The subreddit made such a big difference to me. My 401k was auto-invested in a TDF, but I really had no idea what to invest in in a taxable account or IRA. I someone came across the sub on reddit,...
The subreddit made such a big difference to me. My 401k was auto-invested in a TDF, but I really had no idea what to invest in in a taxable account or IRA. I someone came across the sub on reddit, read some of the posts and book recaps, and it all made so much sense! Why not just buy…the entire market?
There’s no way an individual (especially one who doesn’t invest for a living) can beat the crazy algorithms and supercomputers, and even hedge funds cant beat the market consistently, so why bother? I’ve been investing way more since I learned about the approach, all VT.
Trying to start investing for the first time feels like getting into an exercise routine: you become inundated with information, the loudest voices all have their own systems, it's nearly...
Trying to start investing for the first time feels like getting into an exercise routine: you become inundated with information, the loudest voices all have their own systems, it's nearly impossible to differentiate the people trying to take your money from those giving honest advice, and in the end many people just give up. People wind up seeing investing as this risky, complex task where they'll go broke if they aren't day trading across 6 monitors.
The reality is that the best method or routine is the one you stick to - whether it's complex or just simply auto-investing into a broad market fund. Bogleheads is a great way to understand the basics and get started before you go too deep. Personally, I just chuck my money into diverse IRA / 401k accounts and forget it because I know I wouldn't keep up with anything much more complex.
The day I discovered John Bogle was the last day I worried about investing and retirement. Bogle's book(s) and/or the forum should be required reading for anyone in their 20s, and anyone in...
The day I discovered John Bogle was the last day I worried about investing and retirement. Bogle's book(s) and/or the forum should be required reading for anyone in their 20s, and anyone in general if they're getting started later.
I somewhat follow this. However, there's one simple rule that I wish I had understood earlier: due to interest rate risk, don't buy bonds (or bond funds) when interest rates are near zero. Cash is...
I somewhat follow this. However, there's one simple rule that I wish I had understood earlier: due to interest rate risk, don't buy bonds (or bond funds) when interest rates are near zero. Cash is a fine substitute for a fixed-income investment under those conditions.
The traditional asset allocation between stocks and bonds doesn't take this into account.
I suppose it doesn't matter now. 5% is pretty good.
It's worth noting that, even when interest rates are 0%, your expected long term returns are still higher than that of uninvested cash, especially if you plan to hold the bonds for a longer...
It's worth noting that, even when interest rates are 0%, your expected long term returns are still higher than that of uninvested cash, especially if you plan to hold the bonds for a longer timeframe than the average maturity of the bonds in the fund.
You're obviously exposed to the volatility of the fund in case of fast interest rate hikes, but at the time nobody could tell if that hike was coming, when it was coming and how steep it would be. If our central banks didn't always operate like a headless chicken and they had slowly raised interest rates over the course of several years, volatility would've been much lower. Hindsight is always 20/20 of course.
In the meantime, while rates were at 0% and everybody expected them to remain like that for another decade, a typical intermediate-duration bond fund (7-10 years) would give you a better yield than cash. The price (and the return) of a bond doesn't evolve linearly overtime, and funds buy and sell bonds all the time to keep the average maturity inline with the spec of the fund. So returns were positive even when rates were at 0%.
But if you're close to retirement or you just think you'll need that money in less than, say, 5 years, it makes sense to move your fixed-income investments to funds with short-term bonds (~3 years) or money market funds (<6 months). MMFs normally don't have any volatility, as they typically have an average maturity (WAM) of just a few days, and so their rate is being constantly renewed. Their price doesn't have time to drop when interest rates go up.
I guess, but when you're investing for the long term, a stock index looks better. The question is what to do with the remainder, since putting it all in stocks is too high-risk for most people....
I guess, but when you're investing for the long term, a stock index looks better. The question is what to do with the remainder, since putting it all in stocks is too high-risk for most people.
The "better yield than cash" was not very much, particularly for short-term bonds, which is why I bought an intermediate bond fund.
I actually did keep more in cash than the bond fund and I feel pretty good about that now. It wasn't planned, though, it's more like I felt wary about having a higher allocation in stocks and was uncertain about bonds, too.
In retrospect, my best investment decisions were due to procrastinating (not just this one; procrastinating about diversifying out of Google was the best thing I did by a lot). What I'm saying now is that I would have felt better about it at the time if I were thinking more about interest rate risk.
Stocks are always going to have better expected returns than bonds in the long term, but that's not the reason why you add bonds to your portfolio. You add them because they tend to reduce the...
I guess, but when you're investing for the long term, a stock index looks better. The question is what to do with the remainder, since putting it all in stocks is too high-risk for most people.
Stocks are always going to have better expected returns than bonds in the long term, but that's not the reason why you add bonds to your portfolio. You add them because they tend to reduce the overall volatility of your portfolio, which reduces your risk exposure according to your risk profile. You should look at your portfolio as a whole, not at each asset separately.
