Does a young investor need bonds?

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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scomac
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Re: Does a young investor need bonds?

Post by scomac »

ISTM that the oft cited recommendation of having somewhere between 25% and 75% in equities has lost a bit of the original message. IIRC, it was first posited by Graham with the idea that the investor would vary his stock exposure between 25% and 75% depending upon relative valuation. If we used one of Graham's classic methodologies, be it intrinsic value or his classic net-net calculation as the benchmark, then equity exposure would have started at 50% and then varied up or down depending upon the proliferation of cheap stocks in the marketplace.

Applying this context to the recommendation, we would most likely have seen typical portfolios running consistently on the low side of equity exposure for the past 20 years or so with ramp ups following the crashes of 98, 02 and 08. The problem with this is that it is implied that the portfolio manager is capable of making these sorts of analyses rather than relying on the boiler plate recommendations based on age and/or risk tolerance.

If we accept that most folks are best served with some sort of balanced fund during the initial stages of investing, then I also think it is reasonable that most folks are going to be best served with a similar sort of asset division throughout their investing careers. That suggests that 50%-60% equity exposure is most likely the upper end of the comfort zone, but most folks don't realise that until they've been made extremely uncomfortable, sometimes more often than once.
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DavidR
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Re: Does a young investor need bonds?

Post by DavidR »

Joe, I don't believe that Buffett meant "bonds should be 25% and equities 75%".
He means: "most people should not go below 25% equities or above 75% equities".

The 50/50 that suits you best falls within his range - which is a very broad range, but of course he wasn't trying to give specific advice to a specific person.
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Re: Does a young investor need bonds?

Post by Shakespeare »

Low bond exposure is tolerable when the paper dollar loss of a major equity drop is easily recoverable from savings. If you have only a $10K portfolio, and are saving (say) $3K ongoing, a start-of-year 25:75 bond:equity drops to $6250 (plus bond interest) which is recoverable to about $10K with the new investments. That doesn't affect the investor very much, because the optics of the loss are hidden.

OTOH, when you have $100K, the same drop is over 20 timesover 12 times the same savings rate and can not be tolerated by many people.

Edited: Oops - used wrong figure.
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Re: Does a young investor need bonds?

Post by gouthro »

Shakespeare wrote:Low bond exposure is tolerable when the paper dollar loss of a major equity drop is easily recoverable from savings. If you have only a $10K portfolio, and are saving (say) $3K ongoing, a start-of-year 25:75 bond:equity drops to $6250 (plus bond interest) which is recoverable to about $10K with the new investments. That doesn't affect the investor very much, because the optics of the loss are hidden.

OTOH, when you have $100K, the same drop is over 20 timesover 12 times the same savings rate and can not be tolerated by many people.

Edited: Oops - used wrong figure.
Yes, I know it would hurt to say drop fifty percent on a larger portfolio. But, I don<t think 25 percent in fixed income would provide the kind of solace that you might need at a time like that. Putting it in dollar amounts may clarify it: Say, for instance, that you had a portfolio of a million dollars. Twenty five percent of that is $250,000. So, I would keep all of my $250,000. But, I would lose say fifty percent on $750,000, leaving me with a loss of $350,000. I don't think I would be feeling protected at that moment. But, if I had a fifty percent fixed income, well, I wouldn<t feel good but I wouldn't feel all that bad. I don't know if this adds anything to the discussion--but the dollar amounts make me more conscious of the situation. I appreciate all your comments because I am thinking this over myself and like to hear others opinions. I believe I have mentioned earlier that I am at 100 percent equities in the current context. And it is a big jump from there to 50 percent fixed income. But, I am prevented from going to 25 percent because i don't think it would provide the psychological solace that I would be doing it for.
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Re: Does a young investor need bonds?

