What caught my eye this week.
Was there ever a rationale way for investors with a 60/40-style equity/bond portfolio to avoid the worst of the government bond rout of 2022?
It’s a question that still bothers me. As a writer and an investing blog owner, mind you, not on my own account.
I didn’t own any bonds going into 2022 as an active investor. I’d felt gilts looked a poor risk-reward proposition for years.
But fret not – this isn’t a brag…
I found plenty of other ways to lose money in 2022. Indeed it was my worst showing on a relative basis in my investing lifetime.
However I didn’t own any government bonds. Which meant at least I didn’t suffer the indignity of seeing the supposedly ‘safer’ bit of a portfolio do worse than if I’d gone all-in on stocks.
Yield to no one
As I wrote in December 2022 in my recap of that woeful year:
Vanguard’s popular LifeStrategy funds have put in a Bizarro World performance:
- The supposedly lowest-risk LifeStrategy option – the 20/80 fund, with just 20% in shares and 80% in bonds – has done the worst.
- The best LifeStrategy fund to own in 2022 was 100% in shares.
This is the opposite of what we’ve come to expect from balanced funds like LifeStrategy.
And let’s be honest – it sucks.
True, the pain of 2022 has made government bonds investable again. That’s a genuine upside.
However for anyone who owned a lot of government bonds before the rout, such a silver lining must feel a bit like when your house burns down and at least you get the chance to plan a new kitchen.
Crying wolf about bonds
Whenever I reproach myself for not writing more about the risks of government bonds on very low yields, my co-blogger The Accumulator reproaches me in turn – by reminding me we did!
Long-time Monevator readers may recall such classics as:
- Why UK inflation-linked funds may not protect you from inflation [2016]
- How much will you lose if bond prices fall? [2020]
- Negative yields on bonds: what do they mean? [2020]
Also, I did fret openly about a potential government bond crash – way back in 2015!
Indeed – and even more tellingly – I first worried government bonds were getting overvalued in 2008, when the financial crisis was still raging and safety was a first resort.
As things turned out, the ‘low’ yields that spooked me then – yields which at the time had not been lower since World War II – still hovered above 3%.
Bond yields had far lower to go in the years ahead.
A wayback machine
In fact, gilt prices continued to climb inexorably – and hence their yields fell to near-zero – until 2022, when suddenly everything reversed.
So precipitous was the subsequent plunge that the iShares core UK Gilts ETF (ticker: IGLT) is still underwater compared to when I first fretted about low yields in December 2008!
IGLT is a distribution fund. Its price doesn’t include the return from dividends. But even if you’d reinvested your income from IGLT, the 16-year gains are puny:
Source: iShares
Over the same period a world equity tracker multiplied your money nearly six-fold. That’s not so much an opportunity cost as an opportunity catastrophe – unless of course you’d been prescient enough to sell your bonds in 2020.
But that’s hindsight speaking.
Good going until it wasn’t
We didn’t know for sure that the world wasn’t headed for another Great Depression in 2008 – or something even worse, if the ATMs had failed and all the banks went bust.
And even as yields fell further over the following 14 years, it still seemed futile to bet against bonds.
Yields would just be lower again the next year, and you’d be left with egg on your face.
The best a strict passive investor could probably do was to reduce their government bonds to a tolerable minimum and hold more cash (and other assets) instead.
But remember that for years that would have been a poor trade. The return on cash was nearly nothing. Yet bonds remained a decent investment, delivering steady returns well into the Covid era.
Our model Slow & Steady Passive Portfolio, for instance, outperformed our expectations for a 60/40 portfolio for years, in large part thanks to those relentless gains in bonds.
Don’t fight the last war
So where does all this looking back leave us as we ponder the future?
Well, arguably it’s all moot.
It’s one thing to say that perhaps there was a case for even a passive investing purist ‘market timing’ away from government bonds when the ten-year yield danced towards zero – and the expected returns from inflation-linked government bonds went negative.
But that isn’t where we are now. And there’s no reason to think we’ll see the like again in the next 50 years.
Those near non-existent bond yields were probably a special case.
In contrast, fiddling when the yield on the ten-year falls to 3.5% and you’d bought at 4% might be the stuff of a lucrative day job on the prop desk of an investment bank.
But everyday investors will surely to do worse for such tinkering…
…or will they?
Trigger happy
I’ll conclude with some interesting research shared by Jim Paulsen a couple of weeks ago on the U.S. flavour of a 60/40 portfolio.
For his purposes, Paulsen1 defines the ‘cost’ of holding a 60/40 portfolio as being how much it would lag a 100% equity allocation over any particular period.