Bond funds dropped so much not just because interest rates were coming from 0%, but because they were raised extremely fast (in a few months) after many years being at 0%. I don't think there has ever been such a fast hike coming from such a low point in history. And yet, despite the dip bond funds took, mixed portfolios never had more drawdown than a 100% stock portfolio, even for the 2020-2023 period.
If rates had simply been raised a bit more gradually, you'd probably have a very different view now. And if interest rates are quickly raised from 4% to 9% next year, you'll again experience the same kind of drop in bond funds as you did last year, despite interest rates not being at 0% right now. Remember the US has had interest rates as high as 16% as close as 4 decades ago, and that we have no way to predict what central banks will do. We don't know when interest will change again, or by how much, or when and where the next war or pandemic will happen, etc.
So I don't think the lesson to take away from this is to avoid bonds when interest rates are 0%. That's too simplistic, and that information is already priced-in at any point in time.
I think the right way to think of it is: you're always exposed to interest risk, which is proportional to the average maturity of your bonds. And we have no way to know if/when interest rates will change, or by how much. So if your time horizon is lower than e.g.: 5 years, you might want to consider moving your bond allocation to shorter-term bonds (e.g.: <3 years) to reduce that risk, regardless of where interest rates are right now.
I actually did keep more in cash than the bond fund and I feel pretty good about that now. It wasn't planned, though, it's more like I felt wary about having a higher allocation in stocks and was uncertain about bonds, too.
If you think about it, this is a bit like those people who do stock picking for the first time and accidentally succeed. So they actually believe they have cracked the market, and proceed to lose a ton of money over the next few months by going all-in with their "method". I know what you did is absolutely nowhere near stock picking, don't get me wrong. But just wanted to draw the comparison.
You feel good about the cash you were holding because of events you had no way to predict when you decided to hold it: the Ukraine war, the inflation surge, the reckless behaviour of central banks, etc. If rates had been increased more slowly, like it's supposed to be done, you'd probably have a very different view by now. Let alone if there had been no war, no inflation and no rate hike... and you were making some moderate profit on your intermediate bond funds while your cash continued to collect dust in your bank account.
I think 0% to 5% is different from 5% to 9% because you’re not missing much by holding cash at 0%, and you will if you’re holding cash at 5%. The opportunity cost from not having “time in the...
I think 0% to 5% is different from 5% to 9% because you’re not missing much by holding cash at 0%, and you will if you’re holding cash at 5%. The opportunity cost from not having “time in the market” is different.
That said, a money market fund would have been better, because the interest rate goes up on its own without making any changes.
Comparing to a 100% stock portfolio doesn’t seem right. The relevant comparison would be a stocks+bonds portfolio to a stock+cash portfolio with the same weight in stock. Or maybe a short-duration bond fund? They’re all mixed portfolios.
Well, you're missing out on the same thing as before: the extra returns you get from intermediate-duration bonds (~7 years) compared to the super short ones found in a money market fund (~6...
I think 0% to 5% is different from 5% to 9% because you’re not missing much by holding cash at 0%, and you will if you’re holding cash at 5%. The opportunity cost from not having “time in the market” is different.
Well, you're missing out on the same thing as before: the extra returns you get from intermediate-duration bonds (~7 years) compared to the super short ones found in a money market fund (~6 months). If you think about it, that's just as true when rates were at 0% as it is now that rates are at 4%. You always have the option to collect the current short-term rates with pretty much zero volatility if you want.
Comparing to a 100% stock portfolio doesn’t seem right. The relevant comparison would be a stocks+bonds portfolio to a stock+cash portfolio with the same weight in stock. Or maybe a short-duration bond fund? They’re all mixed portfolios.
Yeah that's a good point.
I picked this one from Lyxor, as it's a typical MMF ETF for European investors and it's available in curvo's backtesting tool:
As you can see, the MMF portfolios do get reduced volatility compared to the ones with intermediate bonds... but at the expense of performance as expected.
For the 2020-2023 period, the 60/40 MMF portoflio performs about the same as the 80/20 "normal" portfolio, but that's only because we're zooming in to the moment when rates were raised. If we had done what you suggested and swiched to an MMF portfolio as soon as interest rates were at 0%, in Europe we would've made that switch by 2016:
As you can see, the extra returns of the regular portfolios compensated the dips, and always kept them on top of the MMF ones. It's true that depending on your timing you may have incurred in more losses (e.g.: buy high and sell low), but the opposite was even more likely: you had plenty of points in time where you would've sold your regular portfolio at a higher price than the MMF equivalent.
What I do agree with is that, if you're in a conservative stage (maybe close to retirement), I'd seriously consider moving part or all of my fixed-income allocation to short-term bonds or even MMFs, as the extra returns may not be worth the extra risk at that point in time.