Post by StuBee »

If you are young and your primary source of living income is work related, I think that the way to go would be around 25% to 75% bond to equity ratio. But, you have to be willing to accept considerable volatility on the equity side i.e. some version of intelligent buying and then ignoring with the understanding that your horizon is in excess of 20 years. Though it is anecdotal, that was my approach in 1993 and I have learned to be content with my over all CAGR (up until now) of just under 7%. Mind you, in more recent years, as I approach a retire-able age, I have moved towards a 35% to 65% ratio.

And that is just it! My opinion can only be anecdotal!!

As has been mentioned before, so much is dependent on individual circumstances. In deed, I believe that it is almost impossible to give an intelligent answer without having a great deal of knowledge of the individual concerned. Here is a list of only some of the variables which would influence my opinion:

Does he/she have a DB pension? And if so how generous is it and when are they eligible for it?
Is their a spouse? If so what is their financial position? (Not that this is the case but I am not going to get overly involved in a theoretical conversation concerning the relative merits of bonds to equities if combined pension income is in excess of (say) 125K$)
How much is in their portfolio? My approach to a 50K$ portfolio will be MUCH different to my approach to a 1.5M$ portfolio.
What about all the demographics? How old is he/she or they? What about children? None, one, or...six?
Will they be retiring after the children are grown up or not?
Are they a frugal sort? Or, are they globe trotters?
Will they be receiving an inheritance? Or conversely do they want to provide one for their offspring (or whoever...)?

I am sure that I have just scraped the surface of all the possible, yet significant, variables! And I have not even started to consider personality traits (prone to anxiety... a deep set love (or not) for their job...).

Not that I know very much but it seems to me that it is extraordinarily difficult to come to grasps with how "safe" the individual must be (or can be... or can afford to be... or needs to be...). This measure is intimately associated with risk and is at the core of the decision making process.
I personally would be unconcerned by the 70 year old with 5M$. He can do what he wants, he shouldn't ever run out.
What about a young individual who wants an opinion on asset allocation for 150K$ and at the same time has real estate in the millions of dollars and has no significant other? That real estate would significantly impact my opinion.

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Re: Does a young investor need bonds?

Post by ghariton »

Just to remind us that we can incur losses on our fixed income portion too.

When I first started out, I was 100% equities. After suffering the stock market pain of the late 1960s and early 1970s, I swore off equities and put 100% of my money into Royal Trust's bond fund. Interest rates spiked around 1981 and I took huge losses -- huge in percentage terms; fortunately I had very little money to invest back then. So I went back to 100% equities, in time to lose a lot of money in 1987.

In retrospect, I should have stuck with 100% equities until I had built up a sufficient portfolio, then gradually diversified into fixed income. In the early days, as Shakespeare points out upthread, any losses aren't that big and can be made up by stepping up your savings if necessary. That becomes less and less true as you grow older and your potential losses get larger.

The formula setting percent of fixed income equal to your age is a pretty good rule of thumb. I would modify it as follows: When you're in your twenties, it should be: percentage of FI = age - 20. The -20 would then taper off, so that you reach percentage = age by your early forties and hold there.

Of course, as pointed out upthread, individual circumstances vary.

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Re: Does a young investor need bonds?

Post by gouthro »

Sorry just to talk about my own situation here and not mention the OP. I got caught up in the evolving conversation, I suppose. And also, I don't feel particularly qualified to give advice.

I would be in fixed income if the circumstances were different. Starting out, I would probably not be in fixed income. You have such a long timeline. And although no one can predict the future, the world seems to go along rather regularly, and so what they say about equities always coming back, will probably true....You only need enough time.
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Re: Does a young investor need bonds?

Post by kcowan »

So the answer to the OP is not much until you get older and have more assets!
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Re: Does a young investor need bonds?

Post by gouthro »

kcowan wrote:So the answer to the OP is not much until you get older and have more assets!
Yes, you are right, Kcowan, that would be my answer. But, if you notice, I don't follow my own advice!--at least not under these particular market conditions.
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Re: Does a young investor need bonds?

