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May 16, 2013

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I agree with the real estate holdings. I invest in REITs and those are right now taking off in my portfolio. I also agree that bonds should be a smaller percentage. I would take it down to 10% and invest the difference in in high dividend yield ETF's.

I too am troubled by the 60/40 split. When the economy tanked people lost a lot in stocks , people bailed and put it in bonds. Now bonds are questionable and the returns on bond are bleh. Until the market turned around I was allocating half of new funds into my 401k toward bonds. The other half was in stock funds.

I have been looking at my allocation of bonds and looking at the risk factors of a fund instead of blindly going into bonds. I think you can get a better return than bonds in Dividend paying stock funds, Telcom & utility funds, REITS funds which have higher risks than bonds and some not as much as a total market fund. More of a middle of the road in risk and return.

I guess I wonder what you mean by conservative. You're looking at 30 years of additional earnings, when most advisors would be looking at only 15 years to hitting the final nest egg you'll be drawing down from and you need to start pulling away from growth and lessening volatility.

Considering most lifecycle funds have you at something like 20-30% in stocks by your target retirement date, this isn't outrageous, though like every rule of thumb you need to see how it fits your particular situation.

Completely agree with you, FMF. I wish I could convince my parents.

My wife and I are in the same age range, and we have maybe 20% of our retirement savings in bonds. A little bit in commodities and cash, but about 75% in equities. Is that too high? Classic asset allocation modeling would say yes, but like you, I just can't bring myself to sell stocks (even though they've had a great run and may not have much more upside this year) to buy bonds (which have HAD their run, and prices have dropped significantly in 2013). I'm not a market timer, but watch the market enough to know that, barring another economic meltdown like 2008, there is not much potential to make money investing in bonds for the long term, even if inflation doesn't roar back like some people are forecasting.

People have been saying interest rates have to go down for past 20 years. Have they?

I think that most rules of thumb are dangerous. There is no one size fits all in personal finance.

Right now, the USA has historically low interest rates. And like FMF states--- they cannot go down any lower and they will--sooner rather than later-- go up. I agree with him. When that happens-- bonds will get hammered.

The good times in bonds are over for a while. They had a hell of a run as interest rates moved downward-- but now--the prospects are dim.

So what to do? That is a great question, and a tough one at that.

Personally, if you have a typical net worth - I think that going 100% equities at our age ( I am about 50 as well) is too aggressive. There is something to be said for preservation of capital as you age. So I have 20% in bonds and 20% in Real estate. That is my 60/40 split.

And the bonds are all short term -with durations less than 2 years. They should weather the rise in rates a little better (but give me less yield for the moment).

As interest rates rise I will ladder my bonds into higher rates and longer durations. If inflation kicks in and rates rise alot-- I will consider high yield junk bonds as well.

I think you need to be flexible and make rational changes as the world around you evolves. The world of investing is not static-- and investors cannot be either.

That is my two cents.

I thought this CNBC article from yesterday was interesting regarding a potential further drop in bond yields. http://www.cnbc.com/id/100739611

Although the foregoing article indicates that bond yields could drop in the near term, I believe it's a fair assumption that bond yields will likely rise long term.

That said, I like the idea of allocating 40% into bonds and real estate and the remaining 60% into stocks as previously mentioned. I also like to maintain at least 5% in cash to "buy the dips"

I could not agree more FMF. That bond allocation is way too conservative and when rates do eventually go up then you could be in big trouble if you have that much exposure. I think the real estate angle is a great one and brings greater diversification.

I thought the rule of thumb was % in stocks is 100 minus your age. Using that benchmark, this is a more agressive mix than the 50% stocks for someone 50 years old.

That said, someone who has a 30 year life expectancy, can also expect to need to draw down those funds beginning in a decade or so. A shift to fixed income investments is thus entirely appropriate.

Note that Japanese 10 year currently yields about 0.83% or less than half of the US 10 year.

Notwithstanding the Fed's actions, inflation and a rise in bond yields are not a certainty.

The best mix between bonds and stocks doesn't just depend upon your age, it also depends upon the size of your portfolio and how far you are away from retirement.

I am totally in individual bonds that are paying me $335,000/year in tax exempt or tax deferred income. The two best parts are (1) that the amount of bi-annual income is locked in to each bond until it matures, and (2) that when the bond matures you get 100% of your money back. I am 78 and my bonds are laddered from 2013 to 2042, so each year I have some bonds maturing that provide money to reinvest in whatever looks good at the time. Also the only portion of the $335,000 of income that I need to spend is what I need to pay taxes on the minimum required distributions from our IRAs, thus our portfolio continues to grow.

The other big advantage to me is thatI can sleep well because I don't have to worry about a stockmarket crash like the one that most investors lived through in 2008.

Another mistake that people that know little about bonds make is thinking that the word "Bonds" equates to "Treasury Bonds". I don't own any treasury bonds and never have.

I also planned our retirement knowing that we both received nice monthly pensions as well as social security, that we had zero debt, live in a well maintained and furnished $1.3M home that doesn't take much money to maintain, and that the property taxes are only $2,400/year. We also have excellent healthcare from a Medicare Advantage plan through my former employer that only costs us $305/month plus what gets taken out of our SS checks.

