Do I really need both stocks AND bonds in my long-term investments?
November 23, 2013 12:15 PM Subscribe
I am planning to invest for retirement (35+ years away) in a Roth IRA. I've always been told to have a mix of stocks and bonds in any portfolio, starting at about a 90/10 split for someone my age. Considering that I'm not going to touch this money for a very long time, wouldn't I be better off just putting my money into some low expense ratio index funds and skipping the bonds altogether? This seems to fly in the face of every investment advice I've ever seen, but I don't understand why.
I am not an active investor and would rather have my money in Vanguard-style mutual funds. I could put all my money into one of their Target Retirement funds (expense ratio 0.18%) that automatically manage the stocks vs bonds ratio for you, which seems ideal for an investor like me. Or, I could put all my money into Admiral Shares of their 500 index fund (expense ratio 0.05%) and let it camp out there for 20 years before I start thinking about rebalancing.
If I look at past performance, the Admiral Shares 500 Index fund always has a higher long-term performance than the Target Retirement funds, but the Target Retirement funds are more diversified. I guess I'm having a hard time understanding what adding bonds to the mix gains me in the long run, considering I won't be touching this money or counting on it for income for a very long time, other than just checking the box for "diversified portfolio".
Can anyone explain why I shouldn't do this? Certainly, the economy is going to go both up and down over the next 35 years. Do I really need to diversify for this stage of retirement investing?
I am not an active investor and would rather have my money in Vanguard-style mutual funds. I could put all my money into one of their Target Retirement funds (expense ratio 0.18%) that automatically manage the stocks vs bonds ratio for you, which seems ideal for an investor like me. Or, I could put all my money into Admiral Shares of their 500 index fund (expense ratio 0.05%) and let it camp out there for 20 years before I start thinking about rebalancing.
If I look at past performance, the Admiral Shares 500 Index fund always has a higher long-term performance than the Target Retirement funds, but the Target Retirement funds are more diversified. I guess I'm having a hard time understanding what adding bonds to the mix gains me in the long run, considering I won't be touching this money or counting on it for income for a very long time, other than just checking the box for "diversified portfolio".
Can anyone explain why I shouldn't do this? Certainly, the economy is going to go both up and down over the next 35 years. Do I really need to diversify for this stage of retirement investing?
I guess I'm having a hard time understanding what adding bonds to the mix gains me in the long run
Increasing the odds that if the stock market absolutely tanks, like it did in 2008/09, that 10% of your portfolio is basically untouched. If you hold a bond to maturity, its yield will never change once you buy it unless the issuing entity defaults.
Of course, if you had put money into the market in the beginning of 2008, and then basically let things ride, not selling a single share, today you'd mostly be back where you were then, if not actually a bit ahead in some instances. But if for whatever reason you simply had to sell in 2009 (which in the long run is about as likely as the stock market crashing in the first place), you'd have taken a huge bath. Or you could have sold your bonds, taking a very little hit if not actually turning a profit, letting the stocks sit in the hope that they'd recover eventually.
In short, bonds add stability and predictability to an investment portfolio. Which is why the returns tend to be pretty lousy. But they're pretty much the only thing you can do to hedge against market volatility, which is something you should at least be mindful of.
posted by valkyryn at 12:23 PM on November 23, 2013
Increasing the odds that if the stock market absolutely tanks, like it did in 2008/09, that 10% of your portfolio is basically untouched. If you hold a bond to maturity, its yield will never change once you buy it unless the issuing entity defaults.
Of course, if you had put money into the market in the beginning of 2008, and then basically let things ride, not selling a single share, today you'd mostly be back where you were then, if not actually a bit ahead in some instances. But if for whatever reason you simply had to sell in 2009 (which in the long run is about as likely as the stock market crashing in the first place), you'd have taken a huge bath. Or you could have sold your bonds, taking a very little hit if not actually turning a profit, letting the stocks sit in the hope that they'd recover eventually.
