A 0% Allocation to Fixed Income?

zeroI currently have 0% of my personal wealth allocated to fixed income, and I really don’t think that’s much of a bold call. Meanwhile, I have almost 100%Β (I keep some cash on the side for emergencies) of my worldly wealth allocated to equity in high-quality businesses, specifically via common stock. And the stocks I invest in regularly pay and raise dividend payouts to shareholders, thus creating a reliable and rising source of income for me which will eventually exceed my expenses making me financially independent.

Is this crazy?

I don’t think so.

Typically, a good personal finance rule of thumb has been to have a percentage of your assets allocated to bonds, and this allocation percentage was generally tied to your age as a matter of simplicity.

So I’m 32 years old. This rule of thumb would dictate that I have 32% of my assets allocated to bonds and the other 68% allocated to stocks, and this allocation would change as I grew older (adding one percent to bonds every year I aged). This rule of thumb has changed over time, and there are variances to allow for other asset classes (gold, real estate, etc.), but this is the gist of it.

But one thing that people forget about personal finance is the “personal” aspect of it. And that’s where I like to come in.

I don’t think any allocation to bonds is necessary, and I would go so far as to say it would possibly be unintelligent to invest in them at all right now, depending on your personal situation. Obviously, we all have different individual scenarios, but I’m going to take a little time today to discuss why I personally do not have any bond investments, and why I don’t plan to change that anytime soon.

What Is Fixed Income?

First, let’s define what fixed income actually is.

Fixed income isΒ basically a fixed source of income you receive from an investment. The income doesn’t rise with inflation, and is “fixed” or set at a particular rate or figure.

The most common sources of fixed income come from bonds. You can invest in bonds in a number of ways, includingΒ corporate (corporations) bonds, municipal (local municipalities), or treasuries (federal government). With a bond, you’re basically lendingΒ money to an entity in exchange for a fixed payment for a set period of time. At the end of that payment period you’ll get your principle (the amount you lent) back. Income from CDs are another form of fixed income.

Taxation

One major reason I don’t invest in fixed income is due to the taxation regarding dividends and bonds, and how qualified dividends are taxed more efficiently for an investor than bonds.

I’ve discussed before the beneficial taxation that qualified dividends are subject to right now, and howΒ that factored into my decision to invest solely in a taxable account, relinquishing the potential additional benefits of any tax-advantaged accounts.

Basically, with qualified dividends you’re looking at a 0% federal tax bill if you’re in the 15% ordinary income tax bracket or less. Ordinary dividends (typically REITs, BDCs, MLPs) , however, do not qualify for this preferential treatment.

But bond income is taxed as ordinary income. You’ll have to pay normal federal (and state, if applicable) income tax on any bond income you receive, except for certain tax-advantaged bonds like municipal bonds. So that means if you’re looking to retire early by building up passive income sources large enough to exceed expenses, you had better think carefully about how bond income might factor into that, and what type of accounts you invest in.

I personally plan on having a very low total tax obligation at the end of every year once I’m financially independent, because my total income will be relatively low and most of my passive income will be from qualified dividends, which are taxed at very preferential rates. As such, my path to financial independence is quite easy, as I invest most of my wealth in a taxable accountΒ that doesn’t require any of the additional paperwork and bureaucracy that tax-advantaged accounts typically require. Thus, I lose a lot of the headaches and gain most of the advantages.

Low Beta

Beta is a general measure of volatility, or systematic risk. A beta of 1 is on par with the general market. Any number lower than 1 would generally indicate a stock is less volatile than the broader market, while any number greater than 1 would generally indicate a stock is more volatile than the broader market.

You can commonly see a stock’s beta when pulling a quote.

Generally speaking, an allocation to bonds makes sense as the volatility in fixed income is lower than stocks.Β While the underlying value of a bond can fluctuate with interest rates, your income is fixed and your principle (assuming the entity doesn’t go bankrupt) will be returned to you at the end of the investment’s duration period. So by investing in bonds, you’re lowering the overall volatility of your portfolio.

However, stocks that pay and raise dividends typically have a much lower betaΒ than the broader stock market, and therefore have lower volatility already built in. In my experience, my portfolio has been much less volatile than the S&P 500, and the value fluctuates from day to day much less. Thus, I haven’t felt a need for bond exposure to lower this volatility any more. In fact, I welcome volatility as it offers the opportunity to invest in stocks at potentially advantageous prices.

Take a look at The Coca-Cola Company (KO). This stock sports a beta of 0.48, meaning it’s roughly half as volatile as the broader stock market. This beta bears itself out in times of fear.

From January 4, 2008 to December 26, 2008, one of the worst possible periods for equities, the S&P 500 declined by 40.18% (according to Google Finance). Meanwhile, KO declined by 28.42% during this same time period. Even better, the company continued to pay and raise its dividend throughout the massive economic recession because the company’s business model is solid, and people still need to drink beverages even if the economy sucks. They reported earnings per share of $1.29 at the end of 2007, and $1.25 at the end of 2008. I’ll gladly take a slight hit to EPS during one of the biggest recessions we’ve ever seen, especially when the dividends keep flowing and increasing like clockwork.

Clockwork, indeed. The annual dividend was $0.68 per share in 2007, $0.76 in 2008, and $0.82 in 2009. Like the Great Recession never even happened. It’s easy to calm one’s fears when more and more money is hitting the account.

I could repeat this exercise for any number of dividend growth stocks, but it generally works the same across the board. I notice when the S&P 500 is up significantly on the day my portfolio generally lags behind. However, when the S&P 500 is down significantly my portfolio doesn’t decline as much. For instance, as I type this article the S&P 500 is down -0.39% and my portfolio is down -0.12% for the day. Just a worthless anecdote, but I find that’s generally my experience. Of course, I don’t compare my portfolio to the S&P 500, so it’s just an interesting side note.

Inflation

As I pointed out above, Coca-Cola’s dividends to shareholders kept on rising right through one of the biggest economic meltdowns we’ve ever seen. Meanwhile, any Coca-Cola bondholders saw no such advantage. Their payments continued, but at the same static rate they were enjoying before.

And that’s the big problem with fixed income: The income is fixed!

Are your expenses fixed? Is your monthly grocery bill the same as it was 10 years ago? What was gasoline priced at a decadeΒ ago? How about your property taxes – gone up in the last few years? Education? Healthcare?

Expenses aren’t fixed. Inflation is the secret tax that hits us all, no matter our personal situations. Inflation is quoted at somewhere around 2.1% right now, while inflation over the long run (since 1913) is somewhereΒ around 3.2%. That doesn’t sound like much until you realize that prices will roughly doubleΒ every 22 years.