Thus articles such as this are way too generalized because each family has a different set of circumstances.

Japan thought that bond yields would certainly rise too. That was over 10 years ago. And they are still waiting for yields to rise.

Bonds outperformed equities 2000-2010. Historically, over the past 200 years, bonds have in cycles outperformed equities over 60% of the time.

Speaking of tanking, Equities have a greater reason and chance to tank than bonds do in the near future.

Both are being propped up by artificial monetization. When that fails to lift further, or is removed, a flight to safety will ensue.

I do agree with you in selling both bonds and equities to acquire real estate, though. That is an excellent idea over the next 5 years

Right now, bonds are a losing bet, pretty much guaranteed, and will be as long as interest rates are low, which is going to be for quite a while. For a better "safe" bet, I'd choose real estate right now. Prices are still low, and interest rates aren't able to get much lower.

What about the percentage in real estate investments and plain old cash? Stocks & bonds are only one component of a portfolio.

I like Old Limey's model but for someone who is almost 40 years younger, holding bonds only let you keep up with inflation at best without principle growth, assuming a hold until maturity. Dividends and rentals rise with time, hopefully far outstripping inflation... so do MLP's.

I'm a big fan on focusing the portfolio to deliver steady and rising INCOME vs pure portfolio gains... that's just because I think cash flow generation is very important and would rather get it this way instead of selling a portion of the portfolio each year.

-Mike

I am 52 yrs old, and have approx 25% in bonds. But then, I don't plan to retire until I am at least 68.

I do agree that bonds aren't an awesome investment right now. Yields are low and they'll lose principal when interest goes up.

Limey makes good points about the goals and the situation of your portfolio. If I had >$1M in the bank then I'd be happy to have it ALL in safe bonds.

However I don't think that bonds will necessarily 'tank' or 'get killed' in the near future. Yes interest rates will go up and that will hurt the value of bonds. However I expect it will be a gradual thing more than a quick sharp increase in rates. Bonds will lose some value but I don't think it will be a drastic and sharp drop and the bond yield will offset it. I think worst case scenario a typical bond fund might lose 10% in a year due to very fast interest rate jump. A 10% drop is not good of course but not nearly as bad as how much stocks can drop in a short period. Plus you would offset that 10% drop in some interest yield so its more likely to be a 5-7% net loss in a year and I'd think that the worst case. If interest starts to creep up then its more likely you'd have a wash between prinicpal drop and yield.

It's a little bit high, but I think 40% bonds can be the right allocation for almost a lifetime. There are lots of slightly more aggressive balanced funds that approximate this stock/bond allocation that have come close to or actually beaten the returns of the S&P 500 stock index with less volatility. Funds like Vanguard Wellington and T. Rowe Price Capital Appreciation come to mind.

I think 40% bond is a bit high too. I'll probably go for 30% when I hit 50.
I have a large chunk in real estate and we'll see how that works out in the long run. REIT seems expensive right nwo.
Right now, I'm overweight in cash. I'm afraid of both bonds and stocks.

@Mike
I agree with you that my investment choices right now are ideal for someone my age and with the amount of assets we have but when I retired in 1992 at the age of 58 I didn't own a single bond, back then it was all about growing my capital during the buildup to the final climax of the Internet bubble in March 2000.

When I bought the majority of the bonds we now own I was able to buy them at prices well below par and consequently will have some capital gains coming as they mature. Also many of the bonds I bought prior to the great recession have increased greatly in value. For me the increase in value doesn't mean much because as they mature the prices fall back to the par price of $1,000 per bond. However, out of curiosity I keep track of the daily values and our tax exempt bonds are showing an unrealized gain of $309,000 and our corporate bonds an unrealized gain of $177,000 as of yesterday's close.

Can't say I follow the "bonds will get killed" talk but Stocks are fine.

Bonds pay interest until they mature and then you get your money back.

E.g. I have one citigroup bond that pays me 6%. It will continue paying me that same amount every month until it matures, at which point the money is paid back. This has always worked the same way for me. Sure, if Citigroup goes bankrupt then it gets pretty slammed, but not near as much and long after the Stock holders gets wiped out.

Sure if inflation takes off then the yield I'm receiving doesn't look very good anymore, but thats exactly why you ladder, so its not a huge deal because as your current yields are looking worse you're also buying new bonds at a better yield by definition.

Now, if you're buying bond funds, you're kinda missing the most of the point of owning bonds.

This talk about bonds being poised to fall sounds like market timing. If your bond funds hold bonds of shorter duration, a rise in interest rates won't be catastrophic. As others have mentioned, 60% stocks is high for a 50 year old person based upon the traditional "100-age in stocks" rule of thumb.

Why not 100% in stocks? Or open a margin account/mortgage your house and go 150%? It seems like these kind of questions always come up during a long bull market.

I'm only in my late 30s but I don't plan to have any percentage in bonds in my lifetime unless we see early 1980s style yields again.

I will turn 50 this year. Since I will have the benefit of a pension plan at retirement that will cover about 75% of my expected expenses and have also been participating in our executive deferred compensation program (which earns 4.6%), I have been moving downward in my bond allocation. Last year I was at 30%, but will be down to about 15% by the end of the year.

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