ITA Wealth Management

Over a year ago I wrote the following (in blue) about bonds. 

“John Spears wrote a paper, “The Road To Wealth: Long Term Investment In Stocks” where he found, using data from 1871 through 1992, stocks beat bonds in 80% of the rolling 10-year periods.  In rolling 30-year periods, the time most investors save in a lifetime, stocks won out over bonds 100% of the time.

I’ve written previously about a spreadsheet I have that runs from the late 1920s through 2006 and using 5-year rolling periods, bonds only added to the portfolio five times.  The odds are quite strong that over time, stocks outperform bonds.  Therefore, only use bonds later in life when you need to reduce the risk of the portfolio.”

My view at that time was that one did not need bonds in the portfolio, particularly if sufficient income rolled in from a pension and social security.  Since writing this in June of 2008, I’ve changed my mind and I now include bonds in the asset allocation mix.  Why the change in thinking?

The move to include bonds was not made because the above data is false.  Rather, the article by Geoff Considine, “The Retirement Portfolio Showdown:  Jeremy Siegel v. Zvi Bodie” opened my eyes to a different kind of long-term risk if the portfolio is not set up with some risk buffering assets.  If you have not read Considine’s article, I highly recommend doing so.  While it is partially true that stocks over the long run outperform bonds (Siegel view), if given sufficient time there will be a market drop where bonds will perform better than stocks (Bodie view).  We’ve seen this happen twice in the last ten years, so it is not all that infrequent.  The analysis from Considine’s article shows that losses, when holding only equities, impacts future income.  Reducing longevity risk is better accomplished by building a portfolio of equities, bonds, and other low correlation assets as this provides a higher probability of being able to meet future income needs.

To smooth out the “black swan” events such as we experienced in 2008 and early 2009, we are searching for ETFs and/or stocks that show a low correlation with the rest of the portfolio.  Bonds of various types help in this portfolio construction process.

Photograph:  The Catlin Gabel School rummage items that go on sale this afternoon.

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