This cost – in terms of foregone returns – is the price you pay for the lower volatility and downside protection of holding government bonds, with their guaranteed return of capital and knowable returns.
Digging into the numbers, Paulsen found that the cost has previously soared when the yield on a ten-year US Treasury bond falls below 4%:
Source: Paulsen Perspectives
There are probably two reasons for this observation over this period.
Firstly is the one Paulsen focuses on. When bond yields are low, you’re not getting compensated as much for owning government bonds in terms of income. On an inflation-adjusted basis, you might not be making money at all.
But secondly, I suspect there’s an equity timing signal buried here.
When government bond yields are very low, it’s probable people are more fearful than usual. They’ve likely bought government bonds for safety, presumably in part with money that could instead be invested in shares.
In that case equity valuations may be depressed – implying potentially higher returns from the ’60’ part of the portfolio going forward.
A new 4% rule…
Whatever the reason, Paulsen suggests the 4% yield level could act as a trigger for US investors to look again at their asset allocation should the ten-year US treasury yield fall below 4%.
Rightly he doesn’t suggest wholesale abandonment of a diversified portfolio, writing:
The 60/40 balanced portfolio makes sense for many investors and there is no reason to abandon balanced management even if the 10-year Treasury yield does decline again below the 4% trigger.
However, 60/40 investors may want to consider occasionally altering the balance mix depending upon which side of the Trigger they find themselves.
If you generally are a 60/40 investor, perhaps you could adopt the simple rule of being 50/50 when above the yield Trigger and switching to 70/30 when below the yield Trigger.
Depending on each individuals’ risk tolerance, this ‘toggle approach’ may not be appropriate.
But for those balance investors who may want to try and take advantage of the 4% Trigger and keep the ‘relative cost’ of balanced management reasonable, adjusting the mix slightly around the toggle may prove profitable, perhaps as soon as in 2025.
Finally I’d note that Paulsen’s backwards data dive only ran to 1945 (when, as I said above, bond yields were last very low) and also that this is US data, with its rip-roaring equity gains to greatly plump up the ‘cost’ side of the equation.
Still, food for thought. Especially if yields ever do descend into the depths again.
Have a great weekend.
From Monevator
The Japanese stock market crash revisited – Monevator [Members]
FIRE-side chat: contracting killer – Monevator
From the archive-ator: Back-up plans for living off a portfolio – Monevator
News
Note: Some links are Google search results – in PC/desktop view click through to read the article. Try privacy/incognito mode to avoid cookies. Consider subscribing to sites you visit a lot.
Vanguard UK introducing a monthly fee for smaller investors – This Is Money
UK economy shrinks again in October, official figures show – Sky
Average rent up £3,240 annually since the pandemic – BBC
ONS says the cost of average home in England is unaffordable… – Guardian
…while in London even the highest earners are priced out… – City AM
…and business leaders are calling for a ‘new town’ in capital – BBC
Police arrest 93 gang members behind £4m shoplifting spree – Sky
“Train phone snatcher stole £21,000 from my bank apps” – BBC
London Stock Exchange exodus hits £107bn as Ashtead eyes US – City AM
Fewer US companies are demanding their staff return to the office – Sherwood
Hedge fund startups dwindle under fee pressure – Bloomberg via Yahoo Finance
What if the UK isn’t actually the sick man of Europe? [Search result] – FT
Related: OSR issues statement on declining quality of UK statistics – OSR
Strategic Bitcoin reserve mini-special
Whatever a ‘strategic Bitcoin reserve’ is… – Sherwood
…no country needs one – Cullen Roche
Products and services
Best bank account switching deals: make up to £180 – Which
Chase offers 4.75% savings rate to new customers – This Is Money
How to get a refund for delayed trains – Be Clever With Your Cash
British energy firms told to offer ‘zero’ standing charge tariff – Guardian
Open an account with low-cost platform InvestEngine via our link and get up to £50 when you invest at least £100 (T&Cs apply. Capital at risk) – InvestEngine
Interest-only mortgages will make up just 2% of home loans by 2034 – T.I.M.
