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America Turns Its Back On Bonds

“Begin with 100 and subtract your age. Own the resulting percentage in equities and the rest in bonds.”

If you’re like most investors, you’ve heard the common wisdom on owning bonds many times. It’s simple, easy to remember and has been the rule of thumb for at least 40 years. But in this era of rock-bottom rates, does anyone still subscribe to it?

To find out, we analyzed the asset breakdown of Personal Capital users in the “Mass Affluent” group; those who have $100k-$2mm in investable assets. Investable assets include cash, stocks, bonds and alternatives such as gold and commodities, but exclude physical real estate and other illiquid holdings. Currently, we have over 100,000 users of our free Financial Dashboard who fall into the Mass Affluent category, allowing us an unparalleled view into how these folks actually position themselves in the market. Overall, we have over 600,000 users of our technology spread across the entire net worth range.

As we looked under the hood, the results are pretty staggering. To clarify, the following data is a representation of the entire user base who have aggregated between $100,000 to $2 million, and are not a representation of Personal Capital’s clients.

Asset Allocation Charts

Asset Allocation For 35-44 Year Old

We are seeing a huge underweight to both US and international bonds when compared to the “conventional” wisdom. Following the rule, we’d expect the Mass Affluent age group of 20-34 to allocate around twenty-seven percent of their portfolios to bonds. What do they actually own? Nine percent, only a third of what’s expected. And because bonds generally represent the most stable portion of an investor’s portfolio, it’s a very aggressive adjustment.

But, OK, it’s a bunch of 20 and 30 year olds, and aggression comes with the territory. What about the others?

Asset Allocation Chart 45-54




It turns out that the 20-34 year olds are actually the least underweight to bonds of any age group! As mass affluent users grow older, their allocation to bonds should rise significantly, especially as they reach retirement age. And while we did see a small, incremental increase in bonds in their portfolios, it doesn’t begin to keep pace with where they should be according to conventional wisdom. Seeing 75-89 year old investors with more than 50% of their money still allocated to equities is almost unheard of.

These are investors who are no longer earning salaries, so their portfolios are less able to weather the volatility that comes with an equity-heavy allocation. If there is a large drop in the stock market, they will be unable to wait out a recovery, and may have to adjust their standard of living sharply downwards. This is not a risk to be taken lightly, but the relatively smooth gains in stock prices over the last five years have lulled many investors into a sense of complacency.

Bonds just can’t seem to compete. Yields are at historic lows, and show no signs of increasing in the near future. While the Fed has recently ended their latest round of quantitative easing, they were clear in their intention to keep rates low. And an eventual rate hike would only seem to make things worse. Since bond prices move inversely with yields, as rates do begin to recover bond prices will likely be pressured downwards. Under the circumstances, shunning fixed-income seems like a no brainer.



10-Year Historical Bond Yield at 2.34%

Despite the potential risk, the big picture may not be that bleak. Historically, the role of bonds in a diversified portfolio is to generate income and provide stability. Despite low yields, bonds can still do both of these. Not owning them means holding more cash or stock instead. Cash is a sure way to lag inflation, while stocks come with more risk than is appropriate for some investors. Bonds strike a middle ground, yielding more than cash with only a small fraction of the volatility of stocks.

Part of the problem is the widespread fear of bond prices plummeting as rates rise. But is the fear warranted? Passive fixed income funds ladder their bond portfolios, meaning they contain bonds which mature at different times. In a rising rate environment, older maturing bonds would be replaced with bonds yielding the new, higher interest rate. Therefore even if bond fund prices dropped in the short term, that loss would immediately begin to be offset by higher absolute returns from within the fund. After a few years of holding it, you’d likely have more money than if rates had never moved upward.

While many investors are obviously ignoring the common wisdom on fixed income, it’s not yet time to declare it dead. Over the past several market cycles, bonds have been instrumental in offsetting the depreciation risk of cash and the volatility of equities, and low current yield is not enough reason to throw in the towel. Those investors and pundits who have been predicting a big drop in bond prices have been wrong for a long time now. Will they be correct someday? Maybe, but it could be a long, risky wait.

Graphs by Caroline Sohr

Picture by Homsi Flickr Creative Commons

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  1. George

    I’ve come to the conclusion that bonds aren’t worth holding as an asset in a portfolio in these very low interest rate environments except as an alternative to hold cash long term. I feel you have to be a sophisticated bond trader to take advantage of bonds. The only place I see for bonds in a retail investor’s portfolio are if they are held until maturity and even then, interest rates are too low to offer any gain. So bonds seems like a loss to me. If they are not held until maturity, then you may sell them at some point implying a bond trade that may lead to some loss of principle as interest rates are very low right now. If the suggestion is to hold a bond fund, then bond funds are as risky as stocks too as investors found out last year in May. Bond fund holders can get hammered as badly as stock fund holders.

