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Negative yields on bonds: what do they mean?

There was quite the flurry recently over the UK government selling its first ever negative yield bond. The idea of paying somebody to borrow your money sounds pretty la la and it isn’t going to settle the nerves of many Monevator readers who can’t see why they’d bother with bonds in a zero interest rate world.

Article over? If only.

There are good reasons to hold even negative-yielding bonds – and plenty of myths to bust about negative yields and negative interest rates in general.

So let’s go through the looking glass into a world where things are not as they should be.

What do negative yields mean?

Negative yields do not mean that you periodically wire money back to the government for the privilege of loaning them your dosh.

The UK’s maiden negative conventional government bond goes by the name of 0¾% Treasury Gilt 20231 and £3.8 billion worth of the blighter was auctioned off on 20 May 2020.

0¾% Treasury is a 3-year gilt2 that pays an annual interest rate (also known as the coupon rate) of 0.75% on its face value3 of £100.

In an ordinary world that means you get:

  • 75p of income every year you hold the £100 bond.
  • £100 if you hold the bond on its maturity date – this is you getting back the original £100 loan you made to the government in exchange for that whopping 75p interest per year.

In negative-yielding bond world though, successful bidders paid the government an average price of £102.38 for gilts with a face value of £100. It’s the price they paid that plonks us into negative-yield territory.

If you bought this gilt at auction and then held it for three years – collecting your 75p annual interest along the way – you still only get the £100 face value back on its maturity date. That means you’d see a £2.38 capital loss on the £102.38 bid price. After totting up your interest payments and subtracting your capital loss after three years, it’d turn out that you’d ‘enjoyed’ a -0.003% yield4.

Overall, you’ve got back less than you paid the government to take your money. It’s as if you’re paying them a storage fee or an insurance premium to look after it for you.

Positive news side-story Just because investors were willingly fleeced on one gilt doesn’t mean all UK government bonds are now being auctioned off with negative yields: 4¼% Treasury Stock 2032 made it off the starting blocks the very next day with a positive yield of 0.321%. Lucky investors!

Negative yields on bonds: there’s more than one way to lose money

Don’t worry if you’ve failed to snag a specimen of 0¾% Treasury. There are plenty of other ways to add a negative-yielding bond to your collection.

  • The UK’s Debt Management Office (DMO) has been auctioning index-linked gilts at negative yields for years.
  • The FT cited a -1.722% yield on a 20-year linker sold in August 2016 and -0.974% on another linker sold in the fateful June of that year.
  • Negativity has only increased since then. Investors accepted a -2.8% negative yield on 0 1/8% Index-linked Treasury Gilt 2028 when it was auctioned on 21 May 2020.
  • A one-month UK Treasury bill was sold off at a negative yield in 2016, too.

Of course, you or I aren’t raising a hand or waggling our eyebrows at the DMO’s chief auctioneer when we go gilt shopping. We buy our bonds in the secondary market, courtesy of our brokers or fund managers. And yields have turned negative for gilts in this secondary market, for maturity dates of two to five years away5, according to the FT’s UK yield curve chart.

At the time of writing the FT table showed a top yield of 0.6% for gilts maturing in 30 years. This yield is a nominal number. Subtract expected inflation (perhaps 1.5 to 2%) and we’re still neck deep in negative returns across the bond board.

Flip the chart to Eurozone bonds, and we have negative yields all the way out to the 30-year mark – and that’s before even considering inflation.

Negative yields on bonds: what kind of yield is that?

The yield to look at when comparing bonds is the yield to maturity (YTM).

The YTM is the annualised return you earn on a bond if you hold it until the ‘end-date’ indicated by the bond’s name. It’s the return you can expect from receiving the remaining interest payments and getting the bond’s face value back, after you account for the market price that you paid for it.

Any bond on the secondary market can potentially inflict a negative YTM if you pay a sufficiently high price for its future cashflows.

Imagine a gilt that matures in two years that currently trades on the secondary market at £110:

  • Market price: £110
  • Face value: £100
  • Years to maturity: 2
  • Coupon rate: 1%

Pop those particulars into a yield to maturity calculator and it will spit back a -3.8% YTM.

So you’ll lose 3.8% annualised on that (fictitious) bond, at that market price, if you hold it to maturity.

YTM helps you compare bonds that differ by market price, maturity date, and coupon rate. But note that as a bond’s price fluctuates, its YTM will change, too

Why invest in negative yield bonds?

The main reason to invest in a negative-yielding bond is the same reason why we’d invest in any high-quality bond: risk control.

Bond prices go up when yields go down, and nobody knows how low negative yields can go. If you bought in at a negative yield of -0.5%, say, it could slide further to -1% and you may make a handsome capital gain when you need it most – in a crisis:

UK intermediate gilt ETF vs MSCI World equities ETF during the Global Financial Crisis (GFC)

Intermediate gilts rise while World equities fall during the GFC.

This graph shows investors fleeing to the safety of UK government bonds as the equity market bombed from late 2007 to 2009. When the market touched bottom at -38% on 6 March 2009, investors were selling off equities and buying high-quality government bonds as they sought a safe haven for their capital. In comparison, the gilt ETF was up +18.6%6 as of 6 March 2009.

This is the main purpose of bonds: to stabilise our portfolios and stop us panicking when equities plunge. They worked again during the coronavirus crash and are more likely than not to go on working when you need them most. Gilts have played their role as financial parachute in a clear majority of UK downturns for over a century.

UK equities fell -71% in 1973-74. US equities fell by 90% during the Great Depression. You best believe that investors will flee into the arms of negative-yielding bonds if the alternative they see is double-digit losses in the equity markets. The worse the crisis, the more you need high-quality bonds, and the less likely negative yields will be anybody’s foremost concern as they stampede for safety.

Given negative yields are a form of insurance premium paid to the government, today’s prices may even seem cheap in the future – for example if the years to come are dominated by secular stagnation and periodic QE injections aimed at staving off deflation.

I’m not predicting that’s what awaits us – who knows – but it is a plausible scenario. It’s certainly not hard to imagine we could be living in a low-growth world for the next decade or more, given where we are now.

Do interest rates have to go back to normal?

Real interest rates have declined by approximately 1% every 60 years since 1311, according to Yale Professor Paul Schmelzing’s paper Eight Centuries of Global Real Interest Rates. See the chart below.

The secular decline in interest rates over 700 years
The secular decline in real interest rates over the last 700 years.

Now that’s a very topline reading of the paper and there are plenty of instances of mean reversion, but you can see in the Schmelzing chart (excerpted by Bloomberg) that the world was no stranger to negative rates in the 20th century, and that the trend line keeps heading down.

Here’s another view: the relentless drop in government bond yields that kicked in from the early ’80s:

Fall in real yields for government bonds since the early 1980s

Source: Sarasin Compendium Of Investment 2020, p.16

On the other hand, gilt yields climbed for 28 years from 1947-1975. Bond returns would likely be hammered if that experience was repeated over the next few decades.

We can cherry-pick evidence all we like, but the critical point is not to believe that history’s path is already set.

The constant refrain after the GFC was that interest rates would return to normal and that bonds would be beaten with shoes. That didn’t happen.

It still doesn’t have to happen. And it definitely doesn’t have to happen just because we think it should, or because that’s what we were used to.

The greater fool

One reason to buy negative-yielding bonds is because you believe you can make a capital gain later when they go up in price. This is an instance of the greater fool theory: the asset has no long-term positive cashflow expectation and so returns rely on you palming it off for a higher price on some other schmuck in the future.

Gold is a great example of an asset where returns rely on the greater fool because it produces no income. And how many people buy gold but have the fear about negative-yielding bonds?

Some investors are happy to buy negative bonds now because they’re betting on central banks jacking the price as they hoover up bonds shed by government QE programmes.

Another source of demand comes from financial institutions such as pension funds and insurance companies that can’t stop gorging on government bonds because they need them to match future liabilities. They don’t really seem to mind if clients have to pay more in order to get over the pesky negative yield thing.

Bond prices could also be propped up if a future government decided that Austerity II was the way to restore order once the post-lockdown bailout has garnered enough bad headlines. They could snap shut the public purse, and constrict the supply of bonds while demand for safe (-ish) assets remained high.

As a passive investor in bond index funds these aren’t bets I can safely make.

I repeat the fact that I do not know what will happen – accepting that is my chief advantage. Because I don’t know what will happen, I’m not about to ditch bonds because interest rates supposedly must rise.

Even as I write this, the UK’s ‘first’ negative-yielding bond has risen in price from £102.38 to £102.51.

