Novice investor asset allocation - bonds or cash?

pip895

Personally I don't think bonds are particularly useful at the moment - They are at such inflated levels, due in part to QE that they are not capable of performing their historic function in preserving capital in the event of a crash in the equity market.
Indeed some think they may even cause the next crash. My recommendation would be to keep a bit in cash and a bit in a targeted return fund - I hold Henderson European Absolute return among others to give a bit of balance to your equity investment. The only other thing to consider might be gold - you can get exposure through a physical gold etf - not sure I like gold any more than bonds though tbh.:undecided

gadgetmind

guymo wrote: »

Sure --- so I guess what I am trying to understand is what could happen that would make bonds bought in today's situation valuable or preferable to cash.

Several years (or decades!) of deflation would make both the coupons and the final redemptions worth more than they are now.

You may feel that this is unlikely, but that's taking a macroeconomic view rather than investing in a balanced portfolio.

Linton

guymo wrote: »

I feel a bit bad bumping my own thread, but I really would like to see a discussion / information / explanation of what, if anything, bond holdings would offer for a new and small-sum investor in the current situation.

What arguments or factors are there in favour of buying bonds right now? (I think I can see the arguments against, so it's the arguments in favour that I'm interested to explore.)

Thanks again to everyone who has pitched in here!

As a new small investor presumably investing for the very long term I dont think bonds are relevant to you if you have followed the advice to have 6 months living expenses in cash. This should provide sufficient diversification for the time being. Only once your investments have significantly exceeded your cash holdings will you need to consider the use of bonds to limit the downside during any future crash and to be able to marginally increase your returns by regular though infrequent rebalancing.

Jegersmart

guymo wrote: »

I feel a bit bad bumping my own thread, but I really would like to see a discussion / information / explanation of what, if anything, bond holdings would offer for a new and small-sum investor in the current situation.

What arguments or factors are there in favour of buying bonds right now? (I think I can see the arguments against, so it's the arguments in favour that I'm interested to explore.)

Thanks again to everyone who has pitched in here!

In a lot of ways it comes down to the time horizon you envisage being in bonds. They are also called fixed income, because the coupon (yield) paid varies according to the "value" of the instrument. That is to say that if you buy a bond which is yielding 4.5% at the original 100 value, if the bond price drops to 90, you will receive a correspondingly larger coupon in return so that over the period left to maturity you should receive the current yield regardless of what happens to the price in the meantime (unless the company in this example goes bust of course). In the case of bond funds, the fund would possibly be actively managed so holdings will be amended over the period that you are holding and the yield will fluctuate accordingly.

The case for holding bonds in my opinion would be in the case of needing income. If you do not need income, then it may be better to look elsewhere, and as you point out the interest rates or yields on bonds and cash savings are pretty close - especially in the investment/gov grade bonds.

My suggestion would be that you diversify to a point that you feel comfortable with - bearing in mind basics like your own tolerance to volatility - equities can at times be 20-30% down from where you purchased, it is likely perhaps that certain bonds may suffer this in the future too. At the moment though, equities are looking quite toppy imho, so you may want to phase in your purchases over time - or if you have a different view - don't!:)

Good luck and all the best.

J

p.s. As a suggestion for some of your portfolio, I have been buying gold miner stocks and etf's for a few months now. This sector has been hammered over the past 2-3 years and are currently at 2009 lows or so - and I like out-of-favour sectors such as these. They could obviously fall further, and I would probably buy more if that is the case.

guymo

gadgetmind wrote: »

Several years (or decades!) of deflation would make both the coupons and the final redemptions worth more than they are now.

You may feel that this is unlikely, but that's taking a macroeconomic view rather than investing in a balanced portfolio.

The same would apply to cash, though, surely? I suspect that the question of whether bonds are preferable to cash in deflationary times is quite tricky.

Of course the point of my asking these questions is precisely to figure out what would constitute a sensible, balanced portfolio for me. My inclination at the outset was to invest in equities, rather than an equities/bonds mix, and hold on to my cash, at least until the equities portfolio started to equal the cash reserves. On my current plans it would be a couple of years before that happens.

Linton's post suggests the same kind of approach, and as far as I can tell nobody has come up with anything fundamental that this approach gets wrong. I hope I've understood this correctly!

I'm really very grateful for everybody's effort and patience here.

Imnoexpert_2

This is a good thread so I appreciate it guymo.

I have by default kept cash tather than bonds and while at present it seems to be a justifiable option I remember a few years ago a friend buying long term government bonds giving 5% return which he planned to hold to maturity in 15 or 20 years (I forget which). He calculated that he could live on that so why take the risk and do what I was doing and invest in the building society at 7% Now mine is getting 1.5% and he is still getting 5%.

Hindsight is wonderful.

kidmugsy

cathybird wrote: »

I would be interested to know if anyone has holdings in funds that invest in asset classes that are neither equities nor bonds (eg commodities, property, gold etc). I ask because I'm currently wrestling with the same question as guymo.

yes, gold and silver ETFs. We've had the silver so long that it is still handsomely up, in spite of recent travails. The gold is down, but we had a spell when it was up a long way; part way on the way down we sold a lot at a profit and paid a chunk off the mortgage. So PMs have worked reasonably well for us. We'll probably continue to hold "for the medium term". I'm considering gold sovereigns to hold indefinitely if I can find a convenient safety deposit to store them in. There's no CGT on sovereigns minted after (I think) 1837.

grey_gym_sock

for all the talk of a bond bubble, bonds are not likely to fall by a huge percentage (e.g. 50%). equities could do that (not that i'm predicting it).

if you hold a % of your investments in bonds, and equities crash, and bonds don't do much, then your % of bonds will have risen, and you can rebalance back to your original allocation by selling bonds and buying equities (at a low price).

however, as Linton suggested, this is more relevant as a way of protecting your investments when you already have a substantial amount invested. if you have less invested so far, but are adding to your investments as you go along (perhaps through regular investments), then you will get some benefit if equities crash, in that your new investments will be buying at low prices. so in this case, there is less need to allocate anything to bonds. when you're near to retirement, so you won't have much new money to invest, protecting what you already have becomes more important.

kidmugsy

Holding cash in S&S ISAs as a temporary thing is OK, but you'll get only the tiniest of interest (and they'll take 20% tax off that). Happily, if you want to hold cash as part of your portfolio (as distinct from your emergency fund) you can just use a Cash ISA because you can transfer that into an S&S ISA whenever you want to buy shares. But suppose you want to hold something cash-like in an S&S ISA, or SIPP. You could consider this or a competitor.
http://uk.ishares.com/en/rc/stream/pdf/false/publish/repository/documents/kiid/kiid-ir-ish-ishares-corporate-bond-1-5yr-ucits-etf-gb-ie00b5l65r35-en.pdf

(I recently saw an ETF that held 1-3 year corporate bonds, all UK: I'd prefer that but can't find my bookmark.) Such an investment is much less sensitive to the sort of interest rate rise that might make long bonds and equities take a tumble, and while you wait pays a decent income. If you fear longer term that there might be inflation, you could diversify into some long maturity Index-Linked Gilts, or into an ETF of TIPS, the American equivalent. Personally, if I knew an ETF that did it, I'd happily hold a combination of TIPS plus the Canadian, Australian and Swedish equivalents. (I've got some ILGs already.)

Holding a diverse allocation of investments can give you as good (or almost as good) a return as equities alone, with far less volatility, as long as you rebalance regularly. If I were in youngish middle age I might aim at 60% equities, 10% PMs, 20% long-maturity Index-Linked and 10% short-maturity fixed interest. I'd rebalance once a year if anything went more than, say, 25% from its share (e.g. if equities rose above 75% or fell below 45%). If I were contributing every year, it's quite possible that rebalancing could usually be done by using the new money alone, without needing to sell an investment except very occasionally.

Mind you, this approach might reflect the fact that I'm not in middle age: when I was I had everything in international Investment Trusts, plus a Far Eastern unit trust in my Retirement Annuity Policy. I got out of equities in '99: I went for a mixture of fixed interest gilts, index-linked gilts, convertibles and then, a bit later, Precious Metals. So far, so good. Maybe we have too much in cash at the mo', but it's on attractive terms. It's when those accounts mature that I'll be scratching my head.

cathybird

kidmugsy wrote: »

yes, gold and silver ETFs. We've had the silver so long that it is still handsomely up, in spite of recent travails. The gold is down, but we had a spell when it was up a long way; part way on the way down we sold a lot at a profit and paid a chunk off the mortgage. So PMs have worked reasonably well for us. We'll probably continue to hold "for the medium term". I'm considering gold sovereigns to hold indefinitely if I can find a convenient safety deposit to store them in. There's no CGT on sovereigns minted after (I think) 1837.

That's interesting to know. My understanding is that it is mainly gold that has suffered recently and other metals are not doing so badly. Would it be rude of me to ask for more detail on your PM EFTs, kidmugsy? ... It is something I want to seriously consider. It's okay if you'd rather not say, obviously.