    So in summary, the bond options for a retail investor are

    1. Hold a bond till maturity: Principal guaranteed but interest is too low guaranteeing a loss to real world inflation and not too easy to get hold of a bond when they come out as a retail investor.
    2. Hold a bond fund: As risky as stocks and depends on the management capability of the bond fund manager.

    Both these options look bad to me. If investors can do their fundamental analysis and have a long term horizon, a diversified dividend growth portfolio that has fairly valued companies with a history of increasing dividends, rich cash flow, low debt and payout ratios should be the “new normal” for income IMHO.

    • Financial Samurai

      You know what’s been trouncing stocks this year though? Muni bonds. The ETF, MUB is up around 7% YTD. Not bad.

      I have a feeling investors have been lulled into complacency thanks to a 5 year long bull market.

      • George

        You are referring to bond funds which investors found out last year are as risky as stocks.

        While MUB is up by 7% YTD it was down by -7.1% for 2013.
        The S&P 500 ETF SPY is up 9% YTD so not sure how munis are trouncing the stock market.

        I looked at a 5 year chart of MUB. Looks as volatile as a stock chart if you ask me.

        As all bonds and bond funds are not created equal, investors who are close to retirement or in retirement may hold bonds for income and if they want descent income, they’ll be tempted to own junk bond funds. The High Yield Bond ETF (JNK) is down by -1.2% YTD with a yield of ~5.8% while it was down last year by -1.2%. Again, they are as volatile as stocks because they are closely tied to interest rates.

        With bond funds, loss of principal is still possible. You’re left to depending on the skills of the bond manager just like you are left to depending on the skills of a mutual fund manager.

        • George

          Thought I might add some context to why I sound very hard on bond funds….

          Personally, I’m a stock picker of the dividend growth investor type that depends on fundamental analysis with a long term horizon. So I feel the need to do my own due diligence on what I own. Hence, I don’t own stock funds either except index funds because I have no choice in my 401K plan. I’ve held onto stocks during the 08/09 recession because I had a long term horizon and those equities have performed quite well. I was told initially when I started investing to own bonds inorder to protect principal and earn income to stabilize during a down stock market. I read up and didn’t get sold on low interest bonds and felt bond funds are as risky.

          So IMHO, Investors should own what they’re comfortable with and bonds/bond funds should work for different types of investors given enough time too. They should just be aware of the risks for “safe” assets like bond funds too.

  2. Melissa

    Wow that is unexpected to see that many age groups so exposed to equities and not much to bonds. I like bonds personally, and am about 30% invested in bonds so I’m an outlier I guess.

    • Financial Samurai

      I guess it all depends on how old you are? If you are over 50, you fit right into this data on investors being underweight bonds. If you’re 30, then you might very well be the outlier on this study.

  3. Brendan

    Maybe the reason why everyone is underweight bonds is because they are listening to Personal Capital’s recommendations.

    As a 35-year old moderately-aggressive investor, PC advises me to have <13% in bonds, while the "100-age" theory suggests I should have 35% in bonds.

    Most asset allocation models suggest less than 20% bonds for people more than 25 years from retirement.

    Bonds are a useful diversifier (I've done surprisingly well with municipals this year), and lower volatility, but it's hard to argue that younger investors should be holding a lot more bonds in the current environment.

    • Matt Lenore

      Good point, and it drives home the fact that any investing “rule of thumb” needs to be able to adjust to the times.
      Just don’t throw it away entirely. I remember lots of discussion on whether the Price/Earnings ratio was an outmoded form of valuation in 1999-2000. Some pundits considered it a metric that no longer made sense in the “current environment”, and ignored it.

      The 100-age bonds theory may not fit this new environment as written, but long term investors are smart not to ignore bonds completely.

  4. steve

    I keep 3-4 years of spending in bonds. If there is a drop my 80% in equities will not have to be touched

  5. Craig

    The miserable yield and possible principal loss if yields rise is why the only bonds I hold are i-bonds and EE-bonds, which are limited to $10,000 investment per year.

    So, my portfolio is overweight equities, however, I use put options to minimize the risk. In my 401k which does not allow option trading, I purchased Swan’s SDRIX fund. The downside is that you lose some of the upside, due to the cost of the put options – but I find that SDRIX is better than owning less SPY and a bond fund.

    I’m baffled by the lack of funds that use put options. It’s probably because the average retail investor does not understand the market risk and will not invest in the funds due to the lower returns.