Introduced in 1950, the VW “Type 2” microbus played a big role in the countercultural landscape of the 1960s. While not quite as dominant as the Type 1 – the VW Bug - it was a huge success for VW and spawned a slew of competitors. Arlo Guthrie and Bruce Springsteen included it in their songs, and Steve Jobs reportedly sold his bus to fund Apple.
After many half-hearted tries, VW has plans for a 2024 US launch of VW ID.Buzz – an all-electric update of this icon. Now, I realize predicting the auto market is as treacherous as predicting financial markets, but the reviews are quite flattering, and I think it is a contender to replace the uninspired minivans plying our roads.
Speaking of ’60s stars, let’s talk about bonds. I know, I know… could I use a weaker segue to a more boring topic? Hear me out. Classic financial planning advice has always recommended a healthy allocation to bonds, but the last fifteen years have been tremendously generous to those that ignored such advice. In fact, it seemed punitive to have bonds in your allocation. Besides, bonds are boring! All this arcane jargon like "duration" and "spreads" - why bother when you can buy NVDA and ride it to the moon??
Well, it is time to go back to basics.
Stock valuations are at historic highs. The chart below shows my favorite metric – the CAPE 10. As you can see on the graph below, we are in very, very pricey territory. The adjacent graph plots historical PE ratios to subsequent returns. So, if history is any guide, chances are that future returns to stocks are going to be paltry.
At the same time, bond yields have improved significantly. A 10-year government bond yields about 4% while short term bonds yield upwards of 5%. This is a pretty decent time for bonds - if interest rates decline, bond values rise; if they stay where they are today, you continue to earn a healthy interest return; and the chances of a continued run-up in interest rates have declined significantly (the inverted yield curve and falling inflation suggests that short term yields should decline soon).
If all that doesn’t convince you, let’s go back to why the basic advice was always well founded. It is well known that bond returns are lower than stock returns, on average. But averages don’t tell the full story. Stock returns are also highly variable, significantly more so than bonds. The key to ensuring a good retirement is to avoid what is called “sequence of returns risk” - the risk of a big drawdown just as you are approaching retirement. This could be devastating to your plans – you may have to continue to work for several years just when you are getting ready to slow down. Worse yet, you may not have an option to continue working, and would have to significantly curtail your spending in the early years of retirement – precisely when you can actually enjoy a retired life.
What a healthy allocation to bonds does is narrow the range of outcomes as you approach retirement. The chart below, from a remarkable paper by Pfau and Kitces, shows the probability of your nest egg lasting a full thirty years of retirement. The key insight is that the sweet-spot lies in starting your retirement with barely 30% of your funds in stocks, and gradually increasing your exposure to stocks after you retire. So, if you are in your forties or fifties today, you should already be gliding your stock exposure downwards by shifting to bonds.
All this is generic advice. Your portfolio should be tailored to the cushion between your assets and financial needs and your psychological tolerance of large drawdowns in your accounts – even if they are temporary. This is why we craft financial plans tailored to each family's needs. Even if you manage your own funds, a well-crafted plan that is based on historical experience can give you a sound asset allocation strategy. Finally, returning to cars, by the time the ID.Buzz launches in the US in 2024, I would have clocked seven years in my BMW i3. I am already used to driving oddly shaped cars and will be in the market for a versatile car that isn’t too shy to make a statement.
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