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This may sound crazy to most readers here, but as a 45 year-old, until 2022 I had never lived in, let along invested in, a rising interest rate environment.
This is, of course, owing to the enduring bond bull market from 1981-2022 (RIP). Obviously, we all know rates rose in 2022 and have held steady for a bit. They are now mostly in the 4% range depending on duration.
As a young investor in the 2010s and early 20s, I didn’t find bond interest rates in the sub-3%, sometimes sub-2% range to be a compelling investment compared to stocks.
Could now be the time to go long in bonds? Why or why not?
https://corporate.vanguard.com/content/corporatesite/us/en/corp/vemo/vemo-return-forecasts.html
vanguard’s economic projection may be helpful—they show the importance of standard bond/equity and domestic/international diversification.
I find it useful to start with the purpose and “use-by date” of a financial asset when evaluating it. And that purpose and use by date is clarified by our overall strategy and plan. We are currently in retirement with a 25-year time horizon and an overall goal of preservation. Our AA is 60/40 and our stocks are in ETFs with a >10 year use by date for long term growth. Our bond allocation is split between bond ETFs which diversify and stabilize the stocks and an individual TIPs ladder matched against future spending needs. I don’t know for sure because it is not our current situation but if I was more than 10 years out from retirement, I am pretty sure we would have a very high stock allocation. As far as long duration bonds, one of my concerns if I was even considering them, would be interest rate risk.
I’m not a fan of long bonds due to my time horizon. I have been in intermediate bonds for the last 20 years including 2022. I am
less than 3 years from RMDs so I may begin to shorten the duration of my bonds to short term to match my need for the funds. Long term bonds may be in favor, until they aren’t again. Timing that is difficult.
Study the Treasury Market in 1993-1994 before making any decision to buy longer duration bonds. Our deficit was 3x lower then, adjusted for inflation, and our labor market was less tight. Both then and now — as of this morning — we seem poised for higher deficit spending.
Instead of putting all your money into long-duration bonds at once, how about a bond ladder strategy? invest in bonds with staggered maturities (e.g., 2-year, 5-year, 10-year). As your shorter-term bonds mature, you can reinvest the proceeds into longer-term bonds at prevailing rates, this will let you benefit if rates rise further, while still capturing current attractive yields.
I use bond ladder in my taxable account.
Pros: predictable return via yield to maturity, ultra safe and free of state / local tax from Treasuries, no transaction cost with Treasuries.
Cons: illiquid if held to maturity, interest rate risk / loss if sold early, no diversification unless very large capital spreading over many dozen bonds, limited upside, and larger downside when inflation is expected – i.e. real yield (nominal yield – inflation rate) may be small or negative. The longer the bond duration, the higher the price volatility, i.e. NFL or no free lunch.
Last year, I got 5% total return – 3% inflation = 2% real yield. S&P500 index total return for 2024 was 25%.
Long bonds are not for me, but I am unique like everybody else. I learned late in life (still better than never) that proper asset allocation must be anchored in risk capacity first and foremost, before risk tolerance. Risk capacity homes in on time horizon and financial goals. Risk tolerance on the other hand expresses the “nice to have” wishes, i.e. excitement with market speculation or peace with fixed income from coupons. Investors with high capacity have more options in asset allocation that fit their risk tolerance, i.e. ratio of equities to fixed income like bonds. Investors with low capacity should stick to capital preservation allocation since there is 20% risk of losing money in rolling 12 months with stocks.
For my taxable accounts with the goal of a downpayment for my son’s first house, or for my future CCRC, short term treasury bills and TIPS are the core. I leave the intermediate T notes to central banks and hedge funds, and 10+ years notes to insurance companies. I don’t speculate on interest rates in the current geopolitical turmoil. For tax deferred portfolio, I am moving cautiously to full global equities, fitting my 20-year horizon.