. Would you not say that rebalancing is market timing.

any thoughts would be most appreciated.
Yes, rebalancing is a form of market timing. I use a +/- 5% rule to rebalance. If bonds go from the 20% target to 15%, I sell some stocks and buy bonds. If bonds go to 25%, I sell some bonds and buy stocks. I find that typically, I can just rebalance by buying the asset class that is lower than target either from savings or portfolio income. It is only rarely that I had reason to rebalance. In the previous bear market, I rebalanced early... in late October 2008 and so, did not catch the market bottoms (for Canadian stocks) in Nov '08 and Mar '09.
 

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I think a fixed percentage variance combined with a regular review (quarterly) as CC says is the best approach. It removes the emotion out of the equation. Call it methodical market timing.
 

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i think that CC has developed a more subtle, more universal and more shock-resistant model than the venable park all-or-nothing approach.

as far as i know venable park got it dead right in 2008/09. All cash for at least a year, then back into equities, after they'd collapsed by 50%, at least to a certain extent around mid-2009. Even if vp had never made another cent of sales after the middle of 2008, they would have pretty near doubled assets under management. But it's only been 24 months.

we know that no person or organism can keep spectacular outperformance going permanently. No one ever has. So a sustainable model like CC's, which works around all-or-none decision-making, would be far more likely to succeed over many years or over a lifetime, imo.

andrew: thanks, i will look As i mentioned venable park is using market timing systems based on outside models but optimized in-house by the venable part of the team. One would learn more if one were to sit down with them as a prospective client. At least i'd assume they'd have elaborate academic backup to their platforms.

i'm not meaning to cast any doubt whatsoever on this small firm. On the contrary, i think they have a highly efficient approach, enough experience to be esteemed, and an ethical stance. The park part of the team is a prolific writer with a knack for breezy, crystal-clear exposition. Her recent book on finance is Juggling Dynamite. She's critical of nearly all buy-and-hold investment advisors.
 
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