I want to discuss bonds and reasons to won them in 2018. I hope this helps fix errors in my understanding on owning bonds (either directly or through funds) in an environment with low interest rates that are expected to go higher. Below is my write up on how I understand the subject. Let me know where my reasoning isn't right.
The investment community, including this sub, has long debated on how much of the portfolio should be equities vs. bonds and alternatives.
I get the conventional wisdom that equities will give you the best return over the long term. The trade-off of course is higher volatility. This makes sense since economic growth in our societies is driven by firms so it makes sense that by owning stock in the firm you are reaping its economic benefit.
Bonds are understood as having a place in a portfolio for protection in times when the economy isn't booming. The reasoning is a little less obvious since it has to do with the inverse relationship between interest rates and prices. In bad economic environments interest rates drop which pushes bond prices higher. I understand this as being the primary argument for holding bonds in a portfolio as it would offset the losses in equities.
I believe a secondary argument for using them is because your principal, as long as you hold them until maturity is safe (gov bonds), and you are earning income via interest during the duration. Ofcourse, in booming economic markets interest rates are expected to rise to curb inflation and have an adverse effect on bonds. So you get a 2 fold loss, one that is obvious and what that is not so obvious. The obvious loss is the drop in price due to interest rates going up and the less obvious loss is the opportunity cost of not being in an asset that does well in inflationary periods - stocks.
The general wisdom shared on this sub and other investing related subs is - if you want to maximize growth and you are young have a 100% equity portfolio. If you want to decrease the volatility then add bonds. I think even Benjamin Graham recommended having 20 - 30% in bonds and no more and no less than 20 (I could be wrong about this). Buffet ahas also suggest equities as being the dominant part of anyone's portfolio. I've heard from many other well known investors as well that they recommend the same for the simple reason that if you believe in long term positive economic growth then equities will outperform fixed income assets by a large margin.
There are others like Ray Dalio and Harry Browne who actually recommend a significant portion of the portfolio being bonds vs. stocks. Tony Robbins claims that Dalio recommended that 30% allocation in stocks vs. 55 % allocation in bonds for the average investor and that would give around the same return as the market (s&p 500) with limited downside in downturns. I find this hard digest but am openminded to change my thinking. However, I don't get the reasoning. How can a portfolio that is bond heavy perform just as well as an S&P? This contradicts my understanding that you buy bonds to limit your volatility with the understanding that you are foregoing upside.
Earlier this week Dalio at Davos said he is certain (like everyone) that the 30 yr bull market in bonds is over and bonds aren't the place to be in the coming years. This statement contradicts the principle of his "all-weather fund" that is so bond heavy.
I don't own any bonds in my portfolio. My investments are 100% in equities. The rest of my liquid capital is in cash. I could invest a portion of that cash I don't immediately need in bonds or a bond portfolio but I don't understand why I should well enough.
My understanding is that if I buy a bond fund for instance it will likely loose value as interest rates are poised to rise in the coming years. I get that cash loses value due to inflation but wouldn't owning bonds also cause a loss of value due to rising rates? The only reason then to own bonds would be to negate the effects of market volatility or loss in an equity downturn. But if my equity investments are for the 20-30 year horizon and I will always have cash then why would I buy bonds now? Perhaps I'd buy bonds in a high interest rate environment some time in the future.
Am I missing something? Please correct me if my understanding is off.
Also - If you could point me to resources to better my understanding of this subject please share.
Submitted January 26, 2018 at 01:05AM by nowrongturns http://ift.tt/2ndWFzT