You can also read about any number of profitable trades made on negative-yielding Japanese and Eurozone bonds.

And remember that -0.97% yielding 20-year index-linked gilt7 that was issued in June 2016?

Well, investors lapped up another 20-year linker8 with a negative yield of -2.17% that was issued on 14 May 2020.

Here’s what I am doing

  • I’m using a negative real expected return for bonds – I don’t think hoping for the historical average return is realistic.
  • Holding some cash – at least my cash yields are only negative after inflation. The problem is that cash returns don’t spike when equities plunge. But cash has outperformed gilts in some crises, so I maintain a slug for diversification purposes.
  • Holding for the long term – if bond prices fall then you’ll reinvest (ideally) your interest into cheaper bonds with higher yields. Do that for longer than your bond’s duration and you’ll be in profit. (I’ve drastically oversimplified there but that’s the principle.)
  • I’m remembering my response to the coronavirus crash. I didn’t sell. I kept pound-cost averaging into equities. I didn’t have any sleepless nights but I couldn’t rebalance. That suggests my risk tolerance is about right and bonds are an important part of that.
  • I’m not buying long bond funds. Intermediate gilt bond trackers still respond well in a downturn, and won’t be as badly battered as long bonds in a 1947-1975-style rising yield environment.
  • I’m not reaching for yield – I’m not switching any of my high-quality government bond allocation to higher-yielding corporate bonds, junk bonds, minimum volatility ETFs, or dividend aristocrats. More yield equals more risk.

It’s because I don’t know what will happen that I have to buy bonds – negative yields or not.

Take it steady,

The Accumulator

  1. ISIN: GB00BF0HZ991, SEDOL: B-F0H-Z99 []
  2. UK government bonds are generally known as gilts. []
  3. Also known as par value. []
  4. That’s the annualised loss you’d have made on the deal every year. []
  5. Subject to change! Five-year bonds flipped between positive and negative as I wrote this article. []
  6. From 12/10/2007 []
  7. 0 1/8% Index-linked Treasury Gilt 2036, GB00BYZW3J87 []
  8. 0 1/8% Index-linked Treasury Gilt 2048, GB00BZ13DV40 []
{ 73 comments… add one }
  • 1 Chiny June 2, 2020, 10:30 am

    Fascinating that interest rates have been dropping for centuries, near incredible. Still, I’ve been paid for using electricity (negative prices) recently, so I guess the “new normal” has much to surprise me.

    And no mention of Brexit, also amazing, although perhaps the shock of Brexit will be small relative to the shock of the pandemic.

  • 2 palcu June 2, 2020, 10:44 am

    One question that has been bugging me, if we let aside the greater fool theory and think all players are rational. Wouldn’t it be possible to construct an index that doesn’t contain bonds with negative yields? Yes, it would probably change the duration in aggregate, but I also imagine that you “could” replace the negative yield bonds with a money market account. It feels as if this would have better returns, since you’re just not losing money on that “negative trade”.

  • 3 Ben June 2, 2020, 11:07 am

    Too much is made of the “flight to safety” mechanism for bond returns in a crisis. Expectations of a rate cut do more to explain the outperformance and this wasn’t mentioned. This is important because a shock-and-awe rate cut is now impossible. Rates would have to go super-negative and there have been real problems when even small -ives have been tried.

  • 4 Alistair June 2, 2020, 1:00 pm

    Interesting article, though it hasn’t really answered why a rational investor would prefer a negative yield over cash. If all investors prefer cash over a negative yield, the greater fool theory would crash and burn. Is a government bond really safer than cash?

    Negative electricity or oil prices make sense because you have to do something with the product (Power stations are a pain to shutdown and start up again and do you have a tank to store that oil?). But if cash is an option, I can’t see a rational reason for the negative yield.

    The only way I can see this working is if we don’t have rational investors. We have the Bank of England (which is happy to take the loss) and pension & index funds that are following pre-set rules and buying a set amount regardless of the price.

    Can anyone see any other reason to purchase a negative yield if cash is available?

  • 5 Keith June 2, 2020, 2:05 pm

    @Alistair. Some Swiss banks have been charging clients for keeping large amounts of cash on account (between a half and one percent). You could keep the cash yourself, but that becomes a security issue, or it might work out more cheaply to rent a safe deposit box to store it in large denomination notes.

  • 6 Matthew June 2, 2020, 2:13 pm

    How negative can they plausably go before it outweighs any flight to safety market timing advantage?

    If you had so much cash that you exceeded FSCS limits, or were an organisation, I could understand, also keeping cash at home incurs an insurance cost, although that cost does have a limit if people were comparing it to gilts for the purpose of paying for safe storage

  • 7 Christian June 2, 2020, 2:23 pm

    @Alistair @Keith another issue is that depositing your cash in the bank is also a risk if the bank fails. (You are effectively lending your deposit to the bank.) As an individual you have to be relatively wealthy for this to be an issue, as the FSCS covers your deposit up to £85,000 (per bank) and although this is not officially government backed, I think they would be likely to step in if the FSCS was suddenly unable to cover its obligations as otherwise there would be a run on other banks.

    This means your cash is effectively more or less as safe as in a Government bond, so you can enjoy your 1% nominal interest, or whatever the best rate currently available is.

    However if you had lots more money, or aren’t an individual (e.g. a pension scheme), you’d have to spread out your cash loads to get the same level of protection. You might then invest in 3-month government bonds (to have the same level of liquidity and very limited exposure to interest rate changes), which currently only yield about 0.013% or basically 0%. The risk of default is similar to a bank deposit for the rest of us, but the interest rate is 1% less. This spread is nothing new and likely to continue.

  • 8 AtlanticSpan June 2, 2020, 2:26 pm

    I’m 50% in a world equity tracker 25% in intermediate Gilts and 25% in cash. I don’t know whether that is reasonable, and as a passive investor,I don’t care. In the 10 years I’ve been investing,I’ve done reasonably well.
    When I started, I fretted about my allocation,and where we were in the economic cycle, until I saw Jack Bogle in a YouTube clip stating that ‘nobody knows nothin’ ‘ I decided fine,I’ll go with the the level of equity exposure I’m comfortable with, and adjust my portfolio every couple of years, and that is what I’ve stuck with ; I’ve finally learned to ignore the noise!

  • 9 PJM June 2, 2020, 2:30 pm

    What’s the advice for those of us who are inexperienced investors, who prefer to be hands off, and are using Vanguard LS 60 (or VLS40) to build a pension pot?
    In my own case, a pot I will begin drawing from in a year or two.

  • 10 Alistair June 2, 2020, 3:12 pm

    Makes sense. If that is the case, wouldn’t there be a limit on how negative the yields could get (the cost of storing the cash)? In that case the greater fools theory doesn’t have much to work with.

  • 11 Tony June 2, 2020, 3:36 pm

    Just the article I was waiting for, thank you. And the links. More reading to do.
    Alistair: re “it hasn’t really answered why a rational investor would prefer a negative yield over cash”. This has been one of my inexpert thoughts but isn’t there comment here: “They worked again during the coronavirus crash and are more likely than not to go on working when you need them most.” And “The problem is that cash returns don’t spike when equities plunge. But cash has outperformed gilts in some crises”. We know interest rates are dropping further as well. My conclusion at this point is it’s not bond versus cash, it’s consider both as diversification of risk and for the possibility of some returns. Though I want to read further about international bonds. And linkers. And I well recognise my understanding is pretty limited. Which is better than not knowing that (not a reference to you btw).

  • 12 The Investor June 2, 2020, 3:56 pm

    @Alistair @Tony @Ben — The reason for holding high-quality government bonds over cash is that they can still deliver gains if their yields fall further (and prices rise), especially with longer-dated bonds, should markets fall and investors go risk-off.

    They just did this at the start of 2020, despite endless commentary beforehand saying their power to deliver any kind of cushioning was spent.

    Whether you think this is likely is up to you; a passive investor should probably take the market’s judgement to some extent, tempered by the acceptance that there’s some element of distortion going on through central bank action and forced buyers that might encourage them to split-off some of their holding into cash.

    Believe me, most people, including virtually all Monevator readers that have expressed a view, have been (wrongly) predicting bond prices must fall / yields rise for nearly a decade (and many pundits for much longer before that).

    I felt moved to write an article working out how much you’d lose in a bond market crash… in 2012!