Thanks, but I'm a bit confused. The chart for "Lyxor Euro Overnight Return ETF" goes down from about 107 in 2014 to a low of 103 and up a bit recently. That doesn't seem right for a money market...
Thanks, but I'm a bit confused. The chart for "Lyxor Euro Overnight Return ETF" goes down from about 107 in 2014 to a low of 103 and up a bit recently. That doesn't seem right for a money market fund. What kind of fund is this?
One thing I'm learning from this discussion is that figuring out the relevant comparison is important and I was doing it too casually. I'm no longer sure how I did with the intermediate-term bond fund I own. Thanks!
Edit: I realized what I did. I was being lazy and looking at cost basis to judge performance, but this does not work when you reinvest dividends and capital gains. So the bond fund did better than I thought. A pleasant surprise, but I feel dumb about it.
The first link you provided doesn't open for me, but I'm assuming what you're seeing is just the effect of fees + the zoom of the chart. I'm switching to mutual funds here because they're easier...
The first link you provided doesn't open for me, but I'm assuming what you're seeing is just the effect of fees + the zoom of the chart.
I'm switching to mutual funds here because they're easier to compare in morningstar.es, but it's all the same. This is what a typical European MMF looks like if you plot it all alone: https://i.imgur.com/cj7CNVW.png
It looks like a big drop. But if you look at the numbers, it went from about 10,09k in 2017 to 9,92 in mid 2022. That's just a 1,17% drop over the course of 5 long years, which makes sense because rates were at 0% and the fund still had fees... so it had a slightly negative return, year after year.
Now, if we plot that same fund alongside a short-term, an intermediate-term and a long-term bond fund... https://i.imgur.com/OzwvnjG.png
It basically looks like a straight line :-)
Edit: I realized what I did. I was being lazy and looking at cost basis to judge performance, but this does not work when you reinvest dividends and capital gains. So the bond fund did better than I thought. A pleasant surprise, but I feel dumb about it.
Ahh makes sense!
No reason to feel dumb about any of this... it's not straightforward, and we're all just learning along the way (especially since we unfortunately weren't taught any of this at school). 3 years ago I didn't even know what an index fund was, now I'm a die-hard Boglehead haha.
A mutual fund that doesn’t make enough money to cover its costs seems like a pretty bad investment to me, assuming that’s what’s going on. Why do it? Here’s another US money market fund. Hopefully...
A mutual fund that doesn’t make enough money to cover its costs seems like a pretty bad investment to me, assuming that’s what’s going on. Why do it? Here’s another US money market fund. Hopefully this link works.
I have been investing for a lot longer. In retrospect, I noticed that the cost basis for my bond fund was always similar to the current value, and recently it was always down a bit. But I figured it was because this particular fund wasn’t going anywhere. It took me way too long to become suspicious about this.
Particularly since I’ve been paying state taxes on the interest from this fund every year at tax time. (It’s a muni fund.)
It doesn’t change the total value of the account, but it changes my opinion about bond funds.
Money market funds don't get to choose their returns. They are what the central banks dictate they have to be, because they're only allowed to invest in debt with the lowest possible level of...
A mutual fund that doesn’t make enough money to cover its costs seems like a pretty bad investment to me, assuming that’s what’s going on.
Money market funds don't get to choose their returns. They are what the central banks dictate they have to be, because they're only allowed to invest in debt with the lowest possible level of risk: high quality, highly liquid bonds with maturities averaging less than 6 months.
So if interest rates are at 0%, then the MMF will have a 0% gross return rate before costs, which will yield a negative net return because there are still costs to run it. In fact the one you linked has slightly higher costs than the one I chose for the chart (0.11% vs 0.07%).
The reason why USD money market funds remained flat rather than go slightly down is because, unlike the ECB, the FED never actually took rates all the way down to 0%. Sorry for the Spanish captions, that was the best comparison I could find.
Rates in the US did stay somewhere around 0,25%, which was just enough for these funds to cover their costs. And there was another hike in 2016, unlike Europe which stayed flat for 6+ years straight.
Why do it?
That's a good question.
You know how the FDIC in the US insures the cash you hold in your bank up to $250k? (in Europe it's typically 100k€ insured by each national regulator). That's usually more than enough for us regular people, and if you do have 500k, or 750k, or 1M in cash for some reason, you can always open an account in a second, third or fourth bank.
Now imagine you are an individual or a business with $100 million in cash, and you can't or don't want to invest any of that. Even short-term bonds (1-3 years) will have some volatility if interest rates go up. You need to park that money somewhere where it's quickly accessible without surprises. What are your options?
You could put it in a bank, of course... but for all intents and purposes, you would be giving that bank an uninsured loan of $99,750,000. You're putting A LOT of money under credit risk from a single entity. And if they crash, you could lose it all.