Using this calculator, something that cost $20.00 in 2004 already costs $25.19 today. That’s a 25.9% cumulative rate of inflation over just 10 years. Extrapolating that out over multiple decades means you’re losing significant purchasing power if your investment income can’t keep up with inflation.

Meanwhile, going back to the Coca-Cola example the company has managed to increase dividends by an annual average of 9.8% over the last 10 years. That means your purchasing power is actually increasing, whereas an investor in fixed income is watching their purchasing power decrease over that same stretch.

If you were receiving $20/year in dividends from Coca-Cola back in 2004, you had 40 shares paying out $0.50 annually per share. In 2014 you’ll receive $48.80 in dividends from those same 40 shares, as the company now pays out $1.22 annually per share. So that $20/year expense that went up to $25.19/year is not only still covered, but you have extra change left over. That’s not the case, however, for someone investing in fixed income.

Social Security

Ahh, Social Security. Will it be around when I’m older? Is it going to be destroyed?

I honestly don’t know, but I’d be willing to bet that it will still be around.Β As of December 31, 2013, 38 million retirees were receiving a $1,294 average monthly benefit. You don’t just take that away and replace it with an IOU. Pensions are increasingly disappearing, and Americans still don’t save enough (less than 5% of disposable personal income as of Q3 2013, according to NerdWallet) to build up sizable enough assets to produceΒ the type of investment income one could live off of.

Per the SSA, among elderly Social Security beneficiaries, 52% of married couples and 74% of unmarried persons receiveΒ 50% or more of their income from Social Security. That’s pretty startling, if you ask me. That tells me that people rely on SS for a significant portion of their income, and that isn’t going to change. Therefore, SS will not disappear. It may change, and certainly I wouldn’t be surprised to see the age at which one can start to draw SS income rise as life expectancy increases.

Social Security is already like fixed income, except it’s even better because the payments areΒ annually adjusted for inflation..Β The volatility is obviously low, as SS is guaranteed by the government.

So once I’m much olderΒ and the rule of thumb indicates I should have a significant portion of my assets in fixed income, I’ll start drawing Social Security and that will be the icing on what’s already a pretty delicious cake! I don’t know what my benefit will be, as the SS calculator is difficultΒ to accurately use because my recent move to self-employment involves a lot of questions regarding income, but even if it’sΒ less than average at, say, $1,000 per month, that’s like a portfolio worth $342,857 invested at a 3.5% yield today.

Value

Lastly, I don’t find a lot of value in bonds at all right now. The yield on a 10-year Treasury note is 2.62%. With inflation running above 2.1% right now, and the payments from a note set to stay static, I see almost no upside to that investment. Your investment is guaranteed to lose purchasing power over the next 10 years if you hold to maturity, while many high-quality stocks will offer a higher starting yield with growth in the income to boot. Why you’d jump at the opportunity for a lower yield with no growth makes little sense to me, other than the fact that your principle will be intact at the end of the ten years. Of course, that principle will be worth less in real value than it was when you started, so you’re effectively guaranteeing yourself that you will lose wealth.

And this isn’t to even address the potential for rising interest rates. I make no claims to my ability to forecast macroeconomic changes, and as such won’t do so here. But I would think the odds of interest rates staying this low forever are pretty low. Thus, your bond investment could potentially be exposed to a lot of volatility between the period of initial investment and maturity. If you’re holding to maturity, this won’t matter much. But if you’re looking for a way to lower your overall portfolio volatility, this might not be the panacea.

I’m not against investing in bonds completely. If rates were to rise significantly and the numbers made sense I might have a small allocation to long-term Treasuries. But I would never want a large portion of Β my wealth tied up in debt that pays a fixed amount of income when my expenses are held to no such check.

What About Buffett?

If you’re looking for guidance here, I’d like to take the time now to point out that Warren Buffett himselfΒ is putting his faithΒ almost exclusively in equities for his wife’s livelihood after he dies. Per the most recentΒ annual letter to Berkshire Hathaway Inc. (BRK.B) shareholders:

My money, I should add, is where my mouth is: What I advise here is essentially identical to certainΒ instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’sΒ benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed toΒ certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trusteeΒ could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&PΒ 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior toΒ those attained by most investors – whether pension funds, institutions or individuals – who employ high-feeΒ managers.

If this strategy of low allocation to bonds works for Buffett, the most successful investor in history,Β and his will, it works for me. With this plan, he’s basically saying heΒ better trusts the income equities can provide to his wife over bonds. That’s saying a lot.

Full Disclosure: Long KO.

What about you? What’s your allocation to fixed income?Β 

Thanks for reading.

Photo Credit: gubgib/FreeDigitalPhotos.net

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147 Comments

  1. Interesting you quote buffett, have you ever taken the time to read his shareholder letters? Fixed income is actually quite a large portion of the investments he makes at brk. Interesting he would tell us to have 10% but he himself invests close to what’s probably 30-40% of brk investable assets. In a couple shareholder letters I think around 1992 or so he also states several reason why he can like fixed income even more than equities.

  2. took2summit,

    I’d keep in mind that Buffett and Berkshire have access to many investments that us mere mortals do not. He’s made some fixed income, preferred, and warrant investments over the years that I don’t really speak to because it’s not within my realm.

    This is an interesting article that discusses BRK’s asset allocation from 2000-2011:

    http://www.gurufocus.com/news/135497/berkshire-hathaways-asset-allocation-history-over-the-last-decade

    And this is a quote from Buffett in the 2011 annual shareholder letter:

    β€œInvestments that are denominated in a given currency include money-market funds, bonds, mortgages,
    bank deposits, and other instruments. Most of these currency-based investments are thought of as β€œsafe.”
    In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.
    Over the past century these instruments have destroyed the purchasing power of investors in many
    countries, even as the holders continued to receive timely payments of interest and principal. This ugly
    result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic
    forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such
    policies spin out of control.
    Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86%
    in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy
    what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually
    from bond investments over that period to simply maintain its purchasing power. Its managers would
    have been kidding themselves if they thought of any portion of that interest as β€œincome.””

    Source: http://www.berkshirehathaway.com/letters/2011ltr.pdf

    Best wishes!

  3. took2summit,

    I would add that as far as I can tell Buffett’s attitude toward bonds has fluctuated with interest rates, and thus the attractiveness of bonds in terms of valuations and potential returns. He seems to be more keen on them going back more than a decade, but bonds were much more favorable investments back then.

    As I pointed out in the post, I wouldn’t be totally opposed to some bond exposure if rates were much more attractive.

    Best wishes!

  4. I’m 42 and don’t have anything in bonds. I rode the wave down, rode it up, and am better off for it. Sure it will go down again and I’ll ride it down and up again. It’s all cyclical.

  5. My fixed income portion is technically 0. I have some investment real estate which I consider my fixed portion. That said I think there are other ways to achieve better yields that classic government bonds.

    1.REITS – Some have very stable fixed payouts with limited stock movement volatility
    2. Preferred shares – Often better payouts than most stocks but limited share appreciation
    3. Corp Bonds – Still can get pretty decent yields from a laddered ETF with companies ranked B and higher

    But I understand the 0 allocation especially at a young age. Fixed income seems more of a tool of capital preservation than capital growth. Also they help greatly against market crashes giving you the ability to limit your equity losses.

    All in all fixed income products will not give you the big gains needed to grow a portfolio substantially but its a great option to park your money if you are too timid to enter the market or worrisome about the direction of the market.

    I for one dont mind the market swings and doesn’t seem like you do either!

  6. Professional stock market surfer! πŸ™‚

    Many of us youngster, me included even though I am not that young, have not had the wave down yet and it will be interesting to see who will be able to handle the next correction. I keep my fingers crossed that I have the mental stability to do what you did!

  7. Dear Dividend Mantra,

    Great article. I would also include most peoples saved pension income. All those years working hard, contributing to a product that pays a fixed income. Does not make sense to me, even with tax breaks.

    Regards

    Louis Gunn

  8. Thanks for a very well written and balanced blog. Well written and good stuff!

  9. You finally hit the subject that I wanted to talk about for a long time. Warren Buffett would have been bankrupt if it wasn’t for the Fed. Fed rescued a lot of people in the market, especially Warren. I knew what was coming, so I was out of the market few months before its crash. My guess is that Fed will be always there for the market in order to save the economy on a little less scale going forward. I bought PHK 1832 shares for $11.95 in Jan, 2014, it is in my Roth Ira. It gives me $223.275 every month at the annual rate of 12.23% for the price I purchased and fund price as of today is $13.65. PHK paid the same dividend amount since 2003 IPO year and have a big balance sheet for CEF that yield will be sustainable for years to come. I invested $21892.40 and will be received $2679.30 as a dividend by the end of year. I wouldn’t be paying a penny as a tax on this sweet dividend, thanks to Roth Ira. There are so many reasons why I like PHK, other funds in my investment, and Roth Ira. I write this for a reason, but you Mr. Mantra figure that out.

  10. I’m pretty much with you with the 0% fixed asset allocation bit, at least for now when interest rates are so low. I do however have a small portion >5% in a short-term gov. bond ETF. I like the stable, monthly payments and adding shares to it is free at my brokerage for times when i dont have any capital to add to warrent buying stocks with a trading fee. And being short-term bonds , once rates do start going back up, the asset churn in the ETF will eventually get more higher interest rate bonds and increase payments πŸ™‚

  11. I’m with you on the 0% allocation to fixed income, as I’m also aggressively trying to grow my own portfolio of stocks. But I think you’ve written a fantastic, balances post which explains why for you specifically this strategy makes sense, and under what circumstances you might change your views.

    There’s also something to be said for sticking with what you know, what you have some sort of competitive advantage in. I invest in stocks because they’re what I understand best, as well as being the best tool for me to achieve my goals – and it looks like you’re in the same boat. I think it’s not necessarily a good idea to ‘diversify’ into other asset classes without a good understanding of what you’re investing in, and why. In times of stress, this is where you can make some bad decisions with assets you don’t have a good grasp of.

    I’m really loving your blog DM, you’re producing some great quality stuff here!

  12. Allow me to congratulate you, Young, for your “hidden” insight. I know exactly what you have just said and I hope people learn to do their homework thoroughly.
    I add only that there is ALWAYS a need for a “cash” portion in your portfolio. Look into the circumstance of what we shall call a “600 year event”, which in these times may occur much sooner. Risk adjusted investing is key.

  13. Great article, DM, as always! I don’t really understand the fixed income ‘rules’, especially now while interest rates are so low. Now when they start to rise, I will move more of my portfolio into fixed income. I have very little in fixed income at age 54 and my father who is 89 is still heavily invested in equities. I’ll have to ask him what his %’s are. It almost feels like a marketing / sales ploy when the investment firms say to put certain %’s in fixed income. Sure you have to manage risk, but when you are far behind in growing your portfolio, you have to take some risk too.

    Thanks for the tip on Beta metric!

  14. There is a pocket of fixed income like investments called preferred stocks. Ive been using these as a substitute for fixed income. The ones that i own pay about 7% yield, from BAC or Realty Income.

    There wil come a time when markets will return to more normal returns, which means down and up years. A high quality DGI can return double digits over time, but preferreds offer near equity returns while you wait for bargains. This hasn’t happened yet, but i will continue to have these investments which can be liquidated when opportunities arrive.

  15. Hi Jason,

    I think I selected an extremely small portion of just my 401(k) (like 5%) to a Total Bond Market Fund. Considering other assets can be considered “fixed” investments (such as principle on the home, cash value of pension, and social security), maybe I shouldn’t even have this allocation, but it is relatively small considering it is one 401k out of 2 and then we have 2 ROTHs besides that.

    On a side note, I am considering starting a blog earlier than previously mentioned, maybe next month after some one time stuff gets cleared out… but then I was thinking, well one time crap comes up all the time and it is part of reality, so really there is no reason to wait other than laziness. Paying large deductibles and getting a mortgage escrow surplus is part of life. Some stuff works in your favor and some doesn’t!

    -Kipp

  16. Great article DM. I’m overweight in equities as well, but I do have a small 5% of my portfolio in fixed income. It’s a mortgage backed security that pays about 7% a year, and it’s similar to a high yield bond. I keep it in a tax sheltered account of course. I was wondering what you thought about preferred shares as an alternative to bonds? I’ve heard preferreds offer yield but are not as volatile as their stock counter parts.

  17. My portfolios have around 6-8% fixed income and the rest are stocks. I guess you are correct because my fixed income generates negative return after the inflation, but I don’t have any plan to buy or sell them now.

    Best Regards,

  18. I don’t have any bonds in my portfolio. I feel that I have enough years left for my retirement and I could ride through any downturns in the stock market. Also, with such low returns for bonds, I am not sure if it is worth it.

  19. I have a small amount of I-bonds. I am lucky enough to have a few from when they paid 3% + inflation. The rest aren’t really for investment at this time but because they pay more interest than my “high-interest” online savings account, even if I cash them in early.

    I’m only using dividend growth investments for part of my portfolio (yes, blasphemy, I know!). The part with index funds is 10% in a bond fund (even though I’m 51) because I rebalance, and bonds are something that pay sort of okay generally and are not generally very highly correlated with stocks, so that helps me profit by rebalancing (selling high and buying low). They don’t pay well enough to have as more than, say, 20% of my index fund portfolio, though, in my opinion.

    In your position, I would probably get some inflation-tied bonds–perhaps about the same amount as you have in one or two company’s stocks.

    **

    To estimate my future SS earnings, I use this page: http://www.ssa.gov/pubs/EN-05-10070.pdf. It shows the current inflation factors by which to multiply your salaries. You add up your top 35 salaries (most of yours will be zero!), then multiply that amount by various factors. I like it because you can include only the salaries you’ve already earned. Or you can make your own estimates of what your future salaries will be. Also, it gives you the answer in today’s dollars. Each year they revise the inflation factors during the first half of the year and update the points at which different percentages are provided.

    And yes, I did make my own spreadsheet which I update with new salaries and the new inflation factors every year so that I only have to enter the salaries once. (Well, twice–once when I have my own estimate, and then I revise it when I get my SS annual statement with the official figure.)

  20. Excellent article. I had not been paying attention to my work 401K as diligently as I should have been and had some money going towards a fixed income Real Estate Investment Fund. Time to put the kibosh on that one!

    I feel like I’ve had the fixed income discussion before with other people, and for some it makes perfect sense. Others either don’t see it, or would rather trust the professionals who typically rely on such ideas. And it is an idea that has not adapted to this time and age, where the market moves faster in one year than it used to in one decade, thanks to technology.

    – Grem

  21. agree on this one. Remember Madoff with fixed 10%? I found some high yield checking accounts for my cash and it’s about it for me. I was thinking to purchase some local bonds but mostly to support that they are doing.

  22. I’m also very curious to see how i personally react to another downturn. I didn’t have a sizeable enough nestegg at the time to have warranted any undue worry. I notice a lot of investors posting nowadays started in the great run-up of the last 5 years.

    But i guess that is one reason i settled on DGI. When we do dip that income coming in is not gonna change. Since the holdings are long term, why should i care the current price took a haircut?

  23. Jason, do you know anything about TIPS? I’ve seen them mentioned before elsewhere but haven’t had time yet to research them.

  24. In my 401k i have about 5% allocated to PFF (preferred’s ETF). The thing to remember is alot of the preferreds are financial companies. I have 10% in VIG. The rest i have balanced across the spartan index funds weighted appropriately across small/mid/large and international (vanguard costs me an arm and leg to buy in that acct so spartan is the best i can get). No bonds but i’m young. Eventually i’d like to get to 10% but not anytime soon.

  25. I have about 2% of my portfolio in a preferred shares ETF. Would eventually like to have about 2-3% in a bonds ETF. Vast majority of portfolio will likely always remain in equities.

  26. For the crowd that generates cash by SELLING assets, I can understand an allocation to bonds. But for us buy and hold forever dividend-heads, forget it. A diversified portfolio of dividend stocks is the way to go. I do advocate, however, building in a buffer where you can withstand a 20% cut in dividends in the event of a ferocious bear market. Or, alternatively, be able to cut your expenses by 20% if necessary.

  27. If I could do it over again, I would invest in individual stocks/securities in my IRA and Roth and index funds in my brokerage account.

    The best time to invest in stocks, or really anything, is yesterday.

    Even my purchase of T in 2012, which I reinvested dividends since then, yields 6.7% on the current annualized dividend compared to my initial purchase. Ah, the power of dividend growth (small) + reinvesting + compounding. Makes me smile very wide. It’s only been around 2.5 years that I’ve held, but I can only imagine the earning power in 10 years. πŸ™‚

  28. I’m in agreement that fixed income securities aren’t a necessity especially when following a dividend growth investment strategy. Personally, I have around 10% of my wealth in fixed income (US Series I Bonds and a fixed income fund through my employer 401K). I’d probably be just as comfortable having everything in equities but I feel a 90/10 allocation works fine for me. As I age, I plan on keeping the same allocation.

  29. I have high yield bond funds in my ROTH. Some of them yield 14% and they are tax free.

  30. Considering the current environment, bonds – esp long term are definitely not a great investment idea. But one point you raised that investors should pay attention to is the low beta. Bonds provide the inertia in a portfolio that stocks cannot. As we saw in the recent crisis, dividends are not guaranteed – even from large corporations that have paid them for decades and can be cut in crisis environment. I still own a very small portion of my portfolio in short term high grade bonds (about 7.5%).

  31. frankiesweep,

    Well, bonds went on a great run there for a few decades. You had massive interest rates at the beginning of the 80s, and that was a great time to invest in bonds. With rates the way they are right now I see no real upside here. You have little potential for appreciation, and the interest in the meanwhile leaves you with little income. But it is definitely cyclical. And I’d say we look to be at a disadvantageous point in the curve.

    Cheers!

  32. Asset-Grinder,

    Great points there! I especially agree with you in regards to preferred issues. The yield on some of the preferred issues I’ve seen over the last year or so is pretty attractive.

    And I also agree that fixed income is more about wealth preservation than growing wealth. I should have probably added that. Although, I would argue that government bonds right now aren’t even preserving your wealth – you’re pretty much guaranteed to lose wealth with long-term bonds, if held to maturity.

    Thanks for stopping by. And I also don’t mind the volatility one bit. πŸ™‚

    Best regards.

  33. Fredrick,

    It’ll be interesting to see how many of us react to the next major correction. I don’t know when we’ll see it, but it will come at some point. Be ready! πŸ™‚

    Take care.

  34. Louis Gunn,

    Well, it all depends on your point of view. Sometimes people need to be forced into saving, because they can’t help themselves. SS is a good example of that. Maybe people could do better on their own vs. SS, but without the SS withholding you have to wonder how people would get by in retirement.

    Take care!

  35. Young,

    Hmm, I’ve never looked into PHK. But it sounds like it’s doing very well for you. πŸ™‚

    Although, I don’t think Buffett or Berkshire would have been bankrupt if not for the Fed. But we’ll never know what would have otherwise happened. I actually wish the Fed would have scaled back a long time ago and let the market roll on its own. Volatility would have given someone like me with limited capital some pretty good opportunities.

    Thanks for stopping by!

    Best regards.

  36. Dividend Wisp,

    Great stuff there. If I were to be in a bond fund it would absolutely be a short-term fund, so that the fund could stay nimble when rates eventually rise.

    Thanks for stopping by!

    Take care.

  37. I prefer high yield investments at this point compared to traditional fixed income. The risk is still there, and the reward is not.

    At this point, even if my portfolio went down 90%, I wouldn’t be any worse off. I would probably cry for a while, but since I am still in my working years, I don’t really draw from my investments at all, so they may as well be in the higher risk/return phase.

    I think some of the high-yield and short-term bond funds may make sense, as the interest rate risk is mitigated compared to medium/long duration, but outside of that, I wouldn’t want much.

  38. I must say DM….your articles among others are what keeps me so interested in the dividend investment business. I didn’t participate early on in life(54) but as they say “better late than never”. I’m building up my portfolio and it’s a very long and intense process but that’s okay. I’m retired now and having a diversified portfolio as well as access to cash is key until my dividends provide the same income as my fixed income.(SSDI)

  39. Jason,

    That’s a really great point there, in sticking to what you know. No sense in investing in an asset class if you don’t truly understand or appreciate it, especially if it’s just to fit into some kind of predetermined personal finance mold. That would be a shame.

    Appreciate the support very much. Glad you enjoy the content. I do put my best effort into it. πŸ™‚

    Best regards.

  40. Debs,

    I don’t necessarily believe in a lot of the rules of thumb out there. And automatically having bond exposure, or exposure related to your age is one of them. I certainly think bonds could be an attractive asset class, but we’re nowhere near that point right now, in my opinion. And equities have far outperformed bonds over long periods of time, so why give up the gains for less volatility?

    I suppose it all depends on your personality. I appreciate volatility, but I can certainly see how others wouldn’t. For those people, less volatile assets might make a lot more sense.

    Best wishes.

  41. Sfi,

    Great point there. I agree preferred issues make a lot more sense than other fixed income securities right now. Nothing wrong with a 7% yield, which can provide some hefty current income which can be reinvested elsewhere, including common stocks. Although, the preferred income is still not taxed advantageously like qualified dividends, so that’s something to keep in mind depending on your tax strategy. I certainly have my exposure to higher-yielding securities, like ARCP, but I still like to keep things pretty balanced.

    Cheers!

  42. Kipp,

    If that allocation makes sense to you, then that’s great. I personally don’t find a need for fixed income, as I appreciate volatility. But not everyone does. And certainly some exposure to fixed income can cushion some of that.

    I do hope you start up a blog. This community grows every day, and it would be great to have another voice out there. πŸ™‚

    Best regards.

  43. Liquid,

    Preferred stock is a great way to access high yield, although the income is still fixed and the taxation isn’t favorable. So that’s just something to keep in mind.

    Some of it depends on your time frame as well. If I were a much older investor then reaching for yield might make a bit more sense. But someone much younger might not need to reach for yield, and can balance current yield with growth in income. And that gets you the best of both worlds.

    Although, some common stock is offering preferred-like yield with growth to boot. ARCP is a good example.

    Thanks for stopping by!

    Best wishes.

  44. Finance Journey,

    Thanks for adding that.

    If that works for you, then that’s fine. We all have different goals which may require different strategies. I just find personal finance tries to sometimes put everyone in a mold, which I think is a disservice.

    Take care!

  45. DGJ,

    I’m with you completely. Low current returns means they’re unattractive, and volatility doesn’t bother someone like me with a long time frame. However, I could see how an older investor might want a different allocation. But I think Buffett’s strategy for his wife, who’s older, is interesting. Just goes to show you the age = bonds scenario doesn’t really hold a lot of weight.

    Cheers!

  46. Debbie M,

    If the bonds work for you, that’s great. And those I-bond rates are fairly attractive. Certainly much better than you can do right now! πŸ™‚

    I did use the SS calculator, but it’s hard for me to estimate my future earnings and how that will impact my ultimate number.

    Although, I didn’t use that pdf page to estimate my future earnings. I used the calculator that uses your real-life earnings and tries to estimate future benefits:

    http://www.ssa.gov/retire2/estimator.htm

    I found it pretty cool to play with the numbers, but it’s tough for me to accurately estimate what my benefits might be. It’s a pretty wide swing depending on how much self-employment income I earn. But even on the low end I’m looking at all gravy. πŸ™‚

    Cheers.

  47. Gremlin,

    It’s tough to convince others that bonds might not make sense right now. I think people too often want to believe in a mold that works for all situations, all the time. And there really isn’t one. And while bonds might not make a lot of sense for me right now, I’m also not saying that will always be the case. Asset prices go up and down, and as such you must be aware of that and stay flexible.

    However, I don’t agree with the crowd that says you must have an allocation to bonds no matter what. That simply makes no sense to me.

    Thanks for stopping by.

    Best regards.

  48. Happy,

    I wasn’t aware of Madoff and his asset allocation. That’s a real shame what happened there, though.

    Supporting some local projects is never a bad idea. I’d just go in to it knowing it’s less an investment and more supporting the local community. That way you’re not disappointed with the financial results. πŸ™‚

    Best regards.

  49. Hi,

    I have about 12% in share based bond investment trusts, I bought in when we had that market swoon a few years back, the YOC is around 8% and the capital appreciation is tickling 40%, its been a nice part of my stage 3 rocket.

    Because I’m older and only one juicy Big Mac away from a heart attack its my intention to slowly rotate in to a larger allocation of bond funds in the future, as for tax I dont worry about it, I make sure any capital gains from trading (Hardly trade now) are below the annual limit, tax on dividends I consider my contribution towards society,healthcare and state pension.

    Cheers,

    Dave….

  50. As an insurance company, Berkshire is required to keep a large amount of money on hand (cash or other liquid investments such as sort term bonds) to cover payouts should something happen and claims need to be paid. If you are required to have billions of dollars sitting around eating a hole in your pocket, you might as well invest them in short term bonds and get some yield out of them, even if it only a fraction of a percentage. I’m sure if it were up to WB, BRK would buy bonds much less often.

  51. Zol,

    TIPS are a bond that simply adjusts to inflation. So you get paid fixed income like any other bond, but the principle is adjusted up or down based on CPI numbers. So if you believe inflation will be strong, these might make a lot of sense. However, you sacrifice current income because the yield TIPS offer is usually much less than other bonds due to the inflation hedge that’s built in.

    You can read more here:

    http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

    I hope that helps!

    Cheers.

  52. $25000,

    Thanks for stopping by and adding that.

    I may eventually find myself with a 5-10% bond allocation like that as well, but only because they were highly attractive and I thought the risk/reward relationship was far in my favor. Otherwise, I’m happy with 0%. πŸ™‚

    Cheers.

  53. Josh,

    Well, I think an allocation to bonds can make sense for those looking for capital appreciation or just the income (on a long-term bond). It really depends on your circumstances and where interest rates are. When interest rates were really high (early 80s and later) you were doing well because as rates were decreasing your bonds were appreciating rapidly. Meanwhile, inflation was decreasing with rates and the income you were earning was great because there was an increasing spread between the income and inflation. But I don’t know when/if we’ll see a situation like that again.

    I wouldn’t be opposed to bonds if the situation was right. I do remember YMOYL actually recommending 30-year treasuries as the preferred investment tool for those seeking financial independence. Of course, that’s back when rates were much, much higher.

    Cheers!

  54. Ehhh I think YMOYL was referring to that as a *risk free* retirement. At least the updated version from the 2000’s seemed to allude to this. I am trying to remember what else was mentioned about investing in YMOYL, but I think I am getting it mixed in my head with a Random Walk Down Wall Street.

  55. Dan Mac,

    Thanks for stopping by!

    Nothing wrong with a 90/10 split. Basically the same as what Buffett is setting up for his wife.

    I might have some allocation to fixed income in the future, but I’d have to see much more attractive rates.

    Cheers!

  56. I’m almost 50 (ugh!) and my current allocation is:
    5% bonds
    7% REIT
    88% stocks

    I sleep fine at nights πŸ™‚ My percentage of fixed income is actually declining as I don’t add anymore to the Bonds

  57. Ah, perfect 10 second summary. Thanks. It’s been on my list to at least research for a while now and i bookmarked the link. I need to stop reading blogs and free up some spare time πŸ˜‰

  58. Dave,

    That’s really interesting. I do wonder how they’re able to achieve such a high yield? What are these funds investing in? Even junk bonds don’t go quite that high. Would be interesting to know exactly what the fund owns.

    Cheers!

  59. R2R,

    Great point there. Bonds are higher up in the corporate structure, so if payments from a bond stop coming then that entity is likely to be forced into bankruptcy. A little different for dividends, which offer no such assurances.

    But I’d venture to say that a well-diversified equity portfolio with mostly high-quality stocks will do quite well when compared to bonds, even factoring in potential dividend cuts. I’d rather risk a static or cut dividend over a guaranteed static bond payment.

    Cheers!

  60. Ravi,

    I agree that some of the short-term bond funds probably make the most sense, but I’m not interested in this asset class at all right now. I’d rather focus on increasing my purchasing power over time, and that’s something that I just can’t see happening with much of the fixed income options out there.

    And while I look forward to pullbacks, I don’t think I’d like to see a 90% decline in value. I think I’d probably cry too!

    Best regards.

  61. maurice,

    Better late than never, indeed. The best time to start investing was yesterday, but today is a fine second choice. πŸ™‚

    Keep at it. The success will eventually build on itself and you’ll start to see the snowball in motion.

    Best wishes!

  62. Dave,

    Sounds like you’ve done pretty well with those investments. I must say I don’t know anything about bond investment trusts, but it looks like you do and that’s what counts. πŸ™‚

    I stick to what I know, but if I were to invest in bonds it would probably be more vanilla stuff like treasuries or munis. Bond funds are nice because you can invest with much less money than some individual bonds require, and you gain wide diversification all at once.

    Cheers!

  63. Spencer,

    Great point there. I remember reading an article on how Berkshire is a bit different in regards to their cash needs, however, due to the businesses they’re invested in and the regular capital (outside of premiums) coming their way. So they’re a really unique insurer. But I agree that they have to have fairly significant portions of cash on hand for claims.

    I do wonder how Buffett would feel toward bonds if this weren’t the case, but maybe his will already tells us.

    Best regards.

  64. Kipp,

    I don’t think I read the updated version. I remember in the one I read that Joe was referring to 30-year treasuries because the yield was quite high (at the time) and one wouldn’t need to worry about the capital. Of course, this was also meant to be really simplistic investment advice, as the book focused much more on the practical side of things, especially relating to why one should pursue this strategy and how effective cutting expenses can be. I think he did this on purpose because the book could have really stretched on about investment advice when that really wasn’t the point of the message. So one could say it focused maybe more on the who, what, when, where, and why, more than how (especially in regards to investment advice).

    Cheers!

  65. Rob,

    Sleeping well at night is really what this is all about. And I think much of the reasoning behind investing in bonds in the first place is for the cushion they provide in regards to volatility, as bonds aren’t really correlated to stocks. If you’re sleeping well at night and hitting your goals then you’re in a great spot. πŸ™‚

    Best wishes.

  66. It’s partially what they invest in (non-investment grade corporate bonds), but mostly that they use a lot of leverage to buy more of it. But hey it’s a stock/bond bull market so what can go wrong with leverage πŸ˜‰

  67. DM – Definitely noticing a difference in the quality of your posts since moving back to Michigan. I can tell you’re really giving this 100%.

    I LOVE that you are able to put more time into these new posts!

    Keep up the good work and inspiration – and I have full confidence that everything is going fall into place very nicely for you.

  68. Ken,

    Ahh, leverage. Seems great…until it isn’t.

    The leverage must be pretty extreme with anything yielding that high, as even most junk bonds aren’t anywhere near that.

    Cheers.

  69. Econ Nick,

    Thanks so much. I’m glad the effort is coming through. I spent a lot of time with this one yesterday. Really appreciate the support and encouragement! πŸ™‚

    Hope to be able to keep it up for a long time to come!

    Best wishes.

  70. Jason- Thanks for starting a lively discussion. I definitely believe in mostly dividend stocks for my taxable account for the reasons you stated. However, I do occasionally buy corporate bonds or international bonds through monthly paying CEFs at a large discounted price when I can’t find a good deal on a dividend stocks.

    As a BRKB shareholder, your Buffett quote (as well as your regular discussions) reminds us of alternatives to that stock for those of us dividend minded investors who also want the Buffett returns! I wonder what alternatives your readers would recommend?

  71. paperboy,

    Is there a specific recommendation you’re looking for? I’m not sure, based on your comment, what kind of guidance you’re looking for. Alternatives to the stocks I discuss here, or just an alternative to BRK.B?

    Let me know how I can help.

    Best regards!

  72. Basically a well-written Wikipedia article on finance (and that’s a compliment!). Keep teaching!

    WE#1

  73. Jason,
    I’m 57, my wife is 58, we hold zero bonds. None. If bonds yielded more than inflation (meaning that they had a real rate of return), we might put a small amount in bonds. We do hold a significant amount in cash (including short term certificates of deposit) in case the market corrects, I lose my job, emergencies, etc.
    Thanks,
    KeithX

  74. Bonds are not a good investment for me at this time.. With the yields so low and the interest payments are fixed, I will be actually losing money due to inflation.

    A lot of people are hesistant to get involved in the stock market as they are scared of losing money… I try to tell people if you invest in a company such as Disney and the share price drops a lot in a few months, do some research to find out why… If you strongly believe in the company, buy more shares to make your money work for you harder.

  75. WE#1,

    Thanks! Appreciate the kind words.

    I hope some readers out there found some value in the post. Just sharing my thoughts and experience. πŸ™‚

    Cheers!