    As Tony says, one can always split ones holdings between bonds and cash, rather than taking what amounts to a heroic ‘anti-market’ stance that most private investors are ill-placed to make by holding no gilts/treasuries. Personally that’s what I’ve been doing, albeit overwhelmingly favouring cash over bonds at that when I’ve wanted to de-risk. (And it’s cost me! But I’m an active investor and my decisions have all sorts of costs and benefits…)

    We’ll follow up this article with some more on how bond yields and prices might respond to various regime changes in a low interest rate world in a future article.

  • 13 ZXSpectrum48k June 2, 2020, 4:04 pm

    Some of you guys seem to be falling into the same trap: comparing cash at say 1% and a 10-year bond at 0% and jumping straight to the conclusion that cash is good and bonds are bad. You seem to be missing the duration mismatch. A 10-year Gilt is (being horribly simplistic) a discounted geometric average of policy rate expectations over the next decade. For all you know, the BoE cuts rates to -5% in the next year and keeps it there for a decade. Yes you earn 1% for the next year but the you find the depo is at -4% for the next 9 years. That’s rollover risk. The 10-year Gilt at 0% would look great value in that scenario.

    @Alistair. Players in the fixed income markets are not being “irrational” as you seem to assume. This is not equities. Many players in these markets are not even investors, they are hedgers. Their aim is risk transfer, not investment returns. This why the “efficient markets hypothesis”, the assumption of “risk-neutral” investors etc don’t really work. We have is a clear segmentation in the aims and objectives of different players. What seems irrational from your perspective is perfectly rational from theirs.

    Moreover, you’re making large assumptions even about the investors. The real money investor may not like a bond at 0% as much as they like it at a 5% yield. The leveraged investor, however, may not see it that way. If they fund at -1% and can buy at bond at 0%, it’s no different than if they fund at 4% and buy a bond at 5%. In both cases the spread is 100bp. Note that fixed income markets are more dominated by funded investors than equity markets.

  • 14 Matthew June 2, 2020, 4:14 pm

    Perhaps gilts should now be held individually rather than in a fund, because if the secondary market value can surge in some years by double digits, surely it’s hypothetically possible it could drop by as much (even if we dont have a precedent for it) – and it might be good to have the option of holding till maturity in this circumstance.

    I’m thinking that inflation could hypothetically take off by itself regardless of base rates or qe if consumers decide all of a sudden to borrow &spend, maybe the next generation will not be savers – I get the feeling that low rates pretty much imply that society currently saves too much & spends too little

  • 15 The Investor June 2, 2020, 4:29 pm

    @ZXSpectrum48k — Very useful points as always, cheers.

    However from the perspective of a private and passive investor, such as the majority of readers of this blog, wouldn’t it be fair to say that as good a working assumption as any other for them (given they’re not expert bond market watchers etc) is that that 10-year bond yield should already very largely bake-in whatever expectations / probabilities are given to the Bank of England cutting interest rates to -5% next year? And similarly for all bonds, up and down the curve?

    In that scenario duration is still important, as you rightly remind us — if say you had to match a known liability in X years time with a risk-less investment now, you’d look at the appropriate bonds and lock-in your return today etc.

    But from the perspective of a passive private investor holding some variation of, effectively, a 60/40 portfolio, to tune their risk/reward expectations, if the yield curve of super liquid super-safe UK government bonds is presumed to be very largely efficient (i.e. they’re not trading micro-deviations in one off-the-run gilts in the market versus another or whatnot) then does not thinking of cash and bonds *at these very low rates* as more interchangeable than in the old days become more understandable — except, as I say, for the ability of bonds to act as shock absorbers (and to do that shock absorbing, by definition, when there’s a market *upset* that *wasn’t* efficiently priced into the bonds beforehand?)

    That’s how I see it anyway. I believe the majority of readers of this site following traditional passive allocation strategies still need to hold cheap, effective non-equity ‘cushioning’, and I think much (maybe most) of it should be high-quality bonds of some particular duration to suit (probably longer than they’d think, due to how longer duration responds in a crash).

    But I do also think cash has a role for private investors, particular as they can lock in rates for some years with fixed-interest accounts and enjoy 100% FCSS protection up to £85,000 per institution. 🙂

  • 16 Matthew June 2, 2020, 4:54 pm

    Sorry for 2nd post, found this saying that low rates make people save more;


    I suppose if income is expensive, people are rising to the task and saving more to avoid pension deficits, rather than being encouraged into spending. Things could change quickly when rates finally do start creeping up again – we almost started to see it! Rises could self perpetuate, by causing more spending, and lower pension deficits discourage saving

  • 17 Grumpy Old Paul June 2, 2020, 6:10 pm

    I hold (non-corporate) bond funds within my ISA for several reasons:

    a) To reduce the impact of a sharp equity decline immediately before my demise on the size of my bequests to my legatees.

    b) To facilitate rebalancing within my ISA after a sharp equity decline and therefore provide a small boost to my overall returns. This assumes that the “traditional” behaviour of bonds during an equity downturn persists.

    c) To reduce the likelihood of me panicking during an equity downturn and increase the probability of my adherence to my long-term strategy and process.

    d) I assume that, at some point, it will no longer be possible to make further contributions to an ISA.

    e) Index-linked bonds provide a measure of protection against inflation and also seem to have little correlation with anything else.

    I’m an old geezer, but if I were young, bright, confident and well-heeled, I’d probably hold a lot of cash and just equities in my ISA. I don’t subscribe to the adage ‘hold (100 – your age) per cent in bonds’ partly because I dislike mindless mantras in general but also because I recognise there are huge differences in personal circumstances and, individual psychological traits and I note the increase in longevity over the last century.

  • 18 The Rhino June 2, 2020, 6:14 pm

    I built a Lars style ETF portfolio last Nov with 2/3 of a lump sum. Other 1/3 I built a dividend hero type IT portfolio.

    IT experiment got smashed and is still deep underwater. Lars experiment is now up again. At a very simplistic level the fact that the bonds VGOV and IGLT went up 10% while VWRL and HMWO tanked 20% was really helpful psychologically. I wouldn’t have got that from cash.

    Very interesting to hear about not being able to rebalance. I couldn’t either. That’s why I’m glad of the life strategy portfolio. That could act without my say so.

  • 19 NewInvestor June 2, 2020, 6:19 pm


    I’m remembering my response to the coronavirus crash. I didn’t sell. I kept pound-cost averaging into equities. I didn’t have any sleepless nights but I couldn’t rebalance

    As a newcomer to this arcane world and very much on the learning curve, I’m curious about why you decided you couldn’t rebalance. What stopped you? Thank you for enlightening me.

  • 20 The Rhino June 2, 2020, 6:28 pm

    On the rebalancing, mainly it’s the thought of buying into something that’s going to lose another 30% in short order. You hesitate for sure. I also had the additional concern of being freshly unemployed with a mortgage due to expire in Sep 2021, so I was half thinking I want those bond funds to pay down mortgage if need be, not flogging them to get balls deep in more equity.

    It was a really informative month. I think I learnt a few bits and pieces.

  • 21 Richard June 2, 2020, 6:53 pm

    Some really interesting points here. I have to admit, I hold bonds because it is the ‘thing to do’. I never really understood why I should hold bonds over cash when most savings accounts pay more than the bonds. During accumulation phase, do I really care about bonds going up when shares go down as this up is not something I will ever realise (assuming they will go down and up down and up during accumulation). I meam I guess there is a pyscological argument there that bonds keep your portfolio value higher during market crashes than cash does.

    I think @zx is the best reason I heard so far – to reduce the impact of interest rate drops. But what sort of duration bond should I hold to really protect against this (assuming I could fix my saving rate for a period of time instead). The only other argument I see is if you have so much cash you are struggling to get decent rates on it all or keep it safe (deposit limits).

    Decumulation probably changes the picture, as @TI says you move into the need for a fixed amount every year so long bonds to protect against lower rates and are longer than saving account fixes begin to make sense. But that is a long way off at the moment so I havent really thought about it too mucj

  • 22 c-strong June 2, 2020, 7:36 pm

    An excellent article. Bonds are something of a bugbear of mine (yes, I’m that interesting).

    It’s really the mindless “you should have x% bonds as part of your portfolio” that you hear a lot (though not here!) that gets me. In my view if:

    (1) You have 15+ years to invest; and

    (2) You understand that equities go up and down a lot, but the correct course of action is to ignore these movements and stay invested;

    – then 100% equities is unequivocally the right option.

    And yet you often hear people saying “time in the market beats timing the market” and “I have 30% bonds” (or whatever) in the next sentence. Sure, your volatility will go down – a bit – with a substantial bond allocation but you are significantly hurting your expected return. I sometimes wonder if the people who say a real yield of ~ -2% is a reasonable price to pay for lower volatility would say the same if it were -5%? What about -10%? At some point you have to say it’s not worth it.