In short, bonds add stability and predictability to an investment portfolio. Which is why the returns tend to be pretty lousy. But they're pretty much the only thing you can do to hedge against market volatility, which is something you should at least be mindful of.
posted by valkyryn at 12:23 PM on November 23, 2013
Just to follow up, I let my money sit when stocks tanked in 2008/2009, and upped my market participation.
Index funds, and being patient have been "berra, berra good to me."
posted by Ruthless Bunny at 12:35 PM on November 23, 2013 [1 favorite]
Index funds, and being patient have been "berra, berra good to me."
posted by Ruthless Bunny at 12:35 PM on November 23, 2013 [1 favorite]
The main reason is that stocks and bonds often move in opposite directions-- during times of fear/uncertainty, investors flee to bonds, during booms they move to stocks. By using a rebalancing strategy, you automatically are following Buffet's advice of "be fearful when others are greedy and greedy when others are fearful."
If you follow a balance, when the market drops, you will be selling bonds and buying stocks when they are down, and buying bonds and selling stocks when they are up. Bubbles and panics are known inefficiency of the markets and rebalancing helps you use that to your advantage.
posted by justkevin at 12:36 PM on November 23, 2013 [4 favorites]
If you follow a balance, when the market drops, you will be selling bonds and buying stocks when they are down, and buying bonds and selling stocks when they are up. Bubbles and panics are known inefficiency of the markets and rebalancing helps you use that to your advantage.
posted by justkevin at 12:36 PM on November 23, 2013 [4 favorites]
I'm in a similar position and VG tells me to target 100% stocks. I owned some bonds as extended cash reserve anyway.
posted by Ms Vegetable at 12:41 PM on November 23, 2013
posted by Ms Vegetable at 12:41 PM on November 23, 2013
To me there is one very good reason to own bonds. Just because in the US, over the long term, stocks have historically outperformed bonds, there is no reason that this must necessarily be true in the future. Other countries (Japan, namely) have had long periods where stocks have not increased in value or have even had negative real (factoring in inflation) returns. Look at the Nikkei index from 1993 to 2013-- 20 years of negative returns. If I was in year 19 of a bear market, not knowing what the future will bring-- I would be wishing that I had had even a token amount of bonds from the beginning.
As for myself I'm at 90% stocks and have been at that percentage or higher since before 2008, so it's not an issue of not being able to deal with the volatility-- I just like a bit of diversification in case of a long bear market.
posted by matcha action at 1:02 PM on November 23, 2013
As for myself I'm at 90% stocks and have been at that percentage or higher since before 2008, so it's not an issue of not being able to deal with the volatility-- I just like a bit of diversification in case of a long bear market.
posted by matcha action at 1:02 PM on November 23, 2013
A person your age would include bonds in their portfolio if they are risk-averse, i.e. you worry every time the value of your stock porfolio goes down (which it WILL do.)
If this volatility worrys you, include bonds to temper the volatility.
If you can take the volatility in stride (very hard for most investors), include just stocks in your portfolio for the next 20 years or so.
G
posted by gnossos at 1:04 PM on November 23, 2013
If this volatility worrys you, include bonds to temper the volatility.
If you can take the volatility in stride (very hard for most investors), include just stocks in your portfolio for the next 20 years or so.
G
posted by gnossos at 1:04 PM on November 23, 2013
The reason to diversify (a part of which would be to include bonds in your portfolio) is that it reduces risk while maintaining returns, or equivalently increases returns for the same level of risk. See modern portfolio theory.
posted by kindall at 1:13 PM on November 23, 2013 [1 favorite]
posted by kindall at 1:13 PM on November 23, 2013 [1 favorite]
I'm in my 30s and am about 80% in equity index funds, with the remaining 20% being stock in private companies.
Simply put, I don't see the point of bonds in my portfolio. The return is meager, and in a truly catastrophic meltdown, they'll take a beating along with the rest of my portfolio.
posted by grudgebgon at 2:11 PM on November 23, 2013
Simply put, I don't see the point of bonds in my portfolio. The return is meager, and in a truly catastrophic meltdown, they'll take a beating along with the rest of my portfolio.
posted by grudgebgon at 2:11 PM on November 23, 2013
real estate and precious metals will retain value after stocks and bonds have gone the other way.
