simon.fischer[at]gmail.com wrote:

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Are you being completely honest with yourself here? The Spartan Total
Market Index Fund is now at about the same level as it was in mid-1999,
which says to me the total rate of return of US equities over the last
5 years has been about equal to that your mattress: 0%. If you are
still having trouble convincing yourself to diversify after that
experience I don't know what it will take.

Andy

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It's true that the Sharpe ratio of short term bonds has historically
been higher than that of long term bonds, when calculated using daily
or monthly returns. That should not be the sole consideration, however,
for an investor who is trying to meet a long-term goal such as saving
for a retirement 20 years from now. Long term bonds hedge against
"intertemporal risk", which is the risk of fluctuating expected
investment returns. Suppose long-term interest rates plummet from 6% to
4%, with only a small change in expected inflation. An investor needs
more money now to meet long-term goals when rates are 4% than 6%. If
you bought the long term bonds when they yielded 6%, the capital gain
on these bonds would partially offset the effect of lower bond returns
going forward. This issue is discussed in the paper "Who Should Buy
Long-Term Bonds?" at
http://papers.ssrn.com/sol3/papers.c...ract_id=140271 and in the
book "Strategic Asset Allocation: Portfolio Choice for Long-Term
Investors", by John Y. Campbell and Luis M. Viceira. IMO the book is
very good, but it is pretty technical, as the Amazon reviews attest.

Pension funds and life insurance companies, who have long-term
liabilities, tend to own more long term than short term bonds, because
maximizing the 1-month Sharpe ratio is not their objective.

I have done studies of "optimal portfolios" that maximize Sharpe
ratios, because the problem is much easier to solve than the true
problem investors face.

You can get bond or reit funds that target different
countries with more friendly interest rate prospects,
with or without currency hedges: firex pfbdx pfodx
or consider other hedges fnmix ffrhrx hsgfx prpfx

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My take is that if you're subscribing to the asset allocation/rebalancing
system, then you need to be disciplined and stick with it. Otherwise, you're
still doing some market timing by waiting to buy bonds until interest rise.

I know that with interest rates at historical lows, it's pretty likely that
they will only go up. But how do you know that stocks won't drop 10% next
year? In that case, you would have been better off holding more bonds that
only drop 3%.

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Well, that's the whole point of rebalancing, to automatically sell the
gainers.

Do not trust your instincts. The rational behind strategic asset
allocation is that it imposes a discipline which protects you from just
exactly the doubts that you are now having. If interest rates are
going up, why haven't they already. Let's presume that we know
interest rates are going to go up. If they do, bondholders will see
the value of their bonds decline. If they know their bonds are going
to decline in value as interest rates increase, why are they still
holding them and volunteering to lose money? The answer to my
sarcastic question is that enough bondholders disagree with the
conventional wisdom that rates are going to sharply rise, otherwise the
would have sold and rates would have risen already.

That said, I like short term bonds. Anything beyond a one year
maturity has a poor risk adjusted return. And remember that the
function of bonds in your portfolio is not to provide return. It is to
dampen volatility.

Stick with your strategy. Adhering to any one (mainstream) strategy is
usually better than constantly switching or ammending your strategy.
Human beings are terrible at timing markets.

Hello,

I've been looking at rebalancing my portfolio,
which is currently almost 100% in well diversified
index mutual funds (including large and small caps,
international, etc)
I lean towards the efficient market theory as an
investment strategy.

Rebalancing would mean adding some percentages of
bonds and REIT, at the very minimum. However, in a
climate of rising interest rates, going from stocks
into bonds and REIT is not necessarily the smartest
investment move for the short and medium terms.

The investments have fared well over the years. In
the most recent history, they didn't lose too badly
over 2000-2002, and have delivered better than
expected for 2003-2004.

The way I see it, I have a few options:
(a) If it ain't broke, don't fix it. I could sit tight
and do nothing.
(b) Plough ahead and do the portfolio rebalancing to
the exact detail. i.e buy bonds and REIT to comprise
X% of the portfolio.
(c) A middling strategy: buy only short-term bonds, at
an amount less than the target X %.


Any opinions?

Happy New Year!

Simon Fischer