    But so much of the advice that gets bandied around was formulated when you could expect a moderate, though low, real return from bonds. And holding bonds on the basis that rates may decline further is mere speculation, which the sensible investor should want no part of.

  • 23 Juan June 2, 2020, 7:49 pm

    Isn’t the point of the bond allocation to have an asset that will appreciate in value precisely when equities are tanking AND this allows the purchase of equities at a point they are likely to give their greatest returns.

    Yes bonds will dampen portfolio volatility but the real value is that rebalancing allows you to lock in future gains which outweigh the reduction in return from holding the bonds.

    Of course that only works if you actually rebalance!

  • 24 Mousecatcher007 June 2, 2020, 8:25 pm

    For SIPP investors cash pays 0%, ie a negative yield in real terms. And cash won’t zig when equities zag. So it’s AA and AAA bonds for me, not cash.

  • 25 Alistair June 2, 2020, 8:46 pm

    Having re-read my comment in a different light I want to clarify that I am not assuming the market is being irrational, only that I can’t see the reason and had hoped that the responses here could help (thanks everyone).

  • 26 Alistair June 2, 2020, 8:52 pm

    Thanks and I look forward to the future article.

  • 27 Griff June 2, 2020, 9:33 pm

    I have a glide path pension with a retirement age set to 60. I am now very close to that age. At the beginning of the latest crisis my pension value dropped about 6 %, but now is actually higher than it ever was. What I can’t grasp is if gilts move opposite to equities i. e investors move to the save haven. Can I expect my fund value to drop as we move out of the crisis and equities become supposedly safer and they move up. In short how does a fund invested I assume primarily in gilts grow in a normal ish environment. I understand equity growth and how say a fund 100 % in equities would grow but not sure about how a majority gilt fund would grow over time. Thanks for any answers I may receive.

  • 28 Ruby June 2, 2020, 9:43 pm

    @ c-strong – a low bond allocation in the abstract is one thing, but it’s quite difficult to judge one’s stomach for the gyrations of the equity market unless one has been through a serious market lurch with meaningful skin in the game (maybe you have) and @ The Rhino makes this point above. Sleeping at night matters. Related to this, return or profit maximisation is not what all of us are about. Some are lucky enough to be able to afford a 40% slug in bonds because they are happy at a modest withdrawal rate or have a big pot and don’t need the extra equities might provide – c/f sleeping at night. If you’re young I agree – buckle up, don’t peak, and invest through the highs and lows, but if you’re older and more sedate…………

  • 29 Richard June 2, 2020, 10:13 pm

    @c-strong – that was my original approach. But then I felt I must be missing something so put a token 5% into bonds. That said, I keep cash as well for emergency and to sleep at night.

    @mousecatcher – if pension is your only form of ‘liquid’ wealth then yes, you are kind of forced into bonds. But if you have investments outside of the pension why not be 100% in equities inside the pension and hold the cash to required amount outside the pension which also doubles as an emergency fund (incidentally I can think of good reasons, but most are for specific use cases).

    I think there was an article on Monevator comparing cash and bond returns. Can’t find it now (not the one I am thinking of at least but perhaps it is all in my head). In the back of my mind I have this feeling that these comparisons often use some cash ‘proxy’ with returns far below that of what you could get in a Best Buy saving account. I don’t know if there is a comparison looking at the best savings account rate you could have got each year and see how bonds perform against that (appreciate this could vary depending if you fixed or if you have vast amounts of cash that you exceed best buys account limits – but probably not a major concern for many small time investors).

  • 30 The Investor June 3, 2020, 12:33 am

    I think there was an article on Monevator comparing cash and bond returns.

    @Richard — I think you might be thinking of this guest article from 2012 comparing cash returns with equity returns? It looks at, among other things, the return boosting capacity of Best Buy accounts.


    I think there’s something it in. (See this from me from 2010!). But it must be said the environment for cash savings has significantly worsened post the financial crisis. Obviously market rates have crashed, we’re in a near-zero world. But also banks before the crisis were over-levered, chasing customers like crazy, lending to anyone etc. These were also factors that led to the astute being able to enjoy those high interest rates on cash deposits.

    I still look back fondly to borrowing five figures on one 0% credit card, moving it through a different conduit card (forget the term we used then) into my current account, and then shuffling it off to a savings account to earn 6% or whatever it was back then. But it really was a different world.

  • 31 Naeclue June 3, 2020, 1:39 am

    A few months ago I would have been 100% in agreement with this article, but profound changes have taken place and I recently sold all our gilts and US Treasuries, for a number of reasons.

    Firstly, there is no universal law that says government bonds rise when equities fall. That can happen and it would not be unreasonable to say it often does, but it cannot be guaranteed. In the biggest bear market in recent times (1973/74), gilts also fell substantially, but short dated bonds/cash produced positive nominal returns. In fact across the whole of the 1970s, short dated bonds/cash gave a better return than longer dated gilts.

    The second point I would make is that gilts trading at say a 4% GRY do not behave the same way as gilts trading at 0% GRY. The price of a 15 year gilt trading at 0% GRY is nearly twice as sensitive to yield changes as a 15 year gilt trading at 4%. In other words the risk rises substantially as yields drop – bigger gains/losses are made for the same yield change.

    The third point, already made by others, is that institutional investors cannot get the returns on cash that retail investors can. If they put cash in a bank, they become creditors of the bank. They have no more protection than if they had bought the banks’s senior unsecured bonds. Retail investors can get FSCS protection, currently up to £85k per bank and up to £1m with NS&I, which is backed by the Treasury. Savvy retail investors can usually get better returns on cash deposits than institutional investors can on short dated gilts. Retail investors do not need to join in with the frenzy for bonds as they have a perfectly viable alternative option for dampening portfolio volatility.

    Finally, I no longer consider gilts as a rational investment as the expected return is lower than is available on retail cash deposits. Gilts can beat cash, but for that to happen yields have to drop into negative territory. That is speculation, not investment. The risk/return profile of retail cash deposits now looks substantially better than that of gilts.

  • 32 BeardyBillionaireBloke June 3, 2020, 3:13 am

    > work out more cheaply to rent a safe deposit box to store it in large denomination notes


  • 33 never give up June 3, 2020, 7:32 am

    I must admit, as a novice investor this type of stuff absolutely terrifies me. It really is the nemesis to my FI super hero. What should be the low risk part of my portfolio causes me more stress than the stocks part. At least with stocks I know they can plunge by double digit percentages, and I have some confidence that given time they are likely to recover. Bonds funds however, make me feel even more insecure than when I was once forced into a lead role in a school play, ironically back in a time when I would have felt very secure in bond funds. Bah, if only I could have extracted a higher savings rate out of that paper round.

    In my pension I only have access to long term government bonds and the Index Linked variety (intermediate and short term bond funds are available, but their fees are more than 1.25% so I keep away) and in my ISA I’m using VGLS 60. I’ve even recommended to my parents to use VGLS 20 but for all I know 80% of this is considerably riskier than in the years gone by.

    I have an awkward gap to bridge before a company pension will come on line. I’m really hopeful TA’s excellent ‘ISA Pension Split Series’ from January will continue. Part 5 mentioned the liability matching approach would be covered next time, which I think will be right for me, but part 6 never came (understandably because of events). Maybe I’ve just got to accept I require the majority of my gap in cash and I will just need to work longer to cover the inflation threat. Alternatively maybe I need to use FI to escape the rat race, but accept I need to do something part time until closer to a ‘normal’ retirement age, in order to minimise risk around some of this investing stuff.

    I appreciate some of the comments on here can on occasion be a bit negative, but thanks again to TI and TA from someone you have genuinely helped. I’m sure there are many others like me out there that probably never post to tell you the same.

  • 34 The Accumulator June 3, 2020, 8:38 am

    @ New investor – global equities went down 25% in the blink of an eye. There was every reason to think they could go down another 25% from there. And then – who knew? – another 25% down… That stayed my hand. I needed time to breathe. It felt better to do nothing than to jump in. Especially because I’m at a critical point in my FI journey where wealth preservation is more important than making a quick buck. I was happy to pound cost average in new cash and pick up some cheaper equities that way. Did I do the wrong thing? I don’t care. Emotionally I did the right thing and that’s a major part of the battle.

    On cash: my short bonds did zip at the height of the crash. Just stayed flat. To be expected. Intermediates did a decent job of counterbalancing my paper losses. I was very glad to have them. If I’d been entirely in cash I’d have been much more stressed.

