Bond Funds and Diversification

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JD101
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Bond Funds and Diversification

Post by JD101 » Sat Oct 28, 2017 11:46 am

In order to diversify, SatuMedia typically build their portfolio around total stock market, International stocks and domestic and international bond funds. For simplicity, let's say an US investor invests in total US stock market index and Total US Bond fund index.

What is the role bond funds play? When the stocks are down, I presume the bond yields go up and it may provide better yields than money market or CDs...is this correct?

Valuethinker
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Re: Bond Funds and Diversification

Post by Valuethinker » Sat Oct 28, 2017 11:51 am

JD101 wrote:
Sat Oct 28, 2017 11:46 am
In order to diversify, SatuMedia typically build their portfolio around total stock market, International stocks and domestic and international bond funds. For simplicity, let's say an US investor invests in total US stock market index and Total US Bond fund index.

What is the role bond funds play? When the stocks are down, I presume the bond yields go up and it may provide better yields than money market or CDs...is this correct?
Stocks are less volatile than bonds in most circumstances.

Go back to 1980-81 then I think stocks did about as badly as bonds. But normally, not. 1994 Bonds did worse, from memory.

The lack of perfect correlation in performance is where the improvement in the risk-return efficiency of the portfolio comes in. At high equity weightings (say 75% +) the additional returns from increasing equity weightings are surprisingly small.

stlutz
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Re: Bond Funds and Diversification

Post by stlutz » Sat Oct 28, 2017 11:56 am

Bond funds accomplish two goals-they stabilize a portfolio because they are less volatile and they provide some return, usually less than stocks.

High-quality bonds are wonderful in a 2008-type scenario where stocks go down and bonds go up. Historically there are other years where both bonds and stocks go down. In that case, the bonds just go down less than stocks.

To put it in more mathematical terms, over time bond returns are uncorrelated to stocks, which is different from saying that they are negatively correlated to stocks.

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Taylor Larimore
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Re: Bond Funds and Diversification

Post by Taylor Larimore » Sat Oct 28, 2017 11:56 am

JD101 wrote:
Sat Oct 28, 2017 11:46 am

What is the role bond funds play? When the stocks are down, I presume the bond yields go up and it may provide better yields than money market or CDs...is this correct?
JD101:

This is how most Vanguard taxable bond funds performed during the 2008 bear market in stocks:

+22.5% Long Term Treasury
+13.3% Intermediate-Term Treasury
+7.2% GNMA
+6.7% Short-Term Treasury
+5.1% Total Bond Market
-2.8% Inflation-Protected Securities
-4.7% Short-Term Investment Grade
-6.2% Intermediate-Term Investment Grade
-21.3% High-Yield Corporate

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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oldcomputerguy
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Re: Bond Funds and Diversification

Post by oldcomputerguy » Sat Oct 28, 2017 12:34 pm

Valuethinker wrote:
Sat Oct 28, 2017 11:51 am

Stocks are less volatile than bonds in most circumstances.
Um, isn’t this backward?
Anybody know why there's a 20-pound frozen turkey up in the light grid?

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patrick013
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Re: Bond Funds and Diversification

Post by patrick013 » Sat Oct 28, 2017 5:56 pm

https://myphotos.mypclinuxos.com/images ... 173051.png

Using a combination of a defensive fund and bonds you can reduce volatility
in terms of beta quite well without reducing return greatly. VPU took a big
hit in 2008 but recovered nicely.

The only way I can see to reduce risk more in terms of beta would be to just
invest in VPU or use ST Govt bonds ticker VGSH which has a 5 year beta of .18
Low beta represents low volatility :)
age in bonds, buy-and-hold, 10 year business cycle

stlutz
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Re: Bond Funds and Diversification

Post by stlutz » Sat Oct 28, 2017 6:02 pm

In this graphic how did you determine the "expected" return?

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patrick013
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Re: Bond Funds and Diversification

Post by patrick013 » Sat Oct 28, 2017 6:17 pm

stlutz wrote:
Sat Oct 28, 2017 6:02 pm
In this graphic how did you determine the "expected" return?
BSV is the current SEC Yield and VTI and VPU are the average annual returns
for the past 10 years, all from the VG website. They don't seem excessive
or too low as an estimate. Beta's for 5 years I took from the Morningstar
website but I see where VG has 36 month beta tucked into the corner.

Why ? Do they seem too low.
age in bonds, buy-and-hold, 10 year business cycle

lack_ey
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Re: Bond Funds and Diversification

Post by lack_ey » Sat Oct 28, 2017 6:31 pm

patrick013 wrote:
Sat Oct 28, 2017 6:17 pm
BSV is the current SEC Yield and VTI and VPU are the average annual returns
for the past 10 years, all from the VG website. They don't seem excessive
or too low as an estimate. Beta's for 5 years I took from the Morningstar
website but I see where VG has 36 month beta tucked into the corner.

Why ? Do they seem too low.
That's not a good way to estimate forward equity returns, or at least one that a lot of people would disagree with and tests less well going back, plus doesn't make as much fundamental/economic sense as some others. The figures happen to not look outside the realm of reason if not building in mean reversion into the estimates so you can't really criticize that much, other than utilities likely looking relatively too good.

It's also not quite the best for the bonds but that should be relatively close (the estimate, not that the estimate will generally track that closely to the realized return over any given period).

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patrick013
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Re: Bond Funds and Diversification

Post by patrick013 » Mon Oct 30, 2017 6:06 pm

lack_ey wrote:
Sat Oct 28, 2017 6:31 pm
patrick013 wrote:
Sat Oct 28, 2017 6:17 pm
BSV is the current SEC Yield and VTI and VPU are the average annual returns
for the past 10 years, all from the VG website. They don't seem excessive
or too low as an estimate. Beta's for 5 years I took from the Morningstar
website but I see where VG has 36 month beta tucked into the corner.

Why ? Do they seem too low.
That's not a good way to estimate forward equity returns, or at least one that a lot of people would disagree with and tests less well going back, plus doesn't make as much fundamental/economic sense as some others.
The main idea was to show how beta could be reduced with bond fund allocations.

One Markowitz website uses 10 year history for better or worse and seeing total returns
are less than multi-decade returns it did not seem like a too high estimate to use.

Actually now that the 500 has EPS over 100 the next goal would be EPS over 120. My
stat program does not see EPS over 120 for the 500 as a current forecast. Complex topic
and that could take a few years going forward.

Have a good one.
age in bonds, buy-and-hold, 10 year business cycle

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