In the world of investing, it seems most people’s energy is focused squarely on stocks. Massive amounts of research goes into stock investing every day and even casual investors have an incredible amount of information at their fingertips. Combine that wealth of data with a long term growth pattern in the stock market since 2009 that means anyone who has been in the market less than ten years has no recollection of a single meaningful bear market, and stocks are so ingrained on our collective investing consciousness that many people don’t give other assets a second thought.
As a result, while bonds were once staples of any self-respecting asset allocation lots of investors just aren’t into them like they used to be. Some of it is definitely recency bias, and I think another factor is that many people don’t truly understand how bonds work. But I’ll concede that the bond market is also different than it was more than a decade ago, and I can understand why people might think twice about relying too much on historical data. After all, bonds sound like awesome choices when they paid 10% interest, but consistent declining rates over time surely boosted any backtested numbers while depressing yields today to something a lot less desirable. So it’s no surprise that I see questions along this line all the time:
With record low interest rates today that are even negative in some situations, what’s the point of having bonds in a portfolio at all?
That’s a very good question. And the full answer is kinda complicated and includes some advanced finance mechanics that fly under the radar even for very experienced investors. But explaining complicated concepts is kinda my thing, so let’s talk about a little thing called bond convexity.
When discussing investing options, the single most common referenced metric has got to be the average return. Reams of books and blogs have been written on individual asset classes and composite portfolios with the highest average returns looking both backward and forward, and amateur and professional investors alike spend more time than they probably want to admit thinking about how to maximize their own average return. Long-term averages are both set on a pedestal and also taken for granted, as many people idolize the average to the point where they’re willing to ignore very real risks under the belief that superior performance is inevitable if they only wait long enough.
But what happens when the long-term average return never manifests in your own portfolio even over extended timeframes? Was the data wrong? Did the markets change?
In reality, it’s most likely none of the above.
As I blindly swung my arm to swat at the tedious drone of the alarm on the night stand, it was pretty much a morning like any other. I labored out of bed, trudged my way through the early routine on autopilot, and set out on my long morning commute down highway 280 towards San Jose. I always found that stretch of road to be an interesting experience in dual realities, as the stunning views of the bay and surreal scene of clouds pouring over the mountaintops were all too often completely hidden by relentless inner thoughts of important job tasks needing immediate attention. Silicon Valley attracts a certain type of always-on engineer and actively feeds their obsessions, and my blossoming career as a successful product designer at a job I loved had long since shaped me into eager, if anxious, submission.
Perhaps because of the proliferation of personal finance websites focusing on early retirement, I’ve noticed a lot of talk lately about safe withdrawal rates. I think this is absolutely terrific, as financial independence is one of the single most empowering life goals one can pursue! But greater exposure also has its downsides, as core assumptions such as the portfolio options, withdrawal method, and retirement length don’t always scale the way you might think and misconceptions can quickly propagate.
Withdrawal rates are an intellectual passion of mine, and I’m always looking for opportunities to contribute to the conversation. And with the recent boon in global portfolio data, I’m finally able to address one of the biggest questions that I’m starting to see more frequently these days.
Does the 4% rule apply outside of the United States?
Investors have a real knack for over-thinking things. There are those who imagine themselves as master traders controlling hundreds of variables at once like rocket scientists or professional sound mixers and squeezing out every last decimal of performance. And of course there are inexperienced types who also imagine investing works like that but who lack the confidence to even start learning. Personally I believe this complexity myth is disruptive to the well-being of both sets of people, and nowhere do I see this more than in the simplest of investing topics — cash.
A fellow Boglehead asked a really good question recently, and I think it’s something we’ve all considered at some point:
Why shouldn’t my asset allocation be 100% stocks during the accumulation phase?
After all, the typical justification for a heavy stock portfolio sounds pretty darn compelling. They historically have a higher return than bonds in the long run, which means bonds are defensive assets that reduce volatility but do not necessarily increase returns. On top of that, interest rates are so low today that bonds look particularly unappealing. So if you can handle the bad years and pile as much money into stocks as possible you’ll be much better off and can feel free to be defensive with a larger pile of money once you retire.
Well you know what? If you’re the type of investor with a rock-solid stable job, few financial commitments, and the personality to ride out both short-term and prolonged market pain without sweating your account balances, then putting all of your money in stocks is just fine. The Total Stock Market portfolio is included on the site because I appreciate that it’s a good choice for many people.
But I’m going to go out on a limb and surmise that you’re reading a blog about portfolio theory because you believe that just maybe there’s another side to the story. You’ve come to the right place, as I’m a strong believer in the power of asset allocation in creating positive and pleasant investing outcomes. So for those interested in a different perspective, I’d like to try my hand at making the case for broad asset allocation in all phases of life.
Why consider diversifying away from stocks not just tomorrow but today?