    @ Never give up – great name. I agree bonds feel like an Alice-In-Wonderland deep and bizarre rabbit hole when you start to research them and even for many years after that. You’ll feel a lot better after learning more about them. A decent book would help, Larry Swedroe wrote: The Only Guide To Bonds You’ll Ever Need. Sadly it doesn’t quite live up to the title but it’s very helpful. I will continue the SWR series – it just didn’t feel right given recent events but I guess if going to BBQs is alright then maybe so is writing about SWRs. There’s nothing wrong with LifeStrategy 60. Maybe one day you can make some changes when you’re more confident but you’ll likely be fine if you never do. I put my mum in LifeStrategy and she’s beaten my ‘fancy’ portfolio for years.

    @ Naeclue – you make some excellent points. The problem is believing that something is now useless when as someone eloquently said earlier: “None of us have a chuffing clue”.
    The answer for many should be diversification. No doubt your personal situation warrants getting out of bonds but I don’t think it’s a good universal strategy.
    You’re dead right that bonds don’t have to go up when equities go down but they so often do. I wrote about when they have and haven’t helped here:

    The outcome of this only confirmed to me I needed some cash, intermediate gilts, linkers, and gold wouldn’t go amiss either. It can all help me weather a storm, especially when I can’t predict what direction it will come from. What proportion do I need? That really turns on how soon you’ll need the money, how wealthy you are, what other income you bring in and how much risk you can handle.

    You’re right that low yielding bonds offer more scope for gain or loss. That’s why many will still be thankful for their bonds if rates go down in Major Crisis part 2.
    By ditching bonds you’re speculating on the future yourself. There are many legitimate reasons to hold onto bonds and I don’t think that admitting we’re blind to the future is speculation. For clarity, I respect your views and your personal reasons for your move, this is just my counterargument – I’m not having a pop!

    @ Juan – the main point is to stop you panicking during a crisis. If you go on to rebalance then yay you. Still, you could rebalance and watch the market get cut in half again. Then panic. Investors in the deaccumulation phase will be using their bonds to pay the bills.

    @ PJM – I think you’re thinking along the right lines. You could hold equal amounts of LifeStrategy 40 and 60 to end up with a 50:50 equity bond allocation or you can decide that you want the possibility of more growth but more risk in your life and that would be LifeStrategy 60. This might help: https://monevator.com/how-to-estimate-your-risk-tolerance/

    @ Griff – you’d expect to grow more slowly with a bond dominated portfolio in the long term. These might help:
    Note, expected returns are generally more pessimistic than when these articles were written but expected returns are not forecasts either. Things could be better, or worse.

  • 35 never give up June 3, 2020, 9:51 am

    @TA, thanks I’ll take a look at that book. To be fair “The Ladybird book of investing in bond funds” would probably be more my pace, but unfortunately they don’t do one.

    I appreciate series such as your SWR one must take a considerable time too prepare, and I understand about the timing. It’s great to know it isn’t forgotten though and will be continued at some point. Be assured I’ll be reading it at least half a dozen times when it comes through.

  • 36 Seeking Fire June 3, 2020, 9:56 am

    Some really good comments here to follow a great article. Personally I think understanding this article is key to understanding asset prices so well worth reading a couple of times. Interest rates underpin valuation for other assets.

    “(UK) Bonds are on a bed of nitroglycerine”. Or so said Bill Gross at Pimco in 2010. And that has turned out to totally incorrect. So the so called experts may not know more than you. Annoyingly he has made a load of cash out of it though.

    Naeclue has made a good point. The technical term, I believe, is convexity. Bond pricing becomes increasingly sensitive as you head toward zero. So zero coupon bonds have the highest convexity. There is an argument to buy the longest duration bond you can find to hedge yourselves against interest rates falls because in that case you don’t need to allocate so much of your portfolio to bonds to obtain the hedge. Of course it can easily work the other way.

    Cash and bonds are very different. I hold cash for liquidity. I hold $TIPS for duration (interest falls if it happens acknowledging if yields rise they will fall) and hedging against inflation risk. As well as a personal view that the £ will be structurally weaker against the $. Also $TIPS are ‘cheaper’ than ILG with a YTM that’s only just negative vs ILG that are now quite significantly negative.

    The negative YTM for bonds has pretty profound implications. A 4% SWR does not look robust in this environment with any meaningful allocation to bonds – at all. It does not feel like taxes need to rise if governments can be paid to borrow. It is harder to persuade children to save when the interest rate is zero and in real terms they are losing money. Put a risk free rate of return of zero into a DCF and asset valuations are very high – hence why equity valuations may not be unreasonable.

    I see no structural reason why interest rates can’t go increasingly negative…at least for a while. After all, let’s say I’ve got a million £ / $, why shouldn’t I have to pay some one to keep it safe – where else am I going to put it? That’s v hard to acknowledge but I feel once you get your head around it, it’s quite logical. The q is how far can they go negative – negative 10% – no way, negative 5% – probably no way – negative 2% – yes maybe. I think we are nearer the end than the beginning of the bond bull market but I know nothing so I allocate to bonds.

  • 37 The Investor June 3, 2020, 10:02 am

    We all need to realize our attitude towards all this will in-part depend on our age/risk profile.

    The maths doesn’t change, but you do.

    At some point in February, I hit my long ago set (and pretty notional) ‘number’, and even took a screenshot of the entry in my Google spreadsheet in the vegetable aisle in Waitrose. By mid-March that felt like a dream, after I’d slumped 25%+ along with everyone else. Ten weeks on I’m back and more (just!) but it’s with a different-looking portfolio.

    At some point during this bear market I realized — emotionally, not mentally — that I probably shouldn’t keep doing this.

    I’m older, I have that mortgage, and I have something to lose now; or as Bernstein (I think?) would have it, on one measure I’d already ‘won’ the game.

    Of course you keep changing the game as time goes on (or you do if you’re like me haha) — the ‘number’ grows, you’re doing it for fun, you want a five-year track record of outperformance so you can convince your hedge fund friend to give you eight-figures to get you started, you decide you want that holiday home in Italy instead of Cornwall, you fancy a weekly meal out when you retire, you don’t want to assume the State pension will be around for people with savings when when you’re 65+ after all. Pick and choose and add your own to suit your circumstances and view.

    And I see that in myself, too. But I decided it was time to get serious about not drifting towards 95%-100% equities every time markets get going again in the blind pursuit of maximum returns, as I have done for nearly 20 years.

    My progress here has fluctuated, but currently I’m at 70% equities so I’m not doing too badly. (This is down from 85% or so in equities just a few weeks ago though!)

    So I very much recognize the repugnance at buying and holding assets that seem primed to deliver nothing. As a market-crazed active investor who has watched my portfolio value daily (and who used to capture it to logs every evening at market close) and who benchmarks his portfolio against four different equity targets, none of which include fixed income, hauling around the deadweight of cash and bonds can feel miserable.

    But it’s not there to deliver return.

    If equities, which still dominate my portfolio by asset allocation, do well, I’ll do well. If equities crash I’ll do a lot less badly.

    If my portfolio falls 30% I’ll need to see a 43% recovery to get back to where I started. That compares to needing a 100% recovery if the portfolio falls 50%. This is the maths that increasingly matters as you age.

    Of course, I’m a naughty active investor. Right now gilts (intermediate) for me are at just 4%, and cash is at 11%. I have a 4% slug of hedged and unhedged US TIPS. I have 6% chunk of gold. I own several actively managed fixed income investment trusts, tending towards the junkier end of the spectrum. Little of this comes endorsed by @TA! And while I think I’m buying cheap, it will all fall more than 100% gilts if there’s another crash.

    But luckily for me, a long time ago I renounced all-or-nothing ‘hero’ bets of all kinds. I don’t run a focused equity portfolio, despite lots of evidence it’s the best way to go for anyone seeking alpha, which is what I’ve been doing (for my sins) all these years.

    I see very little benefit of having the 40% of a 60/40 portfolio in cash, say, versus 20% in intermediate gilts and 20% in cash, or even 10% in hedged/unhedged TIPS, 15% in gilts and 15% in cash.

    Why not mix and match? Just how much smarter than the market do you think you are? 🙂 The upside doesn’t vary much with these different combinations, and nor does the downside, in the grand scheme of things, but the tails of the outcomes you face are curbed.