Theory aside, the price of gold is plummeting, and real estate, well, let's not pretend that's a stable market.
posted by phaedon at 2:50 PM on November 23, 2013 [2 favorites]
Theory aside, the price of gold is plummeting, and real estate, well, let's not pretend that's a stable market.
posted by phaedon at 2:50 PM on November 23, 2013 [2 favorites]
Sounds like you have a relatively high risk-tolerance; no big deal if the overall market tanks 50% in the next year, still have 30+ years to save, etc. There is nothing wrong with this position.
Rather than waiting for 20 years to shift money around, the conventional portfolio management position would be to gradually change your contributions. So right now, you put 100% into the 500 index. In five years, start contributing 75% into 500 index, and 25% into some low-fee bond fund; your portfolio balance will slowly shift from 100:0 to something like 95:5 to 85:15, depending on how the markets play out. As you get older, contribute more toward bonds and less toward stocks, depending on how much risk you are willing to take.
posted by jraenar at 4:45 PM on November 23, 2013
Rather than waiting for 20 years to shift money around, the conventional portfolio management position would be to gradually change your contributions. So right now, you put 100% into the 500 index. In five years, start contributing 75% into 500 index, and 25% into some low-fee bond fund; your portfolio balance will slowly shift from 100:0 to something like 95:5 to 85:15, depending on how the markets play out. As you get older, contribute more toward bonds and less toward stocks, depending on how much risk you are willing to take.
posted by jraenar at 4:45 PM on November 23, 2013
wondercow: "Can anyone explain why I shouldn't do this?"
The advantage of diversification is uncorrelated returns. Given a set of investment options with varying degrees of return, risk and correlation between one another, modern Portfolio Theory can put them to use, within a certain range, to reduce uncertainty without reducing returns. If the wikipedia articles aren't cutting it for you, perhaps Nobel (memorial) winning economist Robert Shiller's lecture on the subject will help.
Also, you say you've compared results, but if you look at this comparison tool, it seems there have been a number of years where stocks underperformed bonds in a 20 year horizon. Or a 30 year. So even over a long term, stocks might not be the optimal pick.
The one open question in my mind is whether the costs of investing in certain asset classes outweigh their gains from diversification.
posted by pwnguin at 5:46 PM on November 23, 2013 [1 favorite]
The advantage of diversification is uncorrelated returns. Given a set of investment options with varying degrees of return, risk and correlation between one another, modern Portfolio Theory can put them to use, within a certain range, to reduce uncertainty without reducing returns. If the wikipedia articles aren't cutting it for you, perhaps Nobel (memorial) winning economist Robert Shiller's lecture on the subject will help.
Also, you say you've compared results, but if you look at this comparison tool, it seems there have been a number of years where stocks underperformed bonds in a 20 year horizon. Or a 30 year. So even over a long term, stocks might not be the optimal pick.
The one open question in my mind is whether the costs of investing in certain asset classes outweigh their gains from diversification.
posted by pwnguin at 5:46 PM on November 23, 2013 [1 favorite]
I let my money sit when stocks tanked in 2008/2009, and upped my market participation.
And if I'd had money in 2008/09, I'd have done exactly the same thing. But there's always the risk that you'll need to pull money out of the market at a bad time, and if you've got some in bonds, you'd take less of a hit.
I'm just sayin' is all.
posted by valkyryn at 6:08 PM on November 23, 2013
And if I'd had money in 2008/09, I'd have done exactly the same thing. But there's always the risk that you'll need to pull money out of the market at a bad time, and if you've got some in bonds, you'd take less of a hit.
