Another Question about Portfolio Allocation

I think you come off as too strong on the bonds hating. Bonds definitely have their place in a portfolio. One thing you didn’t mention is that having means reducing your portfolio volatility. You won’t have any of those -30% years as you call them if you split between bonds and stocks.

Also, your portfolio will be significantly less risky. If you own bonds, you are not at risk to lose all your portfolio on a bad market turn, for instance. During a major, sustained crisis, it is not unreasonable to think stocks could plummet 85%+ in a year. Just look at the financial crisis and you’ll realize that from the top in October 2007 to the bottom in March 2009, stocks were down nearly 60% from their top. In fact, if you had invested at the top of the financial crisis and sold in March 2009, you’d be down more than 50% on your investment despite waiting nearly nine years while bonds would have paid you year after year.

Not unreasonable for stocks to move down 85% in a year? In what world do you live in? Stocks haven’t moved down more than 50% in a year, ever. Even during the worse year, 1931, they were down 43.84%.

You know, it’s one thing when people accuse me of cherry-picking, but it’s another when a reader does the same. But let’s say that, hypothetically, you invested 100% of your money in August 2000, at the top of the dotcom bubble, and held all the way through two major financial crisis:

You’d still obliterate your “bonds” by a wide margin, so I’m not sure what point you’re trying to make. Even if you were the worst investor in the world, a 100% stock strategy would beat all those cute strategies  by 50 miles. And the SPY also pays you year after the year, by the way, and dividends are usually far more tax efficient than bond yields.

Next, or rather, before, you mention reduced volatility. You know, Mike, this is something I never quite understood: why do people care so much about volatility? Why is volatility seen as such a bad thing? Volatility means deviation from the mean, so if you mean is 2% and your volatility is low, as would be typical with a bonds strategy, then you’d have returns very close to your mean. +1%, +3%, -2%, etc. But with a higher volatility typically comes a higher return (also called risk compensation). So while your volatility might go up, so would your returns. You’d get +10%, +25%, -10%, +30%, -15%, etc. Yes, you move further away from the mean, but so what? Moving away from the mean doesn’t necessarily mean moving below the mean, you could also move above the mean. Even if you do get a -30% year, so what? There’s a +50% year somewhere for you. Just look at the graph above: several very bad years on that graph and you still end up with a much better return.

I’m getting tired of all those morons (nothing personal, Mike) writing me like bonds are the panacea to this world’s problems. I do realize that 99% of finance classes promote bonds and for large funds, they do make sense. But for individuals, they are a complete waste of time and money. I don’t see what’s so complicated to understand about that. I receive at least one e-mail per week harassing me with this bullshit. Take this one for instance:

… you do not mention individual investor’s risk tolerance and…

“Risk tolerance” is one of the most overrated concepts in finance after technical analysis. As I said before, there are different definitions of risk and underperforming the market is one of them. Still, I repeat that nobody should care about losing 30% of their money during a bad year. It plain and simply does not matter over the long term. The big problem would be if you had invested in shitty companies, but you shouldn’t do that. As long as you invest in top-quality companies, as long as you don’t sell, you’ll get your 30% back. See it as a temporary setback and move on.

Let’s say you had $500,000 to invest and picked IBM, ATD.B, GOOG, BABA, MCD and so on. Let’s say you are spectacularly unlucky and lose $250,000 on your first year. Does it matter? Well, it’s not fun, your timing was off, but most, if not all of these companies will recover, so why bother? You’ll get your money back eventually.

When you invest, you shouldn’t need that money (barring exceptional circumstances) for the next 10+ years minimum.

… if you are retired and need the income to live, you couldn’t stand a big loss. That’s why bonds…

I did say in my original article that if you do absolutely need the money month after month, then some kind of fixed strategy made some sense. But to blunt with you, I undersold it. I did say that “You are retired and absolutely need the income or else you die. Like, you need that $5,000 per month or else your life is over”  but to be fair, even if such was the case, I would still personally invest 100% of my money in stocks. If you absolutely do need income – that is, money coming in every month – nothing prevents you from investing in high-quality, high-paying dividends. Do you really think McDonald’s is going to stop paying its dividend any time soon? Or Enbridge for that matter? Or Canadian Imperial Bank of Commerce? You know, the bank that has been paying a steady dividend for 100+ year? I mean, it’s possible, but it’s very, very unlikely. And it’s also possible that bonds default.

As someone moves closer and closer to retirement, I would definitely tend to recommend income-based stocks more and more. Yes, the stocks could crash, but it’s highly unlikely the dividends would be cut, so money would keep pouring in.

Anyway, stop harassing me with that bullshit. Yes, what books teach is wrong and you should ignore it.

Liked it? Take a second to support fscomeau on Patreon!

, , ,