Virgin Voyages just launched an annual cruise pass for… $120,000 – Sherwood
Six household costs rising in 2025 and how to beat them – Which
Crumbs! Why are mince pies so expensive this Christmas? – Guardian [Sorry, Homes in Pictures seems to be on holiday early…]
Comment and opinion
ISO: Patina – Money With Katie
Lessons from the Bogleheads 2024 University [Videos] – The Bogle Center
Owning your own home linked to a longer life – University of Oxford
Why retail stock traders underperform – Klement on Investing
Pick your peril – Humble Dollar
“Why can’t I be less anxious about money?” – Guardian
A defence of early retirement – Simple Living in Somerset
Every asset managers’ 2025 forecast – Behavioural Investment
How big is the equity risk premium? – Klement On Investing
The best Wall Street book of 2024 is also the least salacious – Bloomberg
Naughty corner: Active antics
Asset managers make existential dash into private assets – FT
How to spot the UK’s fastest-growing companies – Trustnet
Direct Line: a tale of dividend cuts and takeovers – UK Dividend Stocks
Investors haven’t been this complacent for two years – Sherwood
BlackRock’s 2025 investment outlook is out [PDF] – BlackRock
Investigating ‘formula investing’ [Research] – SSRN
The problem with the Buffett indicator and others like it – Tker
Kindle book bargains
Antifragile: Things that Gain from Disorder by Nassim Taleb – £0.99 on Kindle
The Big Con [On the Consulting Industry] by Mariana Mazzucato – £0.99 on Kindle
Nudge: The Final Edition by Richard Thaler and Cass Sunstein – £0.99 on Kindle
How Westminster Works…and Why It Doesn’t by Ian Dunt – £0.99 on Kindle
Environmental factors
Defra: food insecurity rising in UK because of climate breakdown – Guardian
Scientists urge halt to research on risky ‘mirror microbes’ – B.A.S.
Cotton-and-squid-bond sponge can soak up 99.9% of microplastics – Guardian
Star Wars impact on woodland to be studied – BBC
Plummeting used-EV prices trigger car leasing crisis – This Is Money
How the Amazon’s ‘Boiling River’ foreshadows a warmer world – BBC
Cycles – Cold Eye Earth
Robot overlord roundup
The GPT era is already ending – The Atlantic
Great, now the machines understand us – Klement on Investing
Chatbot ‘encouraged teen to kill parents over screen time limit’ – BBC
The phoney comforts of AI skepticism – Platformer
…and an angry retort – Marcus on AI
Will AI eat the browser? – Crazy Stupid Tech
Hard yards on the Internet mini-special
YouTube creators are struggling to survive on ads alone – Sherwood
This is why you want to make your own website – Aftermath
Off our beat
Google unveils ‘mind-boggling’ quantum computing chip – BBC
How Madrid built its metro cheaply [Essential reading] – Work in Progress
Working the nVidia way – Dror Poleg
Elon Musk is building his own town in Texas – Sherwood
The five-minute city: inside Denmark’s revolutionary neighbourhood – Guardian
Stay away from Dr. Google – NPR [h/t Abnormal Returns]
The six stages of cleaning out a parent’s home – Guardian
Assad’s fall was swift. But the signs were always there – W.P. via MSN
Have official targets made exercise a chore? – Guardian
And finally…
“The game is rigged, but you cannot lose if you do not play.”
– Marla Daniels, The Wire
Like these links? Subscribe to get them every Friday. Note this article includes affiliate links, such as from Amazon and Interactive Investor.
- For many years the chief investment strategist at giant US bank Wells Fargo. [↩]
Another early post much appreciated – can only assume you’re Christmas shopping today @TI!! Thanks for all the wisdom and thought provoking posts over the last year, and best wishes to you and all Monevator readers.
My view is that it is very important from a passive investor to focus on yield and to probably buy gilts direct. Then you can pick the yield for a given duration. Buying gilts near 5% to 2055+ means you can hold forever at an okay return. Buying at 0.5% or not getting a long term on a 1% mortgage is risky not being smart by being passive. Think it applies to equities too though which makes Asia UK, Europe etc lower risk but S&P and world indexes high risk. If you are being passive just check the yield on everything.
The change to Vanguard’s fees is annoying.
I have around 12k in a SIPP there, and am unlikely to add any more anytime soon, as I’m in a public sector job with a good DB pension, so ISAs just make more sense as a savings vehicle for me.
Which means Vanguard has basically just tripled my platform fees.
Time to move, I think. Probably to DODL?
I already have my lifetime ISA there, and would rather not have too many of my eggs in one basket. But doesn’t seem like there’s a great range of options for small SIPPs atm.
60/40 – for a long time the one-size-fits-all for financial planning isn’t fit for purpose – much like my own years of over investing in the stagnant FTSE100 (bond like super tanker company, dividend aristocrats who only occasionally mess up).
But reading Simple Living (and his last post is great) mentioned that his own bond allocation was probably served by his Final Salary pension. That spurred me into a more “risky” approach of pretty much going all in for global ETF trackers(in part to drive down fees).
So the future of me and bonds… I could always payoff the mortgage at 4.45% ( thanks Liz) but I would rather leverage and invest in equities instead.
Yes, very disappointing from Vanguard. Supposedly one of the ‘good guys’.