Or... you can spread it across a few different money market funds. Sure, you may have to pay 0,07% on it every year if interest rates are at 0%. But in exchange for that fee, you'll obtain wide diversification across lots of banks, government bonds and whatever other debt issuers those MMFs pick. Seems like a reasonable price.
So for people like you and me, you're right, MMFs don't make any sense when rates are at 0%. But for bigger players they do, because there's just not many safer places out there to park large sums of money.
I've been thinking about your comment for the last two weeks. Yes, markets clearly priced in rates staying at zero for the next ten years. But clearly markets have been wrong before with regards...
I've been thinking about your comment for the last two weeks.
Yes, markets clearly priced in rates staying at zero for the next ten years.
But clearly markets have been wrong before with regards to macro economic predictions.
At one point, when most of us were distracted by COVID, the yield on the 10 year was below 1%. Even if short term rates went negative, the expected return on that ten year yield was negligible.
There isn't a lot of hard data to do in this situation, but reducing duration and investing in actual bonds not funds to reduce rate risk are two commonly mentioned ideas.
The point isn't to trade on macro economic predictions. The point is to be aware of valuations and associated risks, and to invest where there is value and to diversify away risk as much as...
The point isn't to trade on macro economic predictions. The point is to be aware of valuations and associated risks, and to invest where there is value and to diversify away risk as much as possible.
One way to diversify away rate risk is to ladder actual treasuries.
The yield difference between a 1 year bond and a 10 year bond is always going to be about 10 times the current rates, regardless of what those rates are. And so is the interest risk difference...
At one point, when most of us were distracted by COVID, the yield on the 10 year was below 1%. Even if short term rates went negative, the expected return on that ten year yield was negligible.
The yield difference between a 1 year bond and a 10 year bond is always going to be about 10 times the current rates, regardless of what those rates are. And so is the interest risk difference between them. That was true when rates were at 0%, and it's also true now that rates are around 4%.
For instance, if the FED decided to hike rates from 4% to 9% in just a few months, we'd see the same kind of drop in 10-year bond funds that we already saw when they went from 0 to 4%.
So unless you knew (or know today) in advance when the hike was coming and how steep it was going to be, the choice between a 10-year bond fund and a short term bond fund (or an MMF) was the same as it is today.
investing in actual bonds not funds to reduce rate risk
Buying individual bonds does NOT reduce interest risk whatsoever. That's a common myth, often called the "bond ladder fallacy".
The price of those individual bonds also goes down when interest rates go up, just like bond funds do. You may not bother to check their daily price, but it's still there, fluctuating, like any other asset.
If you need the money before the bonds mature, you'll have to sell them at a loss in the secondary market (again, just like the bond fund). And if you don't need the money and can actually hold them to maturity, then you can also hold the fund until the price bounces back up... so why did you care in the first place?
Offtopic
Exact same thing applies to people who say buying a house to rent is a "safer" investment than the stock market by the way. Their house is not marked to market on a daily basis, but its value is still fluctuating everyday. There's only one reason they feel their investment is safer: market obscurity and poor price discovery.
The only thing that's different about owning a single bond vs a bond fund is that funds usually keep their duration constant, which means their risk stays constant too, and their returns also remain tied to current interest rates. A single 10-year bond starts out with a higher risk (and return), and then gradually "morphs" into a short term bond, which is a weird thing to do unless you intentionally want that for your portfolio.
But even if that was your intention, you could achieve the same thing with funds by simply transferring part of your investment from a 10-year bond fund to a, say, 3-year bond fund, accurately tuning the average duration you seek while retaining the liquidity, diversification and low cost that a fund gives you.
You can probably find lots of literature about it in Google, but here are a couple of sources that talk about it:
That's correct, and it's also the ONLY way to reduce interest rate risk. A common rule of thumb would be to keep the average duration of your bond fund(s) more or less inline or under your investment horizon.
Aaand this is also a lot easier to achieve with funds than by manually building up a bond ladder ;-)
If you want to be super precise about it and maximize your return/risk ratio, you could split your money between two funds: an intermediate duration one (typically 7-10 years) and a short term one (typically 1-3 years). Then you just balance your allocation between them so that the average duration of your portfolio comes out at the value you want.
Holding individual treasuries until maturity (pretty much) guarantees the return of the principal amount. The same is not true of bond funds. What would happen to bond funds over a seven year...
Holding individual treasuries until maturity (pretty much) guarantees the return of the principal amount.
The same is not true of bond funds.
What would happen to bond funds over a seven year period if we were unlucky enough to start stagflating like in the 70s & 80s, where long term rates were hiked up each year over the span of almost a decade?
I'm not convinced bonds make sense for anyone unless they're at least 5-10 years away from accessing the money. Bonds reduce volatility at the expense of returns. If you can wait out the ebbs and...