Post by adrian2 »

The great pension shift: Goodbye safe, dull government bonds
Keith Ambachtsheer has made a living advising pension funds on the best way to meet their obligations to retirees. In 2000, he warned funds to reduce their exposure to stocks, which had reached nose-bleed valuations after a two-decade bull run, and add long-term government bonds. Since then, bond prices have risen about 10 per cent a year on average, while stock markets have treaded water.

Today, his advice has flipped around. With the yield from long-dated bonds barely outpacing the inflation rate, the director of the Rotman International Centre for Pension Management says the safer investment for pension funds – and any long-term investor – is blue chip stocks.

“In this environment, it’s plausible that for long-term investors, their safest investment is buying and holding a diversified international portfolio of dividend-paying stocks” – companies such as Nestlé SA, pipeline utilities and Canadian banks, he said. “It takes a while to wrap your head around that.”

Indeed, it does. Trading in dull but dependable government bonds for inherently riskier stocks seems contrary to sound risk management. Yet, Mr. Ambachtsheer has a lot of company. The Caisse de dépôt et placement du Québec and GMO LLC, the Boston asset manager led by famed investor Jeremy Grantham, recently have said they are substantially reducing their holdings of bonds with long maturities.

“I’m pretty sure the odds of making money on bonds over a five-year horizon are zero,” added Leo de Bever, head of Alberta Investment Management Corp., the province’s public investment fund manager. “I agree being in high quality stocks is probably a better alternative to bonds. Five years ago I wouldn’t have said that.”
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Re: Does a young investor need bonds?

Post by gouthro »

adrian2 wrote:The great pension shift: Goodbye safe, dull government bonds
Keith Ambachtsheer has made a living advising pension funds on the best way to meet their obligations to retirees. In 2000, he warned funds to reduce their exposure to stocks, which had reached nose-bleed valuations after a two-decade bull run, and add long-term government bonds. Since then, bond prices have risen about 10 per cent a year on average, while stock markets have treaded water.

Today, his advice has flipped around. With the yield from long-dated bonds barely outpacing the inflation rate, the director of the Rotman International Centre for Pension Management says the safer investment for pension funds – and any long-term investor – is blue chip stocks.

“In this environment, it’s plausible that for long-term investors, their safest investment is buying and holding a diversified international portfolio of dividend-paying stocks” – companies such as Nestlé SA, pipeline utilities and Canadian banks, he said. “It takes a while to wrap your head around that.”

Indeed, it does. Trading in dull but dependable government bonds for inherently riskier stocks seems contrary to sound risk management. Yet, Mr. Ambachtsheer has a lot of company. The Caisse de dépôt et placement du Québec and GMO LLC, the Boston asset manager led by famed investor Jeremy Grantham, recently have said they are substantially reducing their holdings of bonds with long maturities.

“I’m pretty sure the odds of making money on bonds over a five-year horizon are zero,” added Leo de Bever, head of Alberta Investment Management Corp., the province’s public investment fund manager. “I agree being in high quality stocks is probably a better alternative to bonds. Five years ago I wouldn’t have said that.”
With a certain amount of fear and trepidation, this is the position I find most convincing under current market conditions. I would love to be in bonds. But, not right now.
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Re: Does a young investor need bonds?

Post by dusty2 »

Bond investing is kind of like investing in your own money. The result like an inbred deformed child. Someone says that no one can predict what the future bond price will be but that's not true, since the bond rate will always be less than the inflation rate, so a bond investor is always guaranteed to lose money compared to the inflation rate. The smart thing to do, for a young investor, is to invest in the companies that are selling bonds and in turn using that money to create wealth, which are mostly the banks.
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Re: Does a young investor need bonds?

Post by Bylo Selhi »

A couple of days late :P

Also more discussion starting hereabouts.
gouthro wrote:I would love to be in bonds. But, not right now.
So keep terms short, possibly even in cash in a HISA at 1.9%, since there's lots of risk but little reward in longer terms.

(Pension plans tend to buy long term bonds to defease decades-out obligations. But that's not usually why ordinary investors buy bonds.)
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Re: Does a young investor need bonds?

