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Cutting the Bonds

Dennis E. Quillen

I DON’T WANT BONDS in my portfolio—or, at least, not to the degree traditionally recommended in financial planning guidelines.

For years, I had accepted the premise that bonds should be included in a serious investor’s portfolio. Not that I necessarily followed that dictum. But I accepted the idea that young people should have a low percentage in bonds, and increasingly greater percentages through middle age and retirement.

I kept thinking that someday I’d come around to more bonds, but not now. The years went by. I took early retirement at age 62 and had zero dollars in bonds. Still relatively young, I felt. I’ll definitely think about those bonds down the road. Four years later, after my divorce was finalized, I purchased a blended stock-bond fund. That raised my bond allocation from zero to 1.7%.

Ten years later, my bond allocation reached a lifetime high of 8.7%. About that time, I noted that my blended fund, with both higher fees and lower annual returns, was a drag on my portfolio. I moved two-thirds of the fund into more productive pure stock funds. I accepted the idea of diversification, but chose diversity in large, mid and small cap funds, in both growth and value funds, and in total market funds.

“Later” finally came in 2017, after being reminded for the umpteenth time that I was low on bonds. I moved some money from my cash position into a total bond market index fund. My bond holding quickly moved from 5.3% to 8.6% by early 2018. Now, I’m getting with program, I thought.

Well, this euphoria didn’t last long. I did some serious thinking about my risk tolerance and my annual income, and began to question why I had made the long-postponed move to bonds in the first place. I’ve now reverted to a lower bond component. Bonds are down to 8.2%, with full confidence I’ll get to my new bond target in the sub-5% range.

By no means am I advocating that all, or even most, retirees follow my example. But some readers may feel like “cheating” a bit on their bond allocation.  To “gamble” on a low or zero bond component, you should probably possess most of the following qualities:

  1. High risk tolerance. It’s basically a “self-insurance” mentality—a willingness to suffer temporary losses yourself, rather than relying on the buffer provided by bonds. You should be comfortable with market corrections of 20% and perhaps much more. If you’ve been rattled by the stock market volatility of recent weeks, a stock-heavy portfolio probably isn’t for you.
  2. Large holdings of bond-like instruments, such as a pension, Social Security and cash reserves, including money market funds, savings accounts and interest-bearing checking accounts.
  3. Little need to dip into investments. That means your annual living expenses, including reserves for car costs and home maintenance, should be substantially covered by income from working, Social Security, pensions, income annuities and investment income.
  4. No problem leaving an estate that’s temporarily depressed. Beneficiaries, as well, should be comfortable waiting for a market rebound.
  5. Conviction that stocks substantially outperform bonds over the long run, recognition that they’re generally taxed at lower rates than bonds—and a firm belief that the cushioning benefit offered by bonds is greatly exaggerated.

Dennis E. Quillen is a retired economic geographer and university professor. In addition to blackjack, he loves long-term investing. His previous articles were Bouncing BackStarting Over and Getting Comped.

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Gozo Rabat
Gozo Rabat
3 years ago

I appreciate this affirmation of my own, long-held view. I can think of points in one’s economic life where a focus on amassing cash-based savings has value, but this value ought to diminish over time. What one needs, in lieu of “bonds,” is some access to the stability of cash, for dire circumstances. Beyond that, as Mr. Quillen says, one should have no need.

I suspect that the percentage-based allocation recommendations are efforts to simplify the overarching process of (1) assembling needed savings and (2) growing one’s financial wealth toward the long-term. One-size-fits-all seldom fits any particular, uh, size very well, but has the best chance, on average, of keeping the whole body of readers in good shape.

By the time one retires, one of course hopes to have a portfolio of about ten-gazillion dollars. In such a case—and assuming one’s lifestyle hasn’t expanded to match available resources!—keeping one whole “gazillion” in bonds would probably be pretty, uh, stupid.

Thanks to Mr. Quillen, and Mr. Clements yet again, for giving this curmudgeonly old saver something else to think about, and talk about here.

(($; -)}™

Paul LaVanway
Paul LaVanway
3 years ago

In the present economic environment, one characterized by the likelihood of increasing interest rates, I’m personally more comfortable with CDs than I am with bond funds. Just my “two cents.”

Dan Wicko
Dan Wicko
3 years ago

Lets see, buy when there is blood in the streets. Wouldn’t bonds fit the bill of a depressed asset that may make a good purchase while at a reduced price? I continue to invest in bonds within my IRA that I won’t access for 7 years. The best indicator of bonds return is the yield, and it continues to rise. Maybe we should wait until the interest rate stops rising to invest in bonds- but won’t everyone be thinking the same way at that time?

jsshane
jsshane
3 years ago

I too cannot justify bond mutual funds or bond ETFs in today’s economy. It’s hard to look back at bond performance in any period over the last 18 months and find any in the black; as rates continue to rise, bonds continue to go down which it appears will continue right through 2019.
But that leaves the question of where to park some cash. 2.7% CDs? hmmmmm

Ray Giese
Ray Giese
3 years ago

Yep, bonds are not very attractive – until its too late. Cash and bonds are not designed to beat stocks. They are in our portfolios to provide “ballast” in times of market chaos. If you are unemotional and can handle the volatility of the stock market then maybe you can live with minimal bond exposure – but MOST people are not well equipped to manage their emotions when it comes to stock market volatility. Keep in mind that cash//equivalents are any maturity less than 12 months in duration. Bonds are any duration greater than that. If bond funds don”t work for you then build a CD ladder of 12-48 month CDs and rotate out as they mature. You can achieve 80–90% of the yield on a bond fund with NONE of the risk if you hold to maturity. Beat the market? That’s for fools. Quoting Mark Twain, it is as important to get a return OF your money as than to get a return ON your money – especially for anyone older than 50.

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