I'm just sayin' is all.
posted by valkyryn at 6:08 PM on November 23, 2013
I started investing for retirement when I was in college. I was essentially 100% in the 500 Index Fund for about 10 years. It was fine. But I have a high risk tolerance. As others have mentioned, if you are the same, there is nothing wrong with your plan. Of course, during that time period, my entire portfolio was equal to less than what I can put away in a single year now. That made it easier to be blasé about my returns.
posted by treehorn+bunny at 6:42 PM on November 23, 2013
posted by treehorn+bunny at 6:42 PM on November 23, 2013
I am not an active investor and would rather have my money in Vanguard-style mutual funds.
I think that's the big question, how passive you want to be with your long-term investments. Me personally, I'm pretty passive but occasionally like to jump into something, I don't have much experience with index funds, or bonds for that matter, and I have a relatively long time horizon. Everybody on MetaFilter always says the magic word "Vanguard," but as of late I have been focusing a lot on stocks with dividends.
If you have enough money to play with, you could view dividend payouts from high-quality companies as guaranteed income that you have control over, and can either further insulate you from swings in the market - i.e. feeling that you have to pull in and out - or be cashed out. Yields also tend to be a little higher.
posted by phaedon at 7:33 PM on November 23, 2013
I think that's the big question, how passive you want to be with your long-term investments. Me personally, I'm pretty passive but occasionally like to jump into something, I don't have much experience with index funds, or bonds for that matter, and I have a relatively long time horizon. Everybody on MetaFilter always says the magic word "Vanguard," but as of late I have been focusing a lot on stocks with dividends.
If you have enough money to play with, you could view dividend payouts from high-quality companies as guaranteed income that you have control over, and can either further insulate you from swings in the market - i.e. feeling that you have to pull in and out - or be cashed out. Yields also tend to be a little higher.
posted by phaedon at 7:33 PM on November 23, 2013
This may stray a little from the original question, but I hope you'll consider an SRI mutual fund; this is a way of investing not just for a cash return, but also letting companies know that you, along with all the other investors in the fund, care about more than just "shareholder value".
SRI = Socially Responsible Investing. It's surprisingly more popular than one might think, and I don't think returns are that different from other funds. Calvert seems to be the most well-known SRI company. They have a lot of funds, including some that seem to incorporate bonds.
It's not just about picking "only good companies" for the fund, so the fund isn't as restricted as you might think. My understanding is that the fund representatives exercise their voting rights to help encourage better corporate ethics.
I'm only just learning about this stuff (I'm considering doing an FPP later), so I might be wrong about some details, but please at least look into it. By investing, you're giving companies your money (temporarily), which gives them power to affect a lot of people. By investing through an SRI, you can be represented by just a touch of ethical force in addition to the abstraction of your money.
posted by amtho at 8:42 PM on November 23, 2013 [1 favorite]
SRI = Socially Responsible Investing. It's surprisingly more popular than one might think, and I don't think returns are that different from other funds. Calvert seems to be the most well-known SRI company. They have a lot of funds, including some that seem to incorporate bonds.
It's not just about picking "only good companies" for the fund, so the fund isn't as restricted as you might think. My understanding is that the fund representatives exercise their voting rights to help encourage better corporate ethics.
I'm only just learning about this stuff (I'm considering doing an FPP later), so I might be wrong about some details, but please at least look into it. By investing, you're giving companies your money (temporarily), which gives them power to affect a lot of people. By investing through an SRI, you can be represented by just a touch of ethical force in addition to the abstraction of your money.
posted by amtho at 8:42 PM on November 23, 2013 [1 favorite]
... putting my money into some low expense ratio index funds and skipping the bonds altogether?It doesn't have to be either/or - Vanguard offers bond funds, like their Total Bond Market Index Fund (VBMFX) and a TIPS-like fund, the Inflation-Protected Securities Fund (VIPSX).
Also, seconding MoonOrb's recommendation to check out bogleheads.org. They have some extremely knowledgeable users who answer this very question every week or so.
posted by kristi at 3:23 PM on November 24, 2013
This thread is closed to new comments.
If I had a shit ton of money and I didn't care about growth, then yes, I'd do AAA Muni Bonds. But I like having all my dough in index funds.
posted by Ruthless Bunny at 12:23 PM on November 23, 2013