I'm not convinced bonds make sense for anyone unless they're at least 5-10 years away from accessing the money.
Bonds reduce volatility at the expense of returns. If you can wait out the ebbs and flows, I'd rather have the returns.
I assume you mean retirement savings. While that's reasonable for some, risk tolerance varies. Some people will have trouble sleeping if they put it all in an index fund and we get another year...
I assume you mean retirement savings. While that's reasonable for some, risk tolerance varies. Some people will have trouble sleeping if they put it all in an index fund and we get another year like 2008, or the start of the pandemic, or there's down year like 2022. So the question is what do you do with the rest of the money.
I guess my point is that even if another 2008 happens, as long as you aren’t planning on touching the money within 5-10 years, the markets have historically had time to recover. When you’re buying...
I guess my point is that even if another 2008 happens, as long as you aren’t planning on touching the money within 5-10 years, the markets have historically had time to recover. When you’re buying bonds, you’re knowingly buying an investment that you expect to underperform over long periods of time when compared to equities.
I think if more people understood this, their risk tolerance would be higher. But you’re right, the investor does have to be able to stomach it.
If it’s something you plan on accessing sooner than that (at or near retirement or whatever goal you have) absolutely buy fixed income. Volatility and sequence of return risk matter a lot more when you’re actively spending down the investments.
Emergency fund may as well be cash or a t-bill / CD ladder as far as I’m concerned.
Glad to see a fellow Boglehead here. I’m hoping the finance community here on ~ will be full of people adopting this mentality. I’ve been making some significant changes in my financial life...
Glad to see a fellow Boglehead here. I’m hoping the finance community here on ~ will be full of people adopting this mentality.
I’ve been making some significant changes in my financial life thanks to reading a lot of Bogleheads content over on Reddit and the official forums. I’m happy to contribute to the discussions over on this forum too.
"Bogleheads® emphasize regular saving, broad diversification, and sticking to one’s investment plan regardless of market conditions. We follow a small number of simple investment principles that have been shown over time to produce risk-adjusted returns far greater than those achieved by the average investor. They have been further distilled and explained in thousands of posts on the forum.
The power of the wiki is its ability to link content. If a topic has a link, there’s more material available. This is not a structured course. Use those links to explore anything you want, and consider bookmarking this page in case you get lost. The start-up kits below are designed to help you begin or improve your investing journey."
It was a nice sub too. Hope this sort of investment gets more popular now that people have been burned by crypto and nfts.
The subreddit made such a big difference to me. My 401k was auto-invested in a TDF, but I really had no idea what to invest in in a taxable account or IRA. I someone came across the sub on reddit, read some of the posts and book recaps, and it all made so much sense! Why not just buy…the entire market?
There’s no way an individual (especially one who doesn’t invest for a living) can beat the crazy algorithms and supercomputers, and even hedge funds cant beat the market consistently, so why bother? I’ve been investing way more since I learned about the approach, all VT.
Trying to start investing for the first time feels like getting into an exercise routine: you become inundated with information, the loudest voices all have their own systems, it's nearly impossible to differentiate the people trying to take your money from those giving honest advice, and in the end many people just give up. People wind up seeing investing as this risky, complex task where they'll go broke if they aren't day trading across 6 monitors.
The reality is that the best method or routine is the one you stick to - whether it's complex or just simply auto-investing into a broad market fund. Bogleheads is a great way to understand the basics and get started before you go too deep. Personally, I just chuck my money into diverse IRA / 401k accounts and forget it because I know I wouldn't keep up with anything much more complex.
The day I discovered John Bogle was the last day I worried about investing and retirement. Bogle's book(s) and/or the forum should be required reading for anyone in their 20s, and anyone in general if they're getting started later.
I somewhat follow this. However, there's one simple rule that I wish I had understood earlier: due to interest rate risk, don't buy bonds (or bond funds) when interest rates are near zero. Cash is a fine substitute for a fixed-income investment under those conditions.
The traditional asset allocation between stocks and bonds doesn't take this into account.
I suppose it doesn't matter now. 5% is pretty good.
It's worth noting that, even when interest rates are 0%, your expected long term returns are still higher than that of uninvested cash, especially if you plan to hold the bonds for a longer timeframe than the average maturity of the bonds in the fund.
You're obviously exposed to the volatility of the fund in case of fast interest rate hikes, but at the time nobody could tell if that hike was coming, when it was coming and how steep it would be. If our central banks didn't always operate like a headless chicken and they had slowly raised interest rates over the course of several years, volatility would've been much lower. Hindsight is always 20/20 of course.
In the meantime, while rates were at 0% and everybody expected them to remain like that for another decade, a typical intermediate-duration bond fund (7-10 years) would give you a better yield than cash. The price (and the return) of a bond doesn't evolve linearly overtime, and funds buy and sell bonds all the time to keep the average maturity inline with the spec of the fund. So returns were positive even when rates were at 0%.