Investengine have in the last few days approved transfers in to their platform-fee free SIPP. But only from Vanguard (see what they did there?) . And they only do ETFs and I don’t think they can handle in-specie.
I’d recently convinced a young, self employed relative to start putting something away into a Vanguard SIPP. This move from Vanguard puts her fees up from about £2 a year to £48.
Looks like Investengine will work for her instead.
It’s an odd move by Vanguard to punish young investors at the start of their investing careers. You’d have thought they’d want to retain their custom throughout their investing career.
Throw in the fact that fees on most of their passive offerings are around 10bps more expensive than comparable offerings and I’m beginning to lose a bit of faith in Vanguard.
Thanks for yet another batch of interesting links and thoughtful commentary.
The Madrid Metro article makes fascinating reading and is quite timely given the UKs increased centralisation of planning decisions as announced recently.
Another thought provoking discussion regarding bonds.
I’m currently with Vanguard and from a quick look don’t believe I’m affected by the fee increase. One word of warning however, regarding moving to another platform is the customer service that Vanguard provides that some platforms don’t. They have been very good with several queries that I’ve had over the years.
Liked ‘The Wire’ quote- there are numerous ones of wisdom in that show!
Season’s Greetings to all at Monevator and their readership.
Lee.
As someone who buys government bonds directly and holds them to maturity, I couldn’t care less how their price moves. I know what yield I will get, and I made the decision to buy them at that yield.
The problem isn’t that yields can fall. It’s that inflation can rise. If that happens my real yield will fall. I have some index linked gilts for that, but of course their yield is a joke. Then again I knew this when I bought them.
The risk from a 60/40 portfolio, therefore, is really inflation. That’s why it doesn’t really matter if you think bonds are overvalued – it matters if you think inflation is underestimated.
I have a family member who has a tiny amount in a Vanguard ISA (well under the 32,000) so they are going to have to move. It seems like either Dodl or Invest Engine are the ones people are thinking about?
One more vote of confidence in InvestEngine from me – their customer service were very helpful in producing the exact statement my compliance department needed, and the service itself is a pleasure to use.
They have a swap based S&P 500 tracker, a physically replicated World Ex US ETF and an Emerging Markets ex-China ETF, as well as offering cost free rebalancing, so you can build a cost optimised All-World ETF from Finumus’s recipe despite not having a high invested amount. https://investengine.com/share/portfolio/2bad7a83414d7700cde20b822ccfce922c7280f0/
The only thing that worries me is what their business model is – is payment for order flow enough?
I just checked Hargreaves Lansdown’s website and I cannot see any offer for cashback when transfer a SIPP. How new/old is this offer?
Thanks.
Thanks @TI for Vanguard heads-up. Mrs 2MY has Vanguard SIPP a little below the £32k (and missed the T&Cs email!). When she retires this time next year, TFLS plus very slow drawdown topping up SP to TFA will make an increasing difference. Annoying as they’ve been very good in all other respects. Additional fees will be marginal for the next 12 months so inclined to keep a watching brief; noting IE not slow to make a grab!
Anyone have experience of IE in drawdown? Their website goes a bit quiet on this.
I don’t think Investengine offer drawdown (not yet at least).
I only know this as I was looking to start a SIPP myself this week and almost opened a Vanguard one the day before they announced the fee change!
The Behavioural Investment 2025 Forecast roundup was absolutely brilliant — good find!
But fun aside, while most of Monevator’s readers likely don’t share my soft spot for Jamie Dimon, I must say, his musings on inflation (as seen in this interview https://youtu.be/bI1TL3svaGs?si=kA_IJOI6E-FwWMwk) aren’t completely daft. Love him or loathe him, keeping an eye on inflation might be a 2025 prediction worth taking seriously. Still, more funnies from Behavioural Investment, please — it really made me chuckle.
I just had email confirmation from Investengine. They can accept in specie SIPP transfers, assuming they offer the exact same product as Vanguard. Which they will if you’re in ETFs.
Im still not clear if they can accept partial in specie transfers if you have holdings in a mixture of funds and ETFs. My assumption is that you can but I did not confirm.
I bought into L/S 40/60 in2017 (I was nearing retirement and was looking for a safer plan) last year and this I would have done better in a local Building Society . Oh dear.
@David 15
What numbers/dates are you using? If I use something like the Royal London short term money market fund as a proxy for cash interest rates, then from June 2017 to date I get:
LS 40 – ~28%
LS 60 – ~48%
RL short term- ~13.2%
The 60/40 portfolio gets extensive discussion on the Bogleheads forum and American financial blogs generally
(I notice the videos of the latest Bogleheads meet are in the links this week)
The conclusion seems to be for those American investors using a total stock market index for their equities and bonds -this asset allocation ie 60/40 -then held for ever through thick and thin -the results have been good-certainly better than equivalent actively managed portfolios
Most stockmarket drops of course have been on the equity side but the stockmarket has many twists and turns -predicting and then the escaping these oscillations seems to be difficult-impossible?
U.K. investigators like me have also managed to to do reasonably well copying this 60/40 allocation albeit with a global equity and bonds held for their portfolio
(Should just have held American equities and bonds?)
A U.K. investor with a 60/40 portfolio with a built in U.K. bias will have done less well
Another conclusion seems to be that 60/40 is a fairly arbitrary choice and variations between 30/70 to 70/30 have done similarly well -the choice depending on the investors attitude to risk ,volatility size of portfolio etc
“Staying the course” seems to be the other essential ingredient
xxd09
@Jon Snow — Hmm I agree, it’s not there now.
I’m sure it was there and valid last night! I haven’t included them in the links for ages, and only brought them back for this deal.
Also I pulled the 10 January deadline info in my blurb off their promo.
Actually that date a clue perhaps that they they have withdrawn it…the short time window to complete the application implies a limited ‘budget’ allocated to new transfer incentives.
I wonder if they are somehow getting overwhelmed with Vanguard exiles?
Doesn’t seem super likely though, as they are not a straight swap in terms of cost profile by any means.
Thanks for the heads-up! 🙂
@all — Just to add, I am hopeful that @TA is going to be able share some thoughts on Vanguard and if/where to move as soon as Monday or Tuesday.
So please watch this space, and as always the comments under his article. 🙂
I’ve got a lump of VGOV bond ETF in my SIPP, still underwater. Risk rating 5 and paying 4% dividends. I also have VHYL High Dividend Yield equity ETF risk rating 6 paying 3% dividends. The VGOV plan didn’t work as expected to “smooth the ride”! I can’t bring myself to crystallise the loss – hoping it may improve if interest rates ever come down some more. Yes, I need to look into direct gilt holdings.
When I got the Vanguard email I was expecting to open it and discover they’d reduced their platform charge, what a surprise! Very frustrating for young investors starting out. The one thing going for Vanguard I think is they won’t be sold into private equity if that is a concern. I started a SIPP with them but found transfers in very slow, gave up with it and consolidated more with HL. It is actually cheaper for me to hold Vanguard ETFs with HL too. I hope the slow transfers with Vanguard have improved if they’re upping their fees.
@Jon Snow – I can see the HL SIPP cashback offer registration here
https://www.hl.co.uk/features/register-cashback-pc
Register by January the 10th. If you’re a customer and have issues, call them. They’re very helpful.
About moving from Vanguard to Investengine, you are moving from a global sized company to a really small company who had yet to make a profit. It’s not always about saving a few pounds it’s about the big picture. As for availing of the HL cashback, they are on course to delisting from the London stock market to disappear into a private equity buy out. It is of course your money your choice.
@GF
The same thought had occured to me about moving my SIPP from Vanguard to Investengine, and am currently tempted by the Fidelity SIPP which is only £90 a year if you use ETFs.
However is the change to HL likely to make it detectably more risky – either way it is a huge (and too big to fail?) UK broker?
@Ben Ber. I struggle to see how private Equity can improve HL. When I open up my PE play book then the way to go is put a lot of debt on the balance sheet. Cut as many staff as you can and generally squeeze as much as you can relying on HL customers unwillingness to move. I just can’t see them going for all out growth, squeeze the cash cow is the most likely choice.
@TI 60/40 went through the wringer in 2022, but it should be rather better placed to deliver now vis a vie 100 equity.
But why settle for just 60/40 when 90/60 is now available?
The WisdomTree Global Efficient Core UCITS ETF has recently been listed on the LSE in both USD (NTSG) and GBP (WGEC). 0.25% p.a. OCF. Your getting a 90% global developed markets equity tracker, but with 60% high quality developed world bonds thrown in. 1 ETF for implementing Lars’ 2 asset class solution, but without giving up 40 to make room for gov. bonds.
@GF & @Ben Ber: On HL and PE: it’s hard to know how much (or how little) to be concerned. A known unknown.
There were some articles here on MV in recent years about UK broker protections, but (IIRC) it was not exactly a greatly reassuring picture. We haven’t (yet) had a 2007/8 moment for fund platforms, like we did for the retail banks.
The big practical issues are where, when and how to move. 90% logistics, only 10% strategy.
For all its drawbacks, HL are still only £45 and £200 annual platform fee caps respectively for ISAs and SIPPs (nowt for GIAs) for holding ETFs, ITs, individual shares and gilts (notwithstanding the extortionate 0.45% p.a. headline rate for holding OEICs). Their customer service remains OK (but used to be great) with fairly prompt responses to secure messages and a UK phone line.
