Monday, January 13, 2014

Greatest Hits Part 2: The Bond Market

My previous post tallied up all the cases of stock market drops greater than 50% in inflation-adjusted terms for the 20 countries included in the Dimson, Marsh, Staunton Global Returns Dataset. 
Since then, I've come to realize that it is important to show the same type of table for bonds. This is a reminder about William Bernstein's idea of deep risk as bond investments can also cause a permanent loss of capital (as, for instance, German bond holders in 1899 would still be waiting for their investment to provide as much inflation-adjusted wealth as they held at that time). 
The table below shows all the cases in which stocks and bonds lost more than 50% of their value in inflation-adjusted terms. It's hard to quantify whether stocks or bonds were "more risky" based on the table, but there were plenty of cases in which investors took significant hits with both types of investments. Historically, there have been some very severe bond bear markets.
A major problem for bonds in the past world experience was inflation. And a valid question remains, will inflation-protected bonds now available to investors help to solve this problem?  Though I have written in the past about concerns that TIPS are not a completely safe investment, my personal bond investments are split between I-bonds and Vanguard's TIPS mutual fund. The TIPS ladders for retirement income would also seemingly help investors avoid the types of bond losses highlighted in the table below. 
The table shows the country name, years (beginning of the first listed year to end of the second listed year), and the percentage drop in real terms for the stock or bond market over that period. I also provide the year that the real stock or bond market value would again exceed the level prior to the market drop, as well as the number of years it took for this to happen. 

 Finally, let me add another table rather than extending this discussion into a third blog post. This table shows the results for 50/50 annually rebalanced portfolios of stocks and bonds in all of these countries. As can clearly be noted, diversification does help! Nonetheless, relying solely on volatile investments of stock and bonds funds does still pose threats. Risk is real. 


  1. Could you please characterize what you mean by the "bond market" in your analyses? Are you referring to indices of all of a country's bonds and presuming that assets are held in bond funds? And what sorts of bonds (investment grade corporate, municipal, sovereign debt, high yield, and so forth) are being reflected? This makes a lot of difference.

    Given all of your recent discussion about bond funds and bond ladders, it would be useful to see how the country-by-country results would be different for portfolios (and perhaps ladders) of bonds held to maturity rather than marked to market in mutual funds. I would guess that it would be difficult to compile this from available databases.

    1. Hi,

      The definition of bonds is provided on page 4 of this document:,d.cWc&cad=rja

      Briefly, they aim to use government bonds with approximately 20 years until maturity, though there are exceptions when 20 year maturities are not available. So it's relatively long term government bonds.

      This is presuming a bond fund. I use total returns which captures interest and price changes.

      It would be great to test about bond ladders, but this data only has total returns. I don't know yields to maturity. This makes it hard. As these are nominal bonds, inflation would eat away at real returns even when building a retirement income bond ladder.

      The threat of prolonged high inflation is not really captured in the Monte Carlo simulations I typically use, as inflation volatility in the past US data has been relatively tame.

    2. Hi Wade,
      You mention that the bond term in general is 20 years. There is more price volatility with those types of bonds. Fama had done interesting work for Dimensional & and finds that if you want stock like volatility you should use stocks. Short term bonds have less volatility and that is the purpose for use in portfolios; and, one can adjust faster to rising or falling interest rates when short term bonds mature. Thus, his argument is that seeking return should not be the sole objective, rather tweaking the overall portfolio characteristics to align with what the individual is comfortable with.

      This said, it would be interesting to see a similar chart using notes (i.e., 5 year terms) for additional insight on bonds.

    3. Larry,

      I agree, but unfortunately the other bond data is not available.

      Certainly with the 4% rule, using intermediate term government bonds (5 years) is what allowed the 4% rule to have survived historically. When you replace it with longer-term bonds or corporate bonds, the 4% rule did not always work. The added volatility offset any higher yields.

    4. Indeed Wade, what we have both seen in both our data sets: what returns give, volatility takes away.

      This is true as you mention for the 4% rule approach, and also true in a dynamically adjusting longevity based approach as well.

      Great summary from a global perspective!

  2. Bond funds- a bad idea. I couldn't possibly cover all the negative aspects of funds, although even the costs at Vanguard are too much for me. The best article I have ever seen, The Wall Street Journal, 7 July 1992, the Your Money Matters column: "Sometimes Individual Bonds Are Better." INVESTMENT ILLUSIONS by Martin Fridson, THE GREAT MUTUAL FUND TRAP by Gregory Baer and THE ONLY GUIDE TO A WINNING BOND STRATEGY YOU'LL EVER NEED by Larry Swedroe all have chapters on the defects of bond funds.

    Investors are usually concerned about what happens when interest rates rise, justifiably. But what happens when rates fall? A bunch of new investors (foolishly) think they can capture the higher rate offered by the fund and make purchases. All the fund manager can do is purchase bonds at the current rate and everyone receives a rate somewhere between the old and new. Unless of course the management is so ethical they close the fund to new investors. But mutual funds benefit by maximizing funds under management so.... Fred

    1. Fred, that's an interesting point about the impact of fund flows. Thanks!

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