No Bonds for Charlie Ellis

I read this post earlier in the week and I got quite disappointed. Humble Dollar is supposed to be one of the ‘good’ financial divulgation outlet and the author of the post, Charlie D. Ellis, wrote a seminal book called Winning the Loser’s Game (I did not read the book but everyone in the field has great comments about it). My disappointment came from the fact that the message is very misleading. Let me tell you why.

The title, No Bonds for Me, bring the reader straight to the point: in the current debate of what place bonds should have in an investment portfolio, Charlie answer is none, at least for his portfolio.

The article starts acknowledging the point I was making at the end of my previous post: the composition of investor’s portfolio changes through times. Cannot agree more with this. Then Charlie go to the current issue, bond yields are currently very low and holding bonds is definitely a losing proposition compared to inflation.

First misleading statement: bond as important long-term investments.

I do not think anyone consider bonds as a long term investments per se. I think we are past the point where a 30-something has his/her savings 100% in bonds and planning to retire out of it; if you are investing, you know the juice is in stocks (yes, there’s plenty of people that distrust the system and has 100% cash…or 100% bitcoin…or no savings at all. They will not read Charlie anyway). Investors that are not in retirement, or close to it, hold bonds because they are a stock volatility dampener. It is not an ‘habit’.

Fearing that stock valuation are high and knowing that you will not endure future volatility is not ‘irrational’ or worse, ‘focusing excessively on short term results’. It is knowing yourself. It is way better to hold 60% stocks than going 100% only to panic and sell everything after a crash, and maybe do not re-enter for years due to the shock. Yes, if you have a long horizon in front of you, stocks will eventually overcome any drawdown. Yes, we do not all live in an Excel spreadsheet (even if it will might be part of the metaverse soon).

Second: market timing is very difficult

This statement is not misleading by itself, market timing is indeed very hard. But one of the positive aspects of having a portfolio like the 60/40 is that it helps to perform a kind of market timing that actually works. Bonds are the dry powder you can put to work when stock valuations are low; the timing is dictated by the annual rebalance process: when stocks are down, the rebalancing indicates you to sell bonds and buy stocks. The rule is there to help you overcome the fear of buying something that got smashed in the recent past (if you are interested on how to optimize the rebalance process, here a very good post).

Third: invest your age in bonds

These type of ‘rules’ or heuristic are created to be practical, memorable, not to be optimal. The theory behind is that, if you are retired and your only form of income comes from your portfolio, a prolonged stock crash will see you sell stocks on the cheap: a situation from where you will never recover and risk to outlive your savings. If stocks lose 30% and do not rebound fast enough, the math behind how much you can withdraw each month changes dramatically (let’s not even consider 40% or 50% crashes). It is a scenario you do not want to face, however unlikely, because there is no remedy: you cannot go back to work when you are 80 (maybe you can start play Axie Infinity and web3 will solve this…I do not know). This is why your portfolio, according to this theory, should be full of bonds: because they are stable. They also used to provide income and the fact that they do not anymore is a big problem, no one wants to deny it. But going ape on stocks and thinking you can overcome any crash is not the solution.

Chucky is misleading because he uses his age, 84, to imply that he is in the same position of the majority of 84s out there, i.e. retired. But he is not, by his own admission!

All my adult life, I’ve earned enough to cover all of our family’s expenses. Still do.

I do not know if his current income comes from book royalties, conference fees or crypto yield farming. The point is that he is covering his needs with financial sources outside his portfolio. If the market crashes, he is going to be fine. His circumstances can also be a product of resulting: his brain, the source of his income, is clearly fully functioning at 84, a fact that is unfortunately not the base case for all humanity (he is already lucky to be alive at 84!). Would his family be in the same situation if he had Alzheimer?

Even now, in my mid-80s, most of my investments will be converted into spending not by me, but by family members, particularly my grandchildren, whose average age is 12. My investments will be spent many long years from now.

This is the passage that drove me crazy. If your portfolio is in fact your grandchildren portfolio then obviously having 100% stocks is the right choice.

Chucky is in a great position, he saved more than he can even envision to spend. He found a job that he can still do and love at 84. Congrats Chucky, you won. There are plenty of lessons that all of us can learn from you, unfortunately this is not one of those.

(I am pretty sanguine about this topic because when Charlie says “Life insurance companies and public pension funds typically continued to hold more than 90% in bonds” he is absolutely right. I am in this enviable situation where I spend 80% of my time (i.e. my job) thinking Oh God, why so many bonds (hint: regulation) and 20% (my FinTwit life) thinking If stocks are the conservative bucket of your portfolio, good luck for the next crash. Am I the only connector between these two worlds?)

What I am reading now: