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 [1]. 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 [2] of that woeful year:
Vanguard’s popular LifeStrategy funds [3] 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 [3] 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 [4] [2016]
- How much will you lose if bond prices fall? [5] [2020]
- Negative yields on bonds: what do they mean? [6] [2020]
Also, I did fret openly about a potential government bond crash – way back in 2015 [7]!
Indeed – and even more tellingly – I first worried government bonds were getting overvalued in 2008 [8], 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 [9] 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:
[10]
Source: iShares [11]
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 [12]) 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 [13], 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 [14]. 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 [15] a couple of weeks ago on the U.S. flavour of a 60/40 portfolio.
For his purposes, Paulsen [16]1 [17] 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%:
[18]
Source: Paulsen Perspectives [15]
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 [15]:
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 [19] [Members [20]]
FIRE-side chat: contracting killer – Monevator [21]
From the archive-ator: Back-up plans for living off a portfolio – Monevator [22]
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 [23]
UK economy shrinks again in October, official figures show – Sky [24]
Average rent up £3,240 annually since the pandemic – BBC [25]
ONS says the cost of average home in England is unaffordable… – Guardian [26]
…while in London even the highest earners are priced out… – City AM [27]
…and business leaders are calling for a ‘new town’ in capital – BBC [28]
Police arrest 93 gang members behind £4m shoplifting spree – Sky [29]
“Train phone snatcher stole £21,000 from my bank apps” – BBC [30]
London Stock Exchange exodus hits £107bn as Ashtead eyes US – City AM [31]
Fewer US companies are demanding their staff return to the office – Sherwood [32]
Hedge fund startups dwindle under fee pressure – Bloomberg via Yahoo Finance [33]
[34]
What if the UK isn’t actually the sick man of Europe? [Search result] – FT [35]
Related: OSR issues statement on declining quality of UK statistics – OSR [36]
Strategic Bitcoin reserve mini-special
Whatever a ‘strategic Bitcoin reserve’ is… – Sherwood [37]
…no country needs one – Cullen Roche [38]
Products and services
Best bank account switching deals: make up to £180 – Which [39]
Chase offers 4.75% savings rate to new customers – This Is Money [40]
Get £350-£3,000 cashback if you apply to transfer your pension to a Hargreaves Lansdown SIPP before 10 January. Terms apply – Hargreaves Lansdown [41]
How to get a refund for delayed trains – Be Clever With Your Cash [42]
British energy firms told to offer ‘zero’ standing charge tariff – Guardian [43]
Open an account with low-cost platform InvestEngine via our link [44] and get up to £50 when you invest at least £100 (T&Cs apply. Capital at risk) – InvestEngine [44]
Interest-only mortgages will make up just 2% of home loans by 2034 – T.I.M. [45]
Virgin Voyages just launched an annual cruise pass for… $120,000 – Sherwood [46]
Six household costs rising in 2025 and how to beat them – Which [47]
Crumbs! Why are mince pies so expensive this Christmas? – Guardian [48] [Sorry, Homes in Pictures seems to be on holiday early…]
Comment and opinion
ISO: Patina – Money With Katie [49]
Lessons from the Bogleheads 2024 University [Videos] – The Bogle Center [50]
Owning your own home linked to a longer life – University of Oxford [51]
Why retail stock traders underperform – Klement on Investing [52]
Pick your peril – Humble Dollar [53]
“Why can’t I be less anxious about money?” – Guardian [54]
A defence of early retirement – Simple Living in Somerset [55]
Every asset managers’ 2025 forecast – Behavioural Investment [56]
How big is the equity risk premium? – Klement On Investing [57]
The best Wall Street book of 2024 is also the least salacious – Bloomberg [58]
Naughty corner: Active antics
Asset managers make existential dash into private assets – FT [59]
How to spot the UK’s fastest-growing companies – Trustnet [60]
Direct Line: a tale of dividend cuts and takeovers – UK Dividend Stocks [61]
Investors haven’t been this complacent for two years – Sherwood [62]
BlackRock’s 2025 investment outlook is out [PDF] – BlackRock [63]
Investigating ‘formula investing’ [Research] – SSRN [64]
The problem with the Buffett indicator and others like it – Tker [65]
Kindle book bargains
Antifragile: Things that Gain from Disorder by Nassim Taleb – £0.99 on Kindle [66]
The Big Con [On the Consulting Industry] by Mariana Mazzucato – £0.99 on Kindle [67]
Nudge: The Final Edition by Richard Thaler and Cass Sunstein – £0.99 on Kindle [68]
How Westminster Works…and Why It Doesn’t by Ian Dunt – £0.99 on Kindle [69]
Environmental factors
Defra: food insecurity rising in UK because of climate breakdown – Guardian [70]
Scientists urge halt to research on risky ‘mirror microbes’ – B.A.S. [71]
Cotton-and-squid-bond sponge can soak up 99.9% of microplastics – Guardian [72]
Star Wars impact on woodland to be studied – BBC [73]
Plummeting used-EV prices trigger car leasing crisis – This Is Money [74]
How the Amazon’s ‘Boiling River’ foreshadows a warmer world – BBC [75]
Cycles – Cold Eye Earth [76]
Robot overlord roundup
The GPT era is already ending – The Atlantic [77]
Great, now the machines understand us – Klement on Investing [78]
Chatbot ‘encouraged teen to kill parents over screen time limit’ – BBC [79]
The phoney comforts of AI skepticism – Platformer [80]
…and an angry retort – Marcus on AI [81]
Will AI eat the browser? – Crazy Stupid Tech [82]
Hard yards on the Internet mini-special
YouTube creators are struggling to survive on ads alone – Sherwood [83]
This is why you want to make your own website – Aftermath [84]
Off our beat
Google unveils ‘mind-boggling’ quantum computing chip – BBC [85]
How Madrid built its metro cheaply [Essential reading] – Work in Progress [86]
Working the nVidia way – Dror Poleg [87]
Elon Musk is building his own town in Texas – Sherwood [88]
The five-minute city: inside Denmark’s revolutionary neighbourhood – Guardian [89]
Stay away from Dr. Google – NPR [90] [h/t Abnormal Returns [91]]
The six stages of cleaning out a parent’s home – Guardian [92]
Assad’s fall was swift. But the signs were always there – W.P. via MSN [93]
Have official targets made exercise a chore? – Guardian [94]
And finally…
“The game is rigged, but you cannot lose if you do not play.”
– Marla Daniels, The Wire [95]
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- For many years the chief investment strategist at giant US bank Wells Fargo. [↩ [103]]