  76. I also have 0% in bonds. Maybe if they yield like 15% then I’ll reconsider. But for now, I don’t think it’s a good idea to buy bonds just for diversification stake.

    Cheers,
    Henry

  77. KeithX,

    Thanks for adding that. I think the old rule of thumb that dictates bond allocation based on age is just not really all that intelligent. And especially so with rates so low. Rates would have to rise significantly for me to feel comfortable investing in bonds, because I’d be trading off growth for more current income. And that trade-off would have to be really worth it. Besides, if you’re interested in that trade-off you can invest in T right now with a 5%+ yield, secure payout, and low growth. That’s better than a lot of bonds out there, plus you get the chance at appreciation.

    Best regards.

  78. Investing Pursuits,

    I’m with you, bud. Stocks that are lower priced are just a potential opportunity to pick up cheaper shares, and hence more dividend income. Of course, not all pullbacks are opportunity. If a stock was overvalued by 20% and pulled back by 10% it’s still not a deal. But I generally look forward to cheaper stocks for better opportunities.

    Thanks for stopping by.

    Take care!

  79. Living At Home,

    I’m with you. I’m not sure if I’d have to see 15% rates (and I don’t know when/if we’ll ever see that), but I’d have to see the 10-year cross at least 5% before I’m even mildly interested.

    And I couldn’t agree more that investing in an asset just to diversify is a horrible idea. Invest in what makes sense for you and your goals. Diversifying just to diversify is just not smart.

    Best regards.

  80. Hi DM,

    Another well written article – I started out investing thinking that I needed a mixture of bonds and stocks so I chose some high yield bond funds from Vanguard that pay monthly distributions (about 4-5% annualized). I’m at about 55% stocks in my portfolio currently and slowly reducing the bond component.

    I came to the same conclusion that a stock only investment is sufficient but I’ve been unwilling to sell out of the bonds while I still have cash on the side to buy more shares with. They do tend to go up when the market goes down such as today, but the stocks usually go down by more than the bonds go up!

    Did the article about Warren Buffet’s wife’s legacy fund say how much money he was putting into it? I’d expect it’d be a safe retirement fund just from the scale – after all 2% yield of a very large number is still a large number πŸ™‚

    Thanks for giving us lots to think about!
    Best wishes,
    – DL

  81. I have 0% in bonds as well. I have been looking at i-series bonds as a place to put some of my emergency fund as opposed to having it all in cash.

    I-series avoids a bunch of the normal bond problems.
    Inflation protected: the yield is the CPI-U (currently 1.97%) and the fixed rate (which is currently 0. Woo,) adjusted semi-annually. If deflation takes hold, it simply pays 0% interest, instead of a negative like TIPS.
    Variable bond duration: Able to redeem after 1 year. Before 5 years, it carries a penalty of 3 month’s interest, and keeps earning interest up to 30 years.
    Tax-deferred and/or exempt: Can elect to defer taxes until the bonds are cashed in. If the bond is used for qualified education expenses for yourself, spouse, or dependent, it’s tax exempt.

    It does have to put up with the CPI numbers, which seem vastly understated, but as far as fixed-income goes, they avoid a few of the negatives and give you more flexibility.

  82. Dividend Life,

    As far as I’m aware, Buffett hasn’t specifically said how much money is going to his wife after he dies. I’ve read various articles over the years that dig into his personal portfolio and it was worth more than $2 billion last I looked. So that’s a substantial amount of money. But I haven’t heard of exactly how that money is being split up.

    I hope that helps!

    Cheers.

  83. Justin,

    I Bonds kind of sound like CDs to me, but they earn the investor a higher interest rate right now. Is that correct? If so, it’s not a bad place to park some short-term money, if one needs a place to do so. The penalty for redeeming early isn’t that bad, and it’s nice that you can “cash them in”, which sounds like you’re essentially selling them back to the Treasury at par. That way you don’t need to worry about rising interest rates or an open market.

    Sounds like the way to go for parking cash, as they’re more attractive than similarly termed CDs right now.

    Thanks for stopping by and adding that!

    Best regards.

  84. DM,

    All of the reasons why investing into dividend paying stocks appears to be the right way to go. This article is a great lesson tool for those investors that are debating about the security instruments, either have bonds that are maturing or are looking to get out of them. Great article!

    -Lanny

  85. DM,

    FYI: Preferred shares pay qualified dividends just like common stocks except for REIT preferreds. Common REIT shares don’t pay qualified either, moot point. The reason is that bond interest is paid before corporate taxes, while dividends (both common and preferred) are declared (no guarantees) after taxes are paid in the event the company pulls a profit.

    Unfortunately most of the qualified preferreds are either utilities with crappy yields, or financials without the cumulative feature. Personally I scooped up a couple REIT preferreds and placed them in my ROTH to avoid the tax thing all together. I’ve been very pleased with those investments and may buy more.

    I find preferred stocks to be very interesting, if only interest rates were higher!

    Nice article, and best wishes up in Michigan!

  86. Well I did it, created one. Still have a lot of messing around to do with the format.. but at least it is workable. I am more concerned with how it will show multiple posts, which isn’t a big deal right now with there only be one created.

  87. Bonds aren’t ideal for the apple picker investor. It is more suited for tree farmers. If the market is low sell the bonds and not stocks to live off of. You should rebalance yearly that way you are buying low and selling high. That’s why bonds aren’t really meant for DG investing. I entered my portfolio in Motif and was shocked that my dividend portfolio was out performed by around 15% by the S&P 500. That’s all it took for me to start to edge toward the Knucklehead.. mmm Boglehead portfolio type. I do have a love for Dividend companies though and am certain that I will purchase more stocks once I get my S&P 500 index fund a bit higher. I’m not saying one philosophy is better than the other, since on the other side of the coin the tree farmer investor has a higher percent in bonds, which earn a terrible return.

    If you look at the S&P 500 it is basically just a tad more focused on what you referred as type 2/3 dividend stocks instead of type one. If you look at the profit and growth rates of the S&P 500, it’s pretty strong.

  88. In my ROTH I own SDR yields 27%, WHZ yields 23%, CPR yields 20%, CLM yields 19% among others. No way I would hold in a taxable account.

  89. Lanny,

    Thanks so much. Appreciate the kind words.

    I personally don’t see an advantageous risk/reward profile with bonds right now, but that could change at some point in the future. In the meanwhile, I’ll be happy to invest in wonderful businesses for the long term. πŸ™‚

    Thanks for stopping by! Hope all is well over there.

    Best wishes.

  90. CI,

    Thanks for clearing that up! I’m not quite sure why I had thought preferred dividends were subject to ordinary dividend tax. From some real quick research on it, it looks like the only difference is the holding period necessary to be qualified.