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dusty2 wrote:Bond investing is kind of like investing in your own money. The result like an inbred deformed child. Someone says that no one can predict what the future bond price will be but that's not true, since the bond rate will always be less than the inflation rate, so a bond investor is always guaranteed to lose money compared to the inflation rate. The smart thing to do, for a young investor, is to invest in the companies that are selling bonds and in turn using that money to create wealth, which are mostly the banks.
This post is so wrong on so many levels its not even funny. Care to explain how an investor who bought long duration Canadian government bonds in 1981 @ ~15-20% lost money in real terms over the following 15-20years?
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Re: Does a young investor need bonds?

Post by Shine »

It is easier to stay in shape than to get in shape - bonds help your portfolio "stay in shape" I suggest.
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Re: Does a young investor need bonds?

Post by Thorn »

For any investor, the following might apply, remembering that no investment decision is risk-free:

(1) Cash - has appeared in your investment accounts through a sale, maturity, dividend or interest payment, etc. Let it sit for a while if you don't like anything you are hearing or seeing at present. If you want a small safe return while waiting, GoC T-bills are liquid and other money market instruments are available. In short, no need to rush to invest when you have some cash.

(2) Fixed Income - protection of capital (government and corporate A,AA,AAA) with a return acceptable to you, notably in excess of anticipated inflation. Nice to have in tax-sheltered accounts, and laddered if possible. The bond market in general will be a mess until the US and Canada bond issues begin to increase interest offers. By the way, bond prices vary daily based on comparisons to latest issues of GoC etc. bonds, but if held to maturity will be at the $1,000 par.

(3) Equity - mixture of income and growth should provide best long-term returns with reasonable risk. To improve your chances as time goes along, you should read up on value investing and do some analysis a la Graham and Buffett. Remember, you are buying a piece of a company and that company is NOT the market, where mass psychology and a host of other hidden issues rule prices from day to day.
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Re: Does a young investor need bonds?

Post by AltaRed »

Reference to those quotes please? Seems the author missed the boat on Cash. HISA accounts beat Tbills and money market funds hands down.
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Re: Does a young investor need bonds?

Post by queerasmoi »

FWIW, as a young investor (presently 30) I had a nest egg invested in ETFs, 40% FI, 60% equities plus six months' expenses in an HISA emergency fund as I finished grad school. I was of course not eligible for EI since grad school is not counted as employment. I found some very part-time income, but ultimately within 8-9 months I exhausted the HISA. So I withdrew a chunk of the FI to spend on living expenses. It meant that I did not have to sell equities at what could have been a bad time in the market cycle to do so (which, it turns out, would have indeed been a bad time).

Three months later I had a boring but stable part-time job which stopped the bleed, and another five months later got a full-time job in my field. After eight months at that job I am ready to start accumulating again.

So what I'm saying is - if you suspect you may be vulnerable to the job market in the medium-term, holding some FI can help protect your portfolio from having to be drawn down at the wrong time. When the equity market is doing worst, there are more people in your shoes competing for the same jobs and having to get by in the meantime. Unless you have a very recession-proof or contra-recession line of work.

This is also not to mention the fact that my porfolio pretty much started only months before the equity market fell off a cliff, and having FI around allowed me to rebalance back into equities when others were fearful. I think my comfort level is going to lead me to stick with 40% FI as long as I'm this far down on the pay scale. If at 35 I'm making three times as much, then maybe I'll raise the equities a bit.
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Re: Does a young investor need bonds?

Post by j831robert »

Seems to me I recall similar question back in the Wealthy Boomer days and I liked the answer - "hell No?!" You're young and have years ahead of you to consolidate your winnings and or make up for your mistakes - take a flyer, make the long shots, and don't get caught up in the Scrooge style until you've had your fling and learned (perhaps the hard way)!
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Re: Does a young investor need bonds?