    Again, I remind passive investors that I’m (somewhat oddly on this site I know) an active investor, so it’s easier for me perhaps to take this kind of hybrid approach — and it’s totally nailed-on that my allocation will continue to vary, on my whim, at a pace that would seem frenetic to my co-blogger. So just take these musings for what they’re worth! 🙂

    (I thought I’d written a post about why you should never go all-in / all-out of anything in investing, but I can’t find it. Perhaps it will come in the future! 🙂 )

  • 38 xxd09 June 3, 2020, 10:06 am

    Everyone is at a different stage in their investing career
    I am old(73) retd 17 yrs and actively read this and other financial blogs on a daily basis-even contribute a little
    I have long realised at the level of the amateur investor trying to work out what is going to happen going forward is impossible-it’s just gambling
    Made my pile so 30/65/5 -equities/bonds/cash -been at this asset allocation for many years
    Did nothing in this latest downturn once again -a good policy?
    In illiquid markets I am not going to day trade on a barebones platform
    All you investing work should be done before the crises hit-asset allocation set/written plan in place -sit it out
    Portfolio now back to pre downturn levels
    One bond fund only -Vanguard Global Bond Index Fund hedged to the Pound (VIGBBD)
    Averaged 4.5% pa since 2009
    So low volatility-portfolio protected (and some return as extra bonus)
    Too simplistic?
    Probably will see me out

  • 39 ZXSpectrum48k June 3, 2020, 10:38 am

    @TI. Regarding my previous post. My issue with some of the comments is that they show a severe dichotomy, even a hypocrisy. I’m an active investor. I don’t think active investing is a mathematically zero net sum game as you do. I also don’t believe markets obey some efficient market hypothesis. In fact I’ve staked my career on that. Moreover, at a personal level, over 25% of my portfolio is in hedge funds, I actively invest in most forms of fixed income and I’ve been structurally long some form of long-duration fixed income for 20 years. So if I say Gilts are expensive, their real yield is too low, that EM local bonds are better value, then that’s sort of what I am.

    Against that we have a number of commentators here who are normally part of the “fundamentalist passive” wing. Markets are an efficient zero net sum game. Mention active investing it’s a blasphemy. You need to be burnt at the stake.

    Yet mention Gilts and suddenly they all have a view. Suddenly investing in Gilts is irrational; it’s just speculation, it offers no value vs. cash. I wonder if these the same people who, rather than be long 30-year Gilts and make 9%/annum return, instead were long the FTSE and made just 4.1%/annum for the last two decades. Constantly saying bond yields are too low. The’ve took an active view, it utterly failed, yet they never took a stop-loss. Perhaps they should stick to passive investing!

    In that sense I’m totally with @TA. He doesn’t debate the pros and cons. He just owns some Gilts. End of. He’s passive so it’s a totally consistent view. Where I think he’s wrong is to imply that in some way Gilts are relying on a “greater fool theory”. Gilts are just pricing some probability distribution for rates and that distribution includes scenarios where rates are negative. There is no foolishness, irrationality or speculation. This is why those comments saying cash at 1% is better value than Gilts at 0% are in fact just taking an active view: the view that cash will stay positive. It might but it might not.

  • 40 never give up June 3, 2020, 10:45 am

    @xxdo9, That sounds really good to me. I see from reading one of Jack Bogle’s books that he had an allocation for the last 20 years of his life that is very similar to yours. I wonder what bond funds he used and what he would do now given interest rates.

    I do always wonder why there isn’t a Vanguard LifeStrategy 0 fund too. Surely a well diversified bond fund containing a sensible allocation to the various types of bonds would be really useful to pair with a global stocks fund. I expect there is a non-investing reason, marketing for example that is the reason why.

  • 41 Naeclue June 3, 2020, 11:19 am

    @Seeking Fire, yes convexity increases as yields drop, but it does not peak at zero yield. It carries on going up as yields go negative.

  • 42 The Investor June 3, 2020, 11:22 am

    Against that we have a number of commentators here who are normally part of the “fundamentalist passive” wing. Markets are an efficient zero net sum game. Mention active investing it’s a blasphemy. You need to be burnt at the stake.

    Yet mention Gilts and suddenly they all have a view. Suddenly investing in Gilts is irrational; it’s just speculation, it offers no value vs. cash.

    Well I agree with you there 100% @ZXSpectrum48k. 🙂

    I’ve also pointed out before the cognitive dissonance of decrying active investing in shares as delusional on the one hand, and then believing you can outwit the deepest most liquid markets in the world (the government bond markets) on the other hand.

    I suppose one defense might be that because they share my view that active investing is a zero sum game (not investing itself, of course) that they see a claim that one can expect to outperform on a risk/reward basis from stockpicking as delusional, or at least a poor bet, whereas asset allocation is a different matter.

    The likes of Lars Kroijer, Cullen Roche, perhaps yourself, though, would point out that passive asset allocation is also an active decision.

    The total global market represented by all investment $/£/Yen/Whatnots has said this morning that today’s prices are the best risk/reward reflection of where the weight of money and opinion thinks that weight of money should be invested. *Passively speaking* and efficient market-ly speaking, where one sees anomalies, one probably doesn’t understand the risk/reward judgement being made.

    So I suppose the purist passive view would be to weight an equity/bond/whatnot split by the share of assets in equity/bonds/whatnots of the total global market, and to frequently rebalance.

    In practice this quickly gets you into difficulty because so much stuff is a guesstimate (e.g. unlisted residential property on a global scale, smallholdings in the developing world etc). Hence passive investors use best-guess models that get the job done. (Most simply, the 60/40 portfolio).

    But certainly “I hold no bonds because it’s dumb to but I invest in trackers because outwitting the markets is a Fool’s errand” does seem at least more-than challenge-able from a passive intelligensia perspective.

    With all that said (or indeed because of it!) I stand by my previous comment that a passive investor can/should probably presume the 10-year gilt yield (say) incorporates the market’s best estimate of the chances of big rate cuts etc.

    As an active investor you (and I) are entitled to have a different view and to see our returns fall accordingly, for good or ill, but with a passive mindset I think it’s the most intellectually coherent stance.

    But even then I’d still mix and match assets, as I just wrote above, because why not? Little extra downside, little upside lost, tails trimmed, spreads the risk of any particular view being wrong. 🙂

  • 43 Richard June 3, 2020, 11:22 am

    @ZX – surely asset allocation is always active, even if you invest in passive funds. Unless your portfolio exactly replicates worldwide assets distribution. I think bonds are sold (to the novice at least) as low return assets designed to reduce volitility. I remember looking at it in this light and thinking why would I take bonds over cash when the bonds returned say 1% and the saving account 2%. And I can tap into the saving account anytime without fear of realising capital losses (esp when young and not much to name anyway). Appreaciate bonds could return a capital gain when stocks dropped but again, as most of my portfolio was aiming for long term stock growth what use was this short term benefit – other than @TA’s feeling less nervous about the drop.

    Also, I agree if I put all my cash into bonds 20 years ago I would be laughing (like if I bought a London flat). But if my cash was dripped into the bonds over the 20 years would the picture still look so rosey compared to cash? I would assume the average rate would be much higher in the bonds. So are there long duration bond funds that were around 20 years ago offering significantly higher rates than cash today?

    But I accept that I have potentially completely missed the other benefits bonds bring to a portfolio as you have articulated. This is why these discussion are so useful.

    @TI yes, that looks like what I was thinking about. And it also makes the point about saving accounts being higher than the cash proxy which is what I was thinking.

  • 44 Richard June 3, 2020, 11:38 am

    And my question on the 20 year fund is serious. I assume new money and expiring bonds will dilute out the high payers from previous years and so you would ‘race to the bottom’ in the fund. So as a retail investor in say a pension or ISA what is the best way to build a ‘bond ladder’ to get this better average rate (or not if rates go the other way)? I have always only looked at bond funds due to simplicity.

  • 45 Naeclue June 3, 2020, 11:54 am

    @Richard, the case for holding bonds is not just about sleeping better when stocks fall. There is a “Rebalancing Bonus” to be had when rebalancing across uncorrelated assets. With rebalancing you can expect a higher return than the weighted average returns of the assets. So for example if you had a 50:50 stocks/bonds portfolio and the stocks delivered 5% per year over an extended period, bonds delivered 3%, instead of your return being the average 4%, you can expect about 4.2%. The extra 0.2% being the rebalancing bonus.

    As with many things in finance, this bonus is an “Expected” gain, ie likely but not guaranteed. It is not impossible to end up with a negative bonus. The same is true with an all in stock portfolio. It is reasonable to expect a higher return than bonds over a long period, but that higher return is definitely not guaranteed.