OTOH, the HL FX rates and £12 dealing fee are steep, and look like something a late 1990s stockbroker would charge. Their selection of ETFs is also not as broad as you might think and there can be issues buying certain ETFs and ITs.
If it weren’t for the PE buy out I’d stay put, but there’s that uncertainty to try and parse now, and there’s also lot of choice and switching incentives these days.
The HL offer appears to be by invitation only:
“Subject to these terms and conditions, if you have been invited to take part in the Transfers Cashback Offer (October 2024 – January 2025)…”
“To be eligible for the Offer, you must: have received a communication from Hargreaves Lansdown inviting you to the offer”
@BillD (#31):
Re: “When I got the Vanguard email I was expecting to open it and discover they’d reduced their platform charge, what a surprise! Very frustrating for young investors starting out.”
Yup, that is what I thought the email might say – and it is how Vanguard (V/G) have built their business. I do wonder if JB had still been around if this would have happened?
I just so happen to currently have several a/c’s (with different providers) that meet the criteria – albeit they are not with V/G. So, it is not just greenhorns that may be impacted.
Had these a/c’s been with V/G (which some of them nearly were) it would not have effected me, due to my other V/G holdings. However, given how much V/G take off of me for those other [buy & hold] holdings I think the changes are actually pretty shameful!
Is this just the latest sign that things are not so good with V/G in the UK, or V/G more generally? IIRC, in the UK they dropped cash interest rates and took some missteps with an advised offering.
@tetromino @all — Re: HL, thanks for the extra info, I’ve removed the promo from the article as it’s really not clear what it’s up to.
The HL cashback is offered on the front page only if you’re logged into the account it seems or maybe have a cookie from a previous login. The invite on the front page should count as “a communication from HL”. So I guess you need to be an existing customer, all very strange they’re not using it to attract new customers?!
I saw some comments on another site that Vanguard are changing to taking the direct debit charges monthly rather than quarterly but see no mention in their email? Maybe it’s just if you’re hit with the £4 charge for having a “small” holding. I don’t have a good feeling about them.
I think the Paulson study is a great bit of insight. I think, though, it is
asking something like “when should you put bonds in the portfolio you
will spend from in over 20 years, to stabilize it without hitting
the return too badly” – hence the comparison against just 100% shares
which would usually be the default buy for your very long term savings.
In particular, it’s not saying: “when the risk free rate drops below 4% at some point in 2025, you should dump all the bonds you hold for
nearer term use”. Well, it might mean if your 1y bond gets a 2% boost
from next year’s cuts you should swap it to cash, I suppose, but not to shares!
To @Delta Hedge
>But why settle for just 60/40 when 90/60 is now available?
isn’t it just a big increase in risk & fees? :-
put 60% in bonds paying 4%+ coupon;
spend all the coupon servicing a 50% loan;
put the other 40% and the borrowed 50% in shares;
the return is: the return on 90% shares plus from the bonds we’re
just getting the “carry” if the risk free rate falls or losing if it rises.
So isn’t it better to buy 90% shares and 10% in the 50-year gilt to
get the same carry, plus I keep the coupon and lower fees?
(- which would indeed be a long term portfolio benefitting from
containing bonds, which Paulson says is likely a good idea assuming
the gilt pays over 4%)
@Meany #31: I thought the same initially.
The key difference is these products, unlike ‘traditional’ daily reset ETFs, use rolling 3 month futures to get exposure to the lower risk and hopefully negative correlation (bonds) asset. The high risk asset (stocks) is held physically and unlevered.
In the comment thread to @Finumus’ Leveraged ETFs for the Long Run, posting under my old moniker @Time Like Infinity and as @DH, I’d reached the same conclusion as you for the old school type 2x and 3x leveraged ETFs with daily reset, and concluded there’s each of a significantly bad volatility drag, an interest rate drag, and an interest rate sequence drag to contend with when rates are high (there’s very little research on this last one online, but what there is suggested that 10 year US Treasury bond yields below 4% was a decent threshold below which to consider old style 2x and 3x leverage with daily reset if you had the stomach for it – obviously as Paulson notes lower rates also tend to mean equity outperforms as well).
These capital efficient or returned stacked second generation (and now calendar reset third generation) of leveraged ETFs are quite different beasts.
They don’t do the borrowing in the same way (rolling 3 month futures used for exposure to a negative correlation low volatility asset – bonds – for second generation, and longer rebalance periods in third generation).
