Bonds Are Irrelevant
Bonds are irrelevant for longterm investors
I love the beginning of the year. It's when most people review their portfolio allocation and question why things are how they are. This year, a tweet (or xeet? I haven't written since the name change) caught my eye. @Austen tweeted [1]:
Why isn’t the ideal investment strategy for 99% of people under the age of~45 just putting 100% of cash directly in the S&P 500?
This was in response to a different tweet that showed how shitty their Betterment's portfolio performance has been compared to the S&P 500. Lesson one: robo-advisors extract fees and underperform the market. We did the math three years ago - you're paying more for an inferior product.
Getting back on track - yes, Austen, 100% S&P 500 is the ideal investment strategy for most young adults. Bonds are pretty much irrelevant, but we've touched on that topic multiple times:
- if you have time, you don't need bonds
- if you're a working young adult, you seriously don't need bonds
These are essentially saying the same thing. For most working young adults, bonds are irrelevant. But there are some caveats.
The keyword in Austen's tweet is "ideal." Emotions aside, investors looking for the best returns should avoid bonds because stocks will consistently outperform bonds over a long horizon. Stockholders are taking more risk, so their expected returns are much higher. But the equation changes once you introduce human emotions.
Investors don't lose money to market fluctuations; they lose money to timing decisions. We all feel like selling everything when the market gets ugly, but some of us are slightly better at tuning out the short-term noise. If you can't, bonds may be for you.
I wanted to write this short piece because lifecycle asset allocation became more interesting last November when a new paper found that an even mix of 50/50 domestic and international stocks held indefinitely vastly outperforms other popular strategies like age-based or stock-bond [2]. We're no strangers to lifecycle investing and risk-taking on this blog, but stocks held indefinitely seem risky at retirement, even for me. I've covered how bonds create an illusion of safety for young investors with a long-term horizon. I've even explored a 2x-levered equity portfolio for those with more appetite - starting at 200% stocks and ending at 83% at retirement. But the goal had always been to replace some of your equities with fixed income as you approach retirement.
I recommend reading the paper and listening to the Rational Reminder podcast episode [3] to dive deeper. In the host's words:
50:50 all-stock portfolio outperforms target-date funds, balanced portfolios, age-based asset allocation strategies, and cash on mean, median, and 10th percentile outcomes. This isn't even like on average, it's better, but there's a worse left tail. No, the left tail is also better, which is kind of crazy.
The caveat, as always, is that you must have the stomach for steep drawdowns. It's all fun and games till you lose half of your portfolio in retirement. However, your portfolio should be much higher if it's all in on equities for decades leading up to and beyond retirement.
What I like about this is its simplicity. There are no target-date calculations, no options, and no extra fees. Just 50% domestic equities and 50% international in low-cost index funds until you die. That's very cool.
[1] Austen's tweet
[2] Beyond the Status Quo: A Critical Assessment of Lifecycle Investment Advice
[3] Lifecycle Asset Allocation & Challenging the Status Quo on Lifecycle Asset Allocation
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