The Case for the All-Bond Portfolio

Conventional wisdom in the financial services industry is that bonds are only to be tolerated as a hedge in a well constructed portfolio.  Anyone who knows anything about long-term asset allocation knows that stocks are the only investment that will provide a reasonable chance for growth that outpaces inflation.  “Stocks for the long run” is not only the title of a popular investing book, but a mantra in my business.  In fact, I am strongly encouraged to run computer simulations for clients that clearly show the need to have heavy allocations to stocks.  This is true even with retirees.

Not everyone agrees with this position, but they have largely been marginalized.  But, here is interesting commentary from a husband and wife team that has successfully invested only in bonds since the mid-1970s.

I think there is some merit to the approach they take.  They utilize a wide range of fixed income securities.  Not only have they achieved good returns this way, but they have the admirable benefit of knowing exactly what their cash flow and portfolio value will always be (they hold to maturity).  Financial planning is easy with this level of certainty.

Our core principles…can be summarized as follows: carefully define your objectives; don’t lose any money; if you can’t afford the risk then don’t play in the market; evaluate every investment on a risk-adjusted after-tax basis; make sure you understand all your investments; focus on cash flow; and carefully understand the risks you are taking.

That sounds like good advice to me.  I certainly understand these comments:

Everyone believes stocks will outperform bonds over the long term. But we have never been comfortable with that truism, and that has led us to advocate the all-bond portfolio.

If you are an endowment, investing for the long run may be okay. But an individual has a finite life, and you can’t bet on whether your money will be there when you need it. Advisors get around this by investing for short terms needs – say for the next three years – in cash and short-term bonds and the remainder in stocks. If you are retired and facing this market, it may offer some comfort to know you have money for the next three years. But it is more than a little distressing to know that you may not have enough beyond those three years.

People forget there have been long periods of time when the market has not gone up. We may be living in one of those periods now.

Investors have become fixated on the 1980s and 1990s as the only relevant period. But it is not clear that stocks will be up in five or 10 years or whatever the relevant time period is. People who need their money are going to be in trouble. There are long periods where markets are flat. Buy-and-hold investors may not experience any gains in their portfolios.

Of course, the core argument against bonds is that they do not provide growth.  Further, inflation can destroy their real returns.  They deal with the inflation problem via exposure to TIPS.  Growth has been decent as well:

From January 1, 2000 to August 1, 2008 our portfolios grew 50% on an after-tax basis. We reinvested the coupons in additional bonds. Our clients realized a 4.5% compound annual rate of return, and that is the source of our clients’ growth. Nobody was unhappy with their 50% return over that period of time. Plus, they knew what they were going to get, and they can predict this return into the future as well.

Until recently these types of returns may have seemed unattractive.  But, over that same period the S&P 500 index dropped 14%.  +50% is a lot more attractive than -14%.

There’s more in the interview, including an attack on 529 programs which I appreciate.  I also think 529s are a bad deal, for mostly the same reasons they state.


One response to “The Case for the All-Bond Portfolio

  1. My father retired over 25 years ago. He has remained invested in bonds in at least 90% of his portfolio ever since. He’s done very well, particularly since he lives in Canada where over that period of time real rates of interest have generally been higher than in the US. Up until 2000 I felt pretty smug about the superior returns of my >90% equity portfolio. Needless to say, it’s pretty clear who’s laughing now.

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