Here’s a review of NTSX ETF which in the UK is WTEF ETF and is 90/60 S&P 500 plus intermediate duration US Treasury bonds:
https://www.optimizedportfolio.com/ntsx/
The key bit is “cheaper to lever up bonds than stocks, and by using futures on a bond ladder, they’re not using daily-reset leverage usually seen with leveraged ETFs, so no volatility decay to worry about, and we’re also largely avoiding counterparty risk, as bond futures markets are highly liquid. Even Bogleheads seem to like it for all these reasons.”
And here’s a review the same day from the same source on return stacking generally:
https://www.optimizedportfolio.com/return-stacking/
Disclosure: I invest in WTEF, and it’s held its own very well so far against an S&P 500 only tracker SPXP, which I also own, since launch 14 months ago.
MV commentator @MrBatch is quite into these products too IIRC, and his comments are worth consulting here.
Returning to the 60/40 question, I get the impression that the message should be ‘duration, duration, duration’ as in, make sure your duration fits your circumstances.
Even with some basic bond knowledge in place, it’s so easy to underestimate the difference between IGLS (gilts of duration 2) and VGOV (gilts of duration 10). I think the main benefit of individual gilts is one of transparency: the process of buying an individual bond forces you to choose exactly how much duration you want.
Great post about risks of the 60/40 in the current environment. Thanks TA!
Odd Lots had Nouriel Robini last week (https://m.youtube.com/watch?v=PlZdOVFngsk) and he talked about these risks as well. He mentioned the possibility of the FED eventually being forced by Trump’s inflationary policies to effectively move the inflation target from 2% to 5%. This would then push the Treasury yields gradually up resulting in substantial losses for long duration Treasuries.
He discussed changes to the 40% defensive part of the 60/40. Instead of the usual longish duration bonds, a much more diversified defensive 40%: short duration bonds, inflation linked bonds, gold, and property in places that are less likely to be affected by the worst impacts of climate change.
I’ve been doing a similar sort of 60/40 with 60% of my portfolio for years (since the time of subzero interest rates). The remaining 40% of my portfolio is basically a 70/30 where the 30% is a mixture of a 10% allocation to gold and 20% to short duration bonds and short duration inflation linked bonds. This allocation has worked well for me. My 10 year annualised return (measured over this investment period rather than just estimated based on the current allocation) is a bit higher than 12%.
Guardian Fantasy House Hunt has appeared after the strike
https://www.theguardian.com/money/gallery/2024/dec/14/homes-for-sale-with-an-air-source-heat-pump-in-pictures
We held a 60/40 portfolio right up until 2020, when we moved to 90/10, with the 10 in cash. I had been concerned about falling yields for a while, but in 2020 bonds were offering risk with next to no reward. At the time cash was offering higher returns with no downside risk. I would not have concerns about bonds now and have largely gone back to gilts. I am more concerned about equities than bonds, but there aren’t any sensible alternatives in the way there was with bonds.
We will reduce some of the risk in the new year by buying a couple of RPI linked annuities.
@Naeclue (#36):
Re: “We will reduce some of the risk in the new year by buying a couple of RPI linked annuities.”
I can see that logic – as it locks in [some of] your [real] gains to date.
Couple of thoughts:
a) that nice regular income stream could limit some of your options – esp. if you are worried about income tax [rates] and fiscal drag. Hence my Q (at last post) about a deferred annuity?
b) over annuitizing is/can be wasteful
“UK economy shrinks again in October, official figures show”
At least some of that must be the relentless gloom and doom about the budget and economic outlook, not just from Labour’s opponents but led by Kier Starmer and Rachel Reeves. I was surprised to learn that the small business I’m involved with will pay less employers NI next year than this: the rate will go up but the “employment allowance” will be more than doubled. For those not familiar, this allowance means that a small business doesn’t pay the first 5000 £ of employers NI, and from next year , the first 10,500 £. That represents quite a lot of of wages in a small business. OK, we’re being shafted in multiple other ways, but if this was say a George Osborne budget you can bet he would have headlined this measure & praised it to the skies as the solution to the UK’s economic problems and the birth of golden age for small businesses, while keeping quiet about the other stuff. Are RR & KS just inept politicians ? Do they think they need to present the budget as a full-on, pip-squeaking budget to their Party left-wing (especially after the Winter Fuel Allowance fiasco) ? A few recent news items about cost control and even job cuts in the civil service are interesting in this context….easier for Labour to get those away if they can claim they have pushed soaking the rich as far as possible & still have a crisis in the Gov. finances ?
@Anna — Good spot, thanks!
@Al Cam, we will not be buying large annuities, less than half our expected annual expenditure, but it will give us some explicit inflation protection. I will have a look at deferred annuities as well. Certainly worth thinking about as we don’t need the income right now.
