How I deal with not having bonds in my portfolio

New year party with friends

I want to share what are my market expectations and how I deal with not having bonds in my portfolio.

Ever since I started studying finance I have learned a few recurring themes:

  1. Over the long run, stocks outperform bonds
  2. People add bonds to their portfolio to reduce volatility
What are my portfolio expectations

A few research papers suggest that on average, the stock market (Canadian/US) goes up about 10% per year. Other researches say that the market has become more competitive and now we can expect returns of about 8% per year. Taking all this information, I have decided that I will be happy if my overall return is 6% per year. If I earn more, great. If I earn less, I will be disappointed.

This is a weekly graph of the the TSX for the past 12 month. The blue line represents the ups and down of the Toronto Stock Exchange, the red line represents my expectations from the market which is the 6% line.

During the past 12 months I have built a margin of safety of 5.8%. The TSX had gone up 11.8% and I would have been happy with a return of just 6%. This means that If the TSX drops tomorrow by 5.8%, I am still good. At the same time, if the market doesn’t drop, I feel as if I had won the lottery. Imagine that one day the insurance company calls me and tells me: “Ever since we have been insuring you, you haven’t had any accidents, we would like to give you your money back.” This is the same idea. I imagine that the money above the 6% is NOT my money, it’s the insurance’s money, but if nothing happens, I get to have my money back.

When people invest in bonds, they are reducing their volatility, but they are cutting their returns as well. I believe that if they just change their mindset, they will be able to better handle volatility. Remember bonds ARE NOT safer than stocks, they are lest volatile. Over the long run, stocks are as safe as bonds.

Let’s face it, over the last year bonds had a yield of about  2%, the TSX had a return of about 12% and the S&P had a return of about 12.5%. If had a 50-50 portfolio, my return would have about 7%. Good, but nothing to brag about. .

As for my real portfolio. I am ⅓ in Canadian stocks, ⅓ in International stocks and ⅓ in US stocks. My total return for the past 12 months was about 11% and my margin of safety is 5%. In my mind I have gained 6% and I have a 5% insurance policy.

In my next blog I will talk about how to reduce overall portfolio volatility by adding an assortment of uncorrelated assets.

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2 thoughts on “How I deal with not having bonds in my portfolio

    1. Vanguard shortterm bodn fund ETFs present yield is about 2.5%.

      Assuming I have about 20 to 30 more years to live, I hope to get average market returns of 8%. I would diversify globally so I would not be dependent of North America markets.

      Over the long term, (10 years or more) bonds do not reduce risk, they reduce volatility. If my objective is maximize return, to leave money for my grand kids, I would be 100% stocks…

      If I have a psychological margin of safety, I could handle volatility.

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