But if you're close to retirement or you just think you'll need that money in less than, say, 5 years, it makes sense to move your fixed-income investments to funds with short-term bonds (~3 years) or money market funds (<6 months). MMFs normally don't have any volatility, as they typically have an average maturity (WAM) of just a few days, and so their rate is being constantly renewed. Their price doesn't have time to drop when interest rates go up.
I guess, but when you're investing for the long term, a stock index looks better. The question is what to do with the remainder, since putting it all in stocks is too high-risk for most people.
The "better yield than cash" was not very much, particularly for short-term bonds, which is why I bought an intermediate bond fund.
I actually did keep more in cash than the bond fund and I feel pretty good about that now. It wasn't planned, though, it's more like I felt wary about having a higher allocation in stocks and was uncertain about bonds, too.
In retrospect, my best investment decisions were due to procrastinating (not just this one; procrastinating about diversifying out of Google was the best thing I did by a lot). What I'm saying now is that I would have felt better about it at the time if I were thinking more about interest rate risk.
Stocks are always going to have better expected returns than bonds in the long term, but that's not the reason why you add bonds to your portfolio. You add them because they tend to reduce the overall volatility of your portfolio, which reduces your risk exposure according to your risk profile. You should look at your portfolio as a whole, not at each asset separately.
Bond funds dropped so much not just because interest rates were coming from 0%, but because they were raised extremely fast (in a few months) after many years being at 0%. I don't think there has ever been such a fast hike coming from such a low point in history. And yet, despite the dip bond funds took, mixed portfolios never had more drawdown than a 100% stock portfolio, even for the 2020-2023 period.
If rates had simply been raised a bit more gradually, you'd probably have a very different view now. And if interest rates are quickly raised from 4% to 9% next year, you'll again experience the same kind of drop in bond funds as you did last year, despite interest rates not being at 0% right now. Remember the US has had interest rates as high as 16% as close as 4 decades ago, and that we have no way to predict what central banks will do. We don't know when interest will change again, or by how much, or when and where the next war or pandemic will happen, etc.
So I don't think the lesson to take away from this is to avoid bonds when interest rates are 0%. That's too simplistic, and that information is already priced-in at any point in time.
I think the right way to think of it is: you're always exposed to interest risk, which is proportional to the average maturity of your bonds. And we have no way to know if/when interest rates will change, or by how much. So if your time horizon is lower than e.g.: 5 years, you might want to consider moving your bond allocation to shorter-term bonds (e.g.: <3 years) to reduce that risk, regardless of where interest rates are right now.
If you think about it, this is a bit like those people who do stock picking for the first time and accidentally succeed. So they actually believe they have cracked the market, and proceed to lose a ton of money over the next few months by going all-in with their "method". I know what you did is absolutely nowhere near stock picking, don't get me wrong. But just wanted to draw the comparison.
You feel good about the cash you were holding because of events you had no way to predict when you decided to hold it: the Ukraine war, the inflation surge, the reckless behaviour of central banks, etc. If rates had been increased more slowly, like it's supposed to be done, you'd probably have a very different view by now. Let alone if there had been no war, no inflation and no rate hike... and you were making some moderate profit on your intermediate bond funds while your cash continued to collect dust in your bank account.
I think 0% to 5% is different from 5% to 9% because you’re not missing much by holding cash at 0%, and you will if you’re holding cash at 5%. The opportunity cost from not having “time in the market” is different.
That said, a money market fund would have been better, because the interest rate goes up on its own without making any changes.
Comparing to a 100% stock portfolio doesn’t seem right. The relevant comparison would be a stocks+bonds portfolio to a stock+cash portfolio with the same weight in stock. Or maybe a short-duration bond fund? They’re all mixed portfolios.
Well, you're missing out on the same thing as before: the extra returns you get from intermediate-duration bonds (~7 years) compared to the super short ones found in a money market fund (~6 months). If you think about it, that's just as true when rates were at 0% as it is now that rates are at 4%. You always have the option to collect the current short-term rates with pretty much zero volatility if you want.
Yeah that's a good point.
I picked this one from Lyxor, as it's a typical MMF ETF for European investors and it's available in curvo's backtesting tool:
You can play around with it here if you want.
As you can see, the MMF portfolios do get reduced volatility compared to the ones with intermediate bonds... but at the expense of performance as expected.
For the 2020-2023 period, the 60/40 MMF portoflio performs about the same as the 80/20 "normal" portfolio, but that's only because we're zooming in to the moment when rates were raised. If we had done what you suggested and swiched to an MMF portfolio as soon as interest rates were at 0%, in Europe we would've made that switch by 2016:
As you can see, the extra returns of the regular portfolios compensated the dips, and always kept them on top of the MMF ones. It's true that depending on your timing you may have incurred in more losses (e.g.: buy high and sell low), but the opposite was even more likely: you had plenty of points in time where you would've sold your regular portfolio at a higher price than the MMF equivalent.
What I do agree with is that, if you're in a conservative stage (maybe close to retirement), I'd seriously consider moving part or all of my fixed-income allocation to short-term bonds or even MMFs, as the extra returns may not be worth the extra risk at that point in time.
Thanks, but I'm a bit confused. The chart for "Lyxor Euro Overnight Return ETF" goes down from about 107 in 2014 to a low of 103 and up a bit recently. That doesn't seem right for a money market fund. What kind of fund is this?
(I expected performance more like this.)
One thing I'm learning from this discussion is that figuring out the relevant comparison is important and I was doing it too casually. I'm no longer sure how I did with the intermediate-term bond fund I own. Thanks!
Edit: I realized what I did. I was being lazy and looking at cost basis to judge performance, but this does not work when you reinvest dividends and capital gains. So the bond fund did better than I thought. A pleasant surprise, but I feel dumb about it.
The first link you provided doesn't open for me, but I'm assuming what you're seeing is just the effect of fees + the zoom of the chart.
I'm switching to mutual funds here because they're easier to compare in morningstar.es, but it's all the same. This is what a typical European MMF looks like if you plot it all alone:
https://i.imgur.com/cj7CNVW.png
It looks like a big drop. But if you look at the numbers, it went from about 10,09k in 2017 to 9,92 in mid 2022. That's just a 1,17% drop over the course of 5 long years, which makes sense because rates were at 0% and the fund still had fees... so it had a slightly negative return, year after year.
Now, if we plot that same fund alongside a short-term, an intermediate-term and a long-term bond fund...
https://i.imgur.com/OzwvnjG.png
It basically looks like a straight line :-)
Ahh makes sense!
No reason to feel dumb about any of this... it's not straightforward, and we're all just learning along the way (especially since we unfortunately weren't taught any of this at school). 3 years ago I didn't even know what an index fund was, now I'm a die-hard Boglehead haha.
A mutual fund that doesn’t make enough money to cover its costs seems like a pretty bad investment to me, assuming that’s what’s going on. Why do it? Here’s another US money market fund. Hopefully this link works.
I have been investing for a lot longer. In retrospect, I noticed that the cost basis for my bond fund was always similar to the current value, and recently it was always down a bit. But I figured it was because this particular fund wasn’t going anywhere. It took me way too long to become suspicious about this.
Particularly since I’ve been paying state taxes on the interest from this fund every year at tax time. (It’s a muni fund.)
It doesn’t change the total value of the account, but it changes my opinion about bond funds.
Money market funds don't get to choose their returns. They are what the central banks dictate they have to be, because they're only allowed to invest in debt with the lowest possible level of risk: high quality, highly liquid bonds with maturities averaging less than 6 months.
So if interest rates are at 0%, then the MMF will have a 0% gross return rate before costs, which will yield a negative net return because there are still costs to run it. In fact the one you linked has slightly higher costs than the one I chose for the chart (0.11% vs 0.07%).
The reason why USD money market funds remained flat rather than go slightly down is because, unlike the ECB, the FED never actually took rates all the way down to 0%. Sorry for the Spanish captions, that was the best comparison I could find.
Rates in the US did stay somewhere around 0,25%, which was just enough for these funds to cover their costs. And there was another hike in 2016, unlike Europe which stayed flat for 6+ years straight.
That's a good question.
You know how the FDIC in the US insures the cash you hold in your bank up to $250k? (in Europe it's typically 100k€ insured by each national regulator). That's usually more than enough for us regular people, and if you do have 500k, or 750k, or 1M in cash for some reason, you can always open an account in a second, third or fourth bank.
Now imagine you are an individual or a business with $100 million in cash, and you can't or don't want to invest any of that. Even short-term bonds (1-3 years) will have some volatility if interest rates go up. You need to park that money somewhere where it's quickly accessible without surprises. What are your options?
You could put it in a bank, of course... but for all intents and purposes, you would be giving that bank an uninsured loan of $99,750,000. You're putting A LOT of money under credit risk from a single entity. And if they crash, you could lose it all.
Or... you can spread it across a few different money market funds. Sure, you may have to pay 0,07% on it every year if interest rates are at 0%. But in exchange for that fee, you'll obtain wide diversification across lots of banks, government bonds and whatever other debt issuers those MMFs pick. Seems like a reasonable price.
So for people like you and me, you're right, MMFs don't make any sense when rates are at 0%. But for bigger players they do, because there's just not many safer places out there to park large sums of money.
I've been thinking about your comment for the last two weeks.
Yes, markets clearly priced in rates staying at zero for the next ten years.