Friends and relatives I have known who have made it into their 90s typically spend next to nothing, unless in care homes, even when they are very well off. If we make it that far our annuities may be all we need.
Delaying a year has worked out well with shares up about 20%, but that could easily reverse, so we should probably sell soon once we have a firm plan..
I missed the bond rout in the sense that I avoided the “return free risk” of government bonds, although I have endured some collateral damage to my green energy infrastructure trusts which have taken something of a battering.
What limited bond holdings I did have 2-3 years ago was short dated stuff.
I have been gradually building my fixed income allocation over the last 2 years and will continue to do so. This includes a blend of everything from shorter dated corporate bond ETFs to an individual 15 year gilt.
My work pension choices are more limited so split between a gilt fund and a corporate bond fund.
So I’m balancing gradually through new contributions rather than dumping equities – where I might only add to via dividend cash reinvestment within my SIPP.
But anyway, it isn’t rocket science to see that a gilt yielding 4.5-5% is going to help you drawdown at 4-5% a lot more than a gilt yielding 1%.
I can see why some people might choose to lock in for 20 years or more at today’s rates.
But I’d also still want to hold at least 2 years spending in cash/short dated gilts/money market funds.
@Naeclue (#40):
Good stuff.
FWIW, completely share your [equities] valuation concerns.
Re DA’s, see for example: https://monevator.com/the-slow-and-steady-passive-portfolio-update-q3-2024/#comment-1841096 and subsequent reply
It’s been the case for many years that the yield priced into conventional gilts has been less than the interest rate on best buy fixed rate savings accounts of equivalent term albeit the margin has narrowed on occasions. The current 5 year gilt spot rate is about 4.03%pa (spot rate is the theoretical zero coupon return). And yet the best buy 5 year fixed rate savings account offers about 0.5% more at 4.52%pa (it’s 4.18%pa for an ISA account). If it was 0.5%pa difference for say 20 years then investing in gilts rather than in best buy savings is (ignoring any practical issues such as being able to go the savings route) almost equivalent to giving away 10% (= 0.5% x 20) of your money for no reason.
Above 5 year term there is usually no direct savings comparator to gilts. But even if we magically assume they suddenly represent good ‘value’ (whatever that means) at those longer terms, there is a serious risk of unexpected future inflation eroding their value. So at a time where the real returns on equities reduce during that high future inflation period, we see the conventional gilts hit as well.
It is also interesting to note that the real returns on index linked gilts have recently increased from about minus 2.8%pa (on say 20 year terms) in November 2021 to about plus 1.5%pa now. But implied inflation (which is the gross yield implied by the price of conventional gilts less the real yield on equivalent term ILGs) has hardly changed, currently about 3.3%pa vs 3.8%pa at November 2021 at a 20 year term.
What that tells you is that conventional gilts have until recently been priced to give negative real returns. It’s just with index linked gilts it was completely obvious this was the case as you could see the negative real return implied by the prices. With conventional gilts you had to make the logical step of saying at the very low gross redemption yields baked into prices, inflation was likely to exceed those low yields causing expected future real returns to be negative. The only protection those conventional gilts could ever have provided would be during a significant period of negative inflation.
So it’s reasonable to assume that conventional gilts might now offer some future real returns especially at the shorter terms while watering down risk, or at longer terms if inflation doesn’t rise above expectations or is below expectations. Personally I think index linked gilts especially at around the 20-30 year term (if that coincides with when you might need the proceeds) offer good value to water down risk or provide a secure income floor. But the (high) inflation risk of longer term conventional gilts is significant and at shorter terms best buy savings accounts offer better value. I’ve recently purchased index linked gilts but I’ve never bought conventional gilts preferring savings as a means to water down risk.
@Snowman – great post.
@Snowman, after tax low coupon short dated gilts (0.125%-0.25%) can offer higher returns than equivalent period deposits. An important consideration for me as I prefer to use my ISA to hold shares rather than cash. Otherwise I agree, the best term deposit rates almost always offer better gross returns than equivalent short gilts held to maturity. One other advantage with gilts is that you can cash in early should you want to. Increasingly this option is not available with term deposits.
For 20+ year long dated I would almost always favour equities instead. I used to make an exception with long duration US Treasuries in my portfolio as these can have a “flight to safety” benefit when we have interesting events.
I’d also add convexity to the list of reasons behind the effect Paulsen observes
Apollo’s daily spark post today re the prospects for the 60/40 in 2025 is food for thought: https://www.apolloacademy.com/the-daily-spark/
Interesting to see a slide dedicated to Bitcoin as a portfolio diversifier in the Blackrock outlook, doesn’t get much more ‘adopted by the mainstream’ than that