  • 46 Richard June 3, 2020, 11:59 am

    @Naeclue – yes, good point. I tend to rebalance with new contributions so this effect is probably somewhat hidden to me. Clearly I need a much bigger pot :). Now I think about it, that was probably why I bought the 5% bonds back in the day. I need to write my strategy down. I set it up and haven’t thought about it at all since. Life took over….

  • 47 Keith June 3, 2020, 12:06 pm

    @32. Thanks. Indeed, nothing is certain in this world!

    @40. Bogle also made a case for holding short-term investment grade bonds as an alternative to cash. He didn’t say so explicitly, but I presume he meant in one’s domestic currency. Of course this exposes one to corporate and other bonds that are less safe than sovereign debt, but looking under the hood of e.g. Vanguard’s Short-Term Investment Grade Bond Index Fund, which invests in sterling-denominated debt, there is a substantial holding of government-back development banks, etc.

  • 48 xxd09 June 3, 2020, 12:39 pm

    I have noted with surprise that over my investing career (23 years) I have never “rebalanced”with a trade out with normal contribution/withdrawals times
    In Accumulation phase new contributions restored the set Asset Allocation which had not strayed outside the 5% rule (once a year contributions usually)
    In Deaccumulation phase withdrawals -the same process happened but in reverse
    Will this happy state continue?
    Was my Asset Allocation fortuitously set right for market conditions?
    Too many Bonds?

  • 49 Adrian June 3, 2020, 12:54 pm

    According to portfoliovisualizer.com since 1980 a porfolio of 100% Total US Stock Market Index would have returned 11.10% pa. A porfolio of 60% Total US Stock Market Index and 40% Long Treasuries (rebalanced annually) 10.99% pa.
    The big difference is the stocks-only had a worst year of -37.04% whereas the portfolio-with-bonds worst was -13.22%.

    For me I’m still convinced there’s a case for holding long dated US treasuries (despite currency risk – but let’s face it the long term trend is £ weakening vs the $) and long dated gilts – and they still yield 1.4% and 0.6% respectively.

  • 50 never give up June 3, 2020, 1:27 pm

    @Keith. Thanks. I see there is a Short Term Global Bond fund too. I do wonder how ‘safe’ these two short term funds are, how they differ to cash, and why they’re not included in the LifeStrategy funds. They may be a useful tool in terms of near term funding or bridging a gap before another income stream becomes available.

  • 51 Naeclue June 3, 2020, 1:42 pm

    To put a bit more bones on the reasons for my preference of deposits over gilts at present, I have done a quick calculation based on the FT yield curve page linked to in the article. 10 year gilts currently yielding 0.26%. Extrapolating between the 5 and 10 year yields gives a 7 year gilt yield of about 0.176%. A fictitious 10 year gilt yielding 0.26%, would yield 0.176% in 3 years time if the price rose to about 100.6 (a bond calculator is needed for that step). So the return over 3 years is about 0.26%*3 + 0.5% = 0.138%. divide by 3 gives a rough internal rate of return of about 0.46%. I could do this more accurately, but with bond yields so low compounding does not matter too much. So a reasonable expectation for the return on a 10 year gilt over 3 years is about 0.5% per year, but I can get 1.5% on a 3 year fixed deposit. I give up liquidity to get the extra 1%, but on the other hand I am certain of getting the return, unlike with the 10 year gilt.

    To take this a bit further, in order to get 1.5% per year on a 10 year gilt, I would need a price rise of about 3 times 1.5% – 0.26%, which equals 3.72%, so the 10y gilt would need to rise to 103.72 over 3 years to give the same return as a 3y fixed deposit. A 7 year gilt paying 0.26%, priced at 103.72 implies a yield to maturity of about -0.27%. This is the issue I have with gilts compared with cash deposits. Sure 7 year gilts could be yielding less than -0.27% in 3 years time, but it is unreasonable and speculative to use that as the central projection. By going for a 10 year gilt instead of a 3y fixed deposit, I am taking on risk for a lower expected return, but with the possibility of a greater return should equities do very badly. Everyone needs to make their own minds up, but that does not strike me as a good investment opportunity.

  • 52 Whettam June 3, 2020, 2:28 pm

    Fascinating article and subsequent conversation as always. As others have said, I still struggle with choices / allocations of my “lower” risk assets.

    I have never really regarded cash as part of my retirement investment portfolio. I have an emergency fund, minimum of three months take home, currently at 7 – 8 months and current situation has made me keep adding to this, so maybe I’m just doing the same as you @TI? At end of tax year, I always have option of reducing this and adding it to investment portfolio, but at this point it would be added to my allocations. Maybe I should actually include cash in my asset allocation %’s?

    I nominally have a 25% bond allocation, but in reality about 10% off this is an old with profits pension, which delivers a guaranteed 4% p.a. I regard this a “super bond”, but the underlying investments obvioulsly include a mixed of fixed interest and equities. The remainder of my bond allocation is split 10% UK gilts, 5% Linkers and 5% corporate / strategic bond. Apart from the strategic bonds, no overseas bond allocation, largely on basis of FIRE advice of holding bonds in your own currency.

    As others have said, I view the bond allocation largely as risk mitigation and a diversifier. In Jan I was four years away from my target date. In March about 25% down and at the time I thought that had put retirement back at least two years, but I stuck to my allocations. Now only 2 – 3% down and who knows about that 2024 retirement?! But I’m glad that I have continued to hold a bond allocation, it helps me sleep better.

  • 53 Matthew June 3, 2020, 3:21 pm

    We could use annuities as a store of cash, with 90% fscs protection with no upper limit, and possibly inflation protection. It ensures a certain level of income

  • 54 Berkshire Pat June 3, 2020, 4:34 pm

    I don’t really follow the logic here;
    “A 10-year Gilt is (being horribly simplistic) a discounted geometric average of policy rate expectations over the next decade. For all you know, the BoE cuts rates to -5% in the next year and keeps it there for a decade. Yes you earn 1% for the next year but the you find the depo is at -4% for the next 9 years. That’s rollover risk. The 10-year Gilt at 0% would look great value in that scenario.”
    Surely any rational small investor should lock in 1% or whatever over a few (2?) years, and repeat while interest rates remain positive. If they turn negative the sensible thing to do is to keep the cash in a current account (if free), or in a tin box under the bed, until rates return to normality. So that’s 2 years at 1% and 8 years at 0% in the example above, vs. 10 years at 0% for the Gilt. I do get that the bond yield may go negative resulting in a capital gain if sold before maturity… if…
    It seems to be an odd idea, this greater fool theory, in that people are queuing up to buy assets and are prepared to pay a premium to effectively lose *even more* money than the current holder. I’ll get me some of that. Not.

  • 55 NewInvestor June 3, 2020, 5:07 pm

    Thanks for the response. Your caution is understandable. Of course, if I were being playfully arch, I’d suggest you were edging into timing the market. 😉 And surely that would never do.

  • 56 Algernond June 3, 2020, 5:37 pm

    @never give up (40).
    I’ve often wondered why there was no Lifestrategy 0 fund also.
    But then again, if you never plan to go below 20% equity, I suppose it doesn’t matter..

  • 57 never give up June 3, 2020, 5:55 pm

    @Algernond. I like the LifeStrategy funds for accumulation purposes, but when I’m actually living off of my savings I’d rather be able to sell bonds separately, especially if stocks are experiencing a difficult patch. So if there was a LifeStrategy 0 fund someone could pair it with a Global stocks fund and choose their asset allocation precisely to their needs e.g. 65:35 that couldn’t be created without using two LifeStrategy funds anyway. But even if their desired asset allocation was 20:80 or 60:40 which are available through LifeStrategy, a two fund set up would have the advantage of them being able to draw on the LifeStrategy 0 fund and not impact their stocks at that precise moment in time. But yes other than this fairly small point I guess it doesn’t really matter.

    It’s just given how many different types of bonds there are I find it curious there doesn’t seem to be a diversified all in one bond fund. The concept exists for stocks so why not for bonds.

  • 58 MrOptimistic June 3, 2020, 7:03 pm

    I think you can be too purist about these things. I use LS20 as a bond proxy with a little bit of diversity seasoning, ditto LS80 for equities. I would be happy to sell either to rebalance. It’s not an exact science ( well actually it’s not a science at all but you know).

  • 59 MrOptimistic June 3, 2020, 7:24 pm

    As I spend my young adult life in the 70’s I have a dread of inflation and I am uncomfortable with long duration. Can’t get past that . In deflation, isn’t cash good enough ( assuming no bank crisis and haircuts) ? Wouldn’t inflation plus the response of raising interest rates crease long bonds ? Inflation while keeping rates low ( has this been tried before ?) would seem to still penalise long bonds and probably force money into equities.
    Sold RIO and bought Stoxx 600 basic resources in the hope this embeds some inflation protection albeit with eyewatering volatility: not that much though. Should teach me a lesson one way or the other. Lockdown could make active investors of us all.