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j831robert wrote:Seems to me I recall similar question back in the Wealthy Boomer days and I liked the answer - "hell No?!" You're young and have years ahead of you to consolidate your winnings and or make up for your mistakes - take a flyer, make the long shots, and don't get caught up in the Scrooge style until you've had your fling and learned (perhaps the hard way)!
Yabbut queerasmoi presents a real-life example of why cash and fixed income belong in even a young investor's portfolio. Thanks, queerasmoi!

PS. Congrats on having the full-time job, getting settled and being able to invest again.
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Re: Does a young investor need bonds?

Post by queerasmoi »

j831robert wrote:Seems to me I recall similar question back in the Wealthy Boomer days and I liked the answer - "hell No?!" You're young and have years ahead of you to consolidate your winnings and or make up for your mistakes - take a flyer, make the long shots, and don't get caught up in the Scrooge style until you've had your fling and learned (perhaps the hard way)!
Yeah well, the reality for those who are young today is that very few of us are ever able to have a feeling of job security. Employers have stopped competing for young talent, at least in my field. Now talent is competing for employment. I wonder, if my generation were to be asked "Do you feel confident enough in your job security to plan as if you won't need any of your savings in the next 10 years?", how many would say yes?

So yes, I am young and I have years ahead of me to consolidate/makeup/etc. But the reality is, if my income drops below my expenses or to zero I need to spend "today dollars" to get by, and those are going to have to come from savings or debt. The number of "tomorrow dollars" I still potentially have ahead of me is hard to keep in focus if I'm put in a situation of having to liquidate the "yesterday dollars" that I invested in a dropping market, in order to get by today.

In a way, you could say I'm investing on the assumption that at any point in time I could be forced into partial retirement, hence a withdrawal phase.
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Re: Does a young investor need bonds?

Post by kcowan »

QAM
I think you are appreciating the need for an emergency fund. Probably one that is bigger than it was before. I think most here would agree that it should be in safe short-term investments.
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Re: Does a young investor need bonds?

Post by gouthro »

I would re iterate kcowan's suggestion: a bigger emergency fund. But, everyone's situation is different. I think we are all just speaking for ourselves here, with the kind of risk tolerance, etc., that each of us has. To me it seems like such a long horizon that it makes sense to put as much as you have--aside from emergency funds--into stocks.
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Re: Does a young investor need bonds?

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"hell No?!" You're young and have years ahead of you to consolidate your winnings and or make up for your mistakes - take a flyer, make the long shots, and don't get caught up in the Scrooge style until you've had your fling and learned (perhaps the hard way)!
IMHO I think this is bad advice for young investors. If they have 20 - $30,000 and they take a FLYER and lose it what then. It takes a long time to save that much and then they lose all the compounding as well. A calculated risk with SOME funds based on knowledge/experiance would be more appropriate. When I was first working I would always keep enough funds available if I decided to quit and look for another job.
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Re: Does a young investor need bonds?

Post by ockham »

BRIAN5000 wrote:
"hell No?!" You're young and have years ahead of you to consolidate your winnings and or make up for your mistakes - take a flyer, make the long shots, and don't get caught up in the Scrooge style until you've had your fling and learned (perhaps the hard way)!
IMHO I think this is bad advice for young investors. If they have 20 - $30,000 and they take a FLYER and lose it what then. It takes a long time to save that much and then they lose all the compounding as well. A calculated risk with SOME funds based on knowledge/experiance would be more appropriate. When I was first working I would always keep enough funds available if I decided to quit and look for another job.
+1.

I might add that the investing time-horizon for those, professionals or second career seekers, coming out of college at age 30ish or so is, %-wise, a lot shorter than is the investing time-horizon for those entering the workforce at 20ish.

Moreover, what is it exactly that one is being exhorted to learn "perhaps the hard way"?? The point, I think, is to learn to invest prudently without it being "the hard way". I know too many professionals working into their late 60s and early 70s because they followed the "have your fling and learn the hard way" approach to investing.

St. Augustine prayed: "Lord, give me chastity and continency -- but not yet ." Applied to investing, this is an approach with little to recommend it. WADR.
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