But clearly markets have been wrong before with regards to macro economic predictions.
At one point, when most of us were distracted by COVID, the yield on the 10 year was below 1%. Even if short term rates went negative, the expected return on that ten year yield was negligible.
There isn't a lot of hard data to do in this situation, but reducing duration and investing in actual bonds not funds to reduce rate risk are two commonly mentioned ideas.
Markets are wrong all the time, but the question is more, are you less wrong than they are? Without the power hindsight, most people aren't.
The point isn't to trade on macro economic predictions. The point is to be aware of valuations and associated risks, and to invest where there is value and to diversify away risk as much as possible.
One way to diversify away rate risk is to ladder actual treasuries.
The yield difference between a 1 year bond and a 10 year bond is always going to be about 10 times the current rates, regardless of what those rates are. And so is the interest risk difference between them. That was true when rates were at 0%, and it's also true now that rates are around 4%.
For instance, if the FED decided to hike rates from 4% to 9% in just a few months, we'd see the same kind of drop in 10-year bond funds that we already saw when they went from 0 to 4%.
So unless you knew (or know today) in advance when the hike was coming and how steep it was going to be, the choice between a 10-year bond fund and a short term bond fund (or an MMF) was the same as it is today.
Buying individual bonds does NOT reduce interest risk whatsoever. That's a common myth, often called the "bond ladder fallacy".
The price of those individual bonds also goes down when interest rates go up, just like bond funds do. You may not bother to check their daily price, but it's still there, fluctuating, like any other asset.
If you need the money before the bonds mature, you'll have to sell them at a loss in the secondary market (again, just like the bond fund). And if you don't need the money and can actually hold them to maturity, then you can also hold the fund until the price bounces back up... so why did you care in the first place?
Offtopic
Exact same thing applies to people who say buying a house to rent is a "safer" investment than the stock market by the way. Their house is not marked to market on a daily basis, but its value is still fluctuating everyday. There's only one reason they feel their investment is safer: market obscurity and poor price discovery.The only thing that's different about owning a single bond vs a bond fund is that funds usually keep their duration constant, which means their risk stays constant too, and their returns also remain tied to current interest rates. A single 10-year bond starts out with a higher risk (and return), and then gradually "morphs" into a short term bond, which is a weird thing to do unless you intentionally want that for your portfolio.
But even if that was your intention, you could achieve the same thing with funds by simply transferring part of your investment from a 10-year bond fund to a, say, 3-year bond fund, accurately tuning the average duration you seek while retaining the liquidity, diversification and low cost that a fund gives you.
You can probably find lots of literature about it in Google, but here are a couple of sources that talk about it:
That's correct, and it's also the ONLY way to reduce interest rate risk. A common rule of thumb would be to keep the average duration of your bond fund(s) more or less inline or under your investment horizon.
Aaand this is also a lot easier to achieve with funds than by manually building up a bond ladder ;-)
If you want to be super precise about it and maximize your return/risk ratio, you could split your money between two funds: an intermediate duration one (typically 7-10 years) and a short term one (typically 1-3 years). Then you just balance your allocation between them so that the average duration of your portfolio comes out at the value you want.
Holding individual treasuries until maturity (pretty much) guarantees the return of the principal amount.
The same is not true of bond funds.
What would happen to bond funds over a seven year period if we were unlucky enough to start stagflating like in the 70s & 80s, where long term rates were hiked up each year over the span of almost a decade?
I'm not convinced bonds make sense for anyone unless they're at least 5-10 years away from accessing the money.
Bonds reduce volatility at the expense of returns. If you can wait out the ebbs and flows, I'd rather have the returns.
I assume you mean retirement savings. While that's reasonable for some, risk tolerance varies. Some people will have trouble sleeping if they put it all in an index fund and we get another year like 2008, or the start of the pandemic, or there's down year like 2022. So the question is what do you do with the rest of the money.
I guess my point is that even if another 2008 happens, as long as you aren’t planning on touching the money within 5-10 years, the markets have historically had time to recover. When you’re buying bonds, you’re knowingly buying an investment that you expect to underperform over long periods of time when compared to equities.
I think if more people understood this, their risk tolerance would be higher. But you’re right, the investor does have to be able to stomach it.
If it’s something you plan on accessing sooner than that (at or near retirement or whatever goal you have) absolutely buy fixed income. Volatility and sequence of return risk matter a lot more when you’re actively spending down the investments.
Emergency fund may as well be cash or a t-bill / CD ladder as far as I’m concerned.
Their community Bogleheads wiki is also an excellent personal finance and investing resource.
Glad to see a fellow Boglehead here. I’m hoping the finance community here on ~ will be full of people adopting this mentality.
I’ve been making some significant changes in my financial life thanks to reading a lot of Bogleheads content over on Reddit and the official forums. I’m happy to contribute to the discussions over on this forum too.