  • 60 Gizzard June 3, 2020, 7:56 pm

    @Mousecatcher007 Check out the Morgan Lloyd SIPP. You can invest in a range of interest bearing bank accounts of varying duration and interest rates (jncluding NS&I (i.e. Government backed with a £1M limit). I have started moving over the cash portion of my Hargreaves Lansdown cash allocation (paying 0%).

  • 61 ermine June 3, 2020, 8:14 pm

    > As I spend my young adult life in the 70’s I have a dread of inflation and I am uncomfortable with long duration.

    I too am surprised at the nonchalance re inflation in the FIRE space. But them many will only have seen it as a reference in history books and black and white photos of Germans with wheelbarrows of paper money.

    Perhaps people with largely equity portfolios don’t have to worry about inflation in the way previous generations did, who were dependent on annuities of some sort.

  • 62 bloodonthestreets June 4, 2020, 7:39 am

    I’m by no means an expert in these matters, but with yields so incredibly low, are bonds now too volatile? A tiny move in yield causes large movements in price. As an example, my stocks index fund was up 1.2% yesterday but my U.K. bonds index fund was down almost by the same amount.

    Is it possible that bonds are no longer the “no risk “ asset class they used to be, and the whole passive investing theory If asset allocations needs rethinking now?

  • 63 Algernond June 4, 2020, 8:58 am

    @bloodonthestreets – That’s why I use Global Aggregate Bond fund (hedged)… less volatile.

  • 64 ZXSpectrum48k June 4, 2020, 9:31 am

    @bloodonthestreets. Gilts moved quite a bit higher in yield yesterday, with the 10y 5bp higher and 30y about 8bp higher. So you should have lost about 0.85% on a typical Gilt tracker (duration 13). Nonetheless, the FTSE ASX still moved 2.6% by comparison, 3x as much.

    Remember, as yields fall, the duration of a bond will increase due to positive convexity (convexity = rate of change of duration wrt yield changes). So as bonds rally, you get longer bond exposure, and as yields rise, you get shorter bond exposure. So if you’d bought say £100k notional of the 10-year Gilt at the start of the year when the yield was 90bp, you’re sensitivity to yields changes would have been about £120/basis point of risk. Now at a yield of 26bp, you’ve got around £130/basis point of risk. So you’re around 8% longer of Gilts than you were at the start of the year. If you don’t like being longer, then you can sell 8% of your Gilt portfolio to lock in a profit. Classic rebalancing.

    Personally, I don’t think in terms of the amount of cash I’ve got in bonds. I look at the PVBP (price value of a basis point) in my portfolio. So at the start of the year, in USTs I had $2mm in ZROZ (duration 27), $2mm in TLT (duration 23) and $1mm in VLGT (duration 22) . I didn’t see that as $5mm in USTs, I saw it as $12.2k/bp. So on a 10bp move in either direction I would make/lose around $120k. That’s the relevant metric for understanding my risk. The cash amount just isn’t relevant.

  • 65 ermine June 4, 2020, 11:48 am

    @TI #37

    At some point during this bear market I realized — emotionally, not mentally — that I probably shouldn’t keep doing this.

    I’m older, I have that mortgage, and I have something to lose now; or as Bernstein (I think?) would have it, on one measure I’d already ‘won’ the game.

    Inspiring stuff, and I look forward to the long-form post “The Investor is retired” 😉 Reminds me of Warren Buffett’s words on the LTCM crew.

    Perhaps that is getting older, though matters of the heart can also instigate a reappraisal of priorities. Deep stuff…

  • 66 Seeking Fire June 4, 2020, 12:03 pm

    ZX. You have articulated my previous point better with an example. As yields are now close to zero and convexity is higher my understanding is you need a lower allocation now to bonds to achieve the same hedge against a fall in equities (assuming the relationship that when equities fall bonds rise continues). If you are allocating to bonds for that reason there seems to be a reasonable argument to find the longest duration bond you can find, which will then enable you to allocate less of your overall portfolio to bonds if that’s what you’d like to do. As long as you recognise the bond sensitivity to increasing rates has increased as well. Or perhaps lower your overall allocation to bonds within your overall asset allocation. But I am happy to be disabused of that position.

  • 67 The Investor June 4, 2020, 12:05 pm

    Inspiring stuff, and I look forward to the long-form post “The Investor is retired” Reminds me of Warren Buffett’s words on the LTCM crew.

    Oh, I have in no way retired. 🙂

    I’m just finally trying to keep my risk dialed down by quite a bit (for me) which means I’m very unlikely to beat the market on a pure (non-risk adjusted) comparison. But it should hopefully mean I’m less likely to throw away the progress I’ve slogged up over the past 17 years to a deep crash. We’ll see!

  • 68 TheIFA June 4, 2020, 1:08 pm

    “I accept the fact that long-term bond returns will likely be low and am adjusting my financial independence plan to deal with that.”

    Not sure where you are on your investing journey but you mention you are already taking a very conservative SWR so would be interested to know what other adjustments to the plan you are making re long term bond returns. As Abraham points out in his book, SWR frameworks have potential shoddy returns already built-in, so are you being overly cautious?

  • 69 Richard June 4, 2020, 1:32 pm

    @TI – nearly missed it, congrats on hitting your number. Amazing!

    Though perhaps you annouced it back in Feb and I missed it then as well.

  • 70 ermine June 4, 2020, 1:44 pm

    > Oh, I have in no way retired.

    I meant from active investing. I appreciate that hell has to freeze over before you consider the other sort of retirement!

  • 71 The Investor June 4, 2020, 1:56 pm

    @Richard — I’ve alluded to it as much as I have above in other comments, and I believe I mentioned it in one of my virus posts in March, from memory. It’s not a ‘number’ as firmly as many FIRE numbers though, because I don’t intend to retire (yet) and it’s not quite comparable anyway (for a host of reasons, including my likely drawdown strategy and my ongoing mortgage (though my ‘number’ of course takes this into account) and hence leverage.

    It was more a long-term big hairy and audacious (for me!) goal.

    My co-blogger @TA thinks I should write about it and do a big song-and-dance but that’s not really my scene, and as unlike him I haven’t really documented the struggle etc so it could be seen as a bit boastful (also because for me it hasn’t been a struggle — I save and invest naturally and boringly, like a blue whale eats krill. It’s in my genes. 🙂 )

    I’m ever more private. And finally, I’ve got bored over the years of having certain readers sniping and trolling about anything I write that’s personal. It shouldn’t matter but it’s not exactly an incentive.

    On the other hand you do see articles doubting early financial independence and ‘The Snowball’ effect, whereas I have no doubt the snowball (including compound interest) is real and achievable on a middle-class income — although obviously it’s much harder with a lower income / higher dependents.

    So that *is* a good reason for writing about it. We’ll see!


    I meant from active investing. I appreciate that hell has to freeze over before you consider the other sort of retirement!

    Nope, I’ve in no way retired from active investing, either. 🙂

    I guess I wasn’t clear.

    I have (or at least I am currently experimenting with) ‘retired’ from often being 95-99-100% invested in equities (excluding flat and emergency fund and fun money).

    This is all really off-track for this thread though. I have a post in mind I want to write about this shift, so we can reconvene then!

    Cheers for the interest though. 🙂

  • 72 The Accumulator June 5, 2020, 8:47 am

    @TheIFA – you could well be right, the problem is that’ll probably take me 20 years to find out. The bond situation seems unprecedented and not adequately accounted for in the historical record. Though it could be that the UK’s atrocious sequence of returns in the early 20th century allows more wiggle room than the US experience. I’ll write a post on how I’m managing the risk. Thank you for the idea!

  • 73 Dawn June 10, 2020, 1:50 pm

    Read through all this and still I remain stuck on bonds.
    I did buy an index linked guilt.and invest in royal london global index linked fund. But I remain stuck with a huge wodge of cash and have done for years. I’m fine with equities ,I understand them and I didn’t sell any infact I invested some of my cash at the worst of the crash. I’m living off my portfolio atm. So I’m taking from the cash bit. I’ve lowered my swr to 3.5 % because of the cash.
    I just hate bonds cos i carnt decide.
    With hindsite I should have done what jim Collins suggests a bond fund of all time scales.short, intermediate and long years ago.. Just stuck.

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