    I may look into preferred issues at some point, but right now I still find the best risk-adjusted potential returns in most common dividend growth stocks.

    Thanks again! πŸ™‚

    And keep up the great work over there. Love the consistency, and hopefully the new frugal measures like cutting cable allow for some extra investment capital.

    Take care.

  91. Kipp,

    Looking really nice! That’s awesome. I hope you really love blogging. It’s been really rewarding for me. πŸ™‚

    And I still remain jealous that you live out in the Grand Rapids area. I personally think that’s probably the best area to live in, other than perhaps Ann Arbor. You get big city amenities without some of the big city issues (crime, traffic, etc.). However, I don’t like the city tax. That really sucks, and that’s one of the major reasons I’m shying away from moving out that way at some point. I remember you saying you’re not right in the city, but I really like the downtown area.

    Best of luck with the blog. πŸ™‚

    Best wishes.

  92. Monty,

    That’s an interesting scenario there. How did Motif calculate your total returns? It’s tough to calculate after the fact because you’re buying stocks at different dates, and you’d have to compare each purchase going forward against the S&P 500 index going forward.

    I was personally outperforming the S&P 500 as of early last year, but I’ve pretty much stopped tracking myself against the S&P 500 index because I didn’t find it to add any value for me and since then I’ve actually realized that it was potentially a disservice to me.

    Best of luck either way. Many ways to skin a cat. The important thing is that you accomplish your goals! πŸ™‚

    Best regards.

  93. DM,

    Good explanation and case for not needing to own fixed income. I have 0% allocation to bonds in both my Roth IRA and Taxable Brokerage.

    I do have some in a high yield fund (SPHIX) and couple other small amount of shares allocated to bond funds in my 403b through work and Fidelity which does not offer individual stocks. I like the interest it gives in the tax deferred account since I have different stock and international funds as well.

    I just don’t get a match nor am I able to pick my own dividend stocks which has caused me to lower my contributions for now towards it and focus more on the taxable brokerage. I should have a small pension vested by the start of 2015 as well from work.

    Happy investing!

  94. As I side note I rode out the last 2 bear markets with a 0 percent bond allocation. Huge mistake. It sounds easy until you see years of saving 100k only to see it turn into 50k in a few months, then your job is cut. Being so aggressive in a bull market with stock allocations is a huge mistake IMO. The psychological impact, which happens in a bear market, is tremendous. It’s not just stock values that you have to deal with, but job prospects. Imagine if a person’s investments were cut by half and then they lost their job. They would be forced to sell stocks, at any price, to survive. This is common in severe bear markets.

    Heck if you look at the historical yield of the S&P 500 you could make the case that its 75% overvalued. No-one knows the future, so I say keep a solid amount in Ibonds/Cash/SBonds/CDs. I really don’t like bonds, but it is necessary in a balanced portfolio, trust me from experience! As much as I find the Boglehead guys a tad obnoxious, there is no doubt in their long term investment expertise. Most of them have been investing for 30 plus years. Most are very intelligent and the average portfolio is probably over 1 mil. That’s a ton of experience to not pay some attention IMO.

    Love the blog as always!

  95. It lets you back log it for one year to compare against the S&P. I’m sure KO didn’t help my cause.

  96. SWAN,

    I didn’t invest anything in the 401(k) my former employer offered for the same reasons. No match, high fees, and poor options left me focusing on the taxable account, which works for me. πŸ™‚

    Keep investing in those sleep-at-night investments over there!

    Cheers.

  97. Monty,

    I honestly don’t find bonds necessary for that purpose. To me, that’s akin to saying one should keep cash under their mattress because of the psychological disaster awaiting you at the next major correction. That would be effectively the same thing – assuming low risk for low returns. But what I attempted to point out is that the risk is very real with bonds right now. Inflation might not be something that shows up in a quote, but it’s there.

    However, I don’t think you can go wrong with a low-cost S&P 500 index fund. If I were to invest any other way I’d probably have almost all of my assets in a Vanguard S&P 500 index fund. I might be interested in bonds at some point when they appear more attractive, but I don’t see the benefits right now. Just my opinion.

    Best wishes!

  98. I’m currently in a similar situation at my work. I’m in a pretty high level job (CIO) and the organization still doesn’t match their 457 plan. That’s why FI is so important. You cant depend on any company to do you any favors!

  99. I haven’t put a dime in bonds because they’ve been overpriced for years. When I started investing back in 2010, people like D4L were dumping their bond funds left and right, so I wasn’t exactly motivated to jump in that game. Maybe some day bonds will find their way into our portfolio, but for now DG stocks are just fine for us.

  100. Like a lot of “rules of thumb” the bond allocation being relative to your age, I believe was valid when peoples retirement period was much lower than it is now (if you are not going to draw income for too long, you don’t need to protect income against inflation as much).

    Now that people are anticipating living in retirement much longer (my dad is now 20 years past retirement age), it is essential to protect yourself against inflation. Bonds don’t do this.

    I am like you therefore with a 0% fixed income allocation and will anticipate remaining this way even in retirement (depends on comparison to share dividends), as I will want to achieve growing income from a dividend portfolio not a static income from a bond portfolio. I will however hold more cash to allow me to fund my living expenses.

    My ideal scenario when I do finish working would be to be in a position to require less than 100% of my dividend income to live on so that I have a buffer for when a recession comes along and dividends do reduce instead of increase. This would provide a growing income (by greater than inflation if history is a guide), with an increasing buffer of cash to protect against the downside risks, and no requirement to use any capital to live on. I don’t believe I will actually achieve this as I do want to finish working in the next 2 – 5 years (i.e before I am 60), and probably will not have a portfolio big enough to fund all my income, but I will accept he risk that goes along with use of a small amount of capital to fund my living expenses, and if I achieve 30 years of good living, with enough cash to do the things I haven’t had time to do before, then I will be content and prepared to “survive” on my state pension from then onwards

    Best Wishes
    FI UK

  101. Thank you for the encouragement. Yea, I live about 20 miles north of GR. My wife actually works in GR while I work in a town straight west. Our immediate family, except for a couple, are all either in GR, on the north side of GR, or west of where we live. Which makes it easier to spend time with family :).

    I am pillaging my wife’s photo collection for the pictures, at some point I will have to start taking some new ones for certain projects, but I like the look of the beach on the front page from our recent vacation. The waves almost have a painting like feel to them.

    Thank you for stopping by!

  102. There are plenty of stocks that have low (or even negative) correlation to the broader market.

    The example that comes to mind is REITs which tend to underperform in a bull/risking market and outperform in a bear market. You don’t necessarily need to get into other investment products in order to hedge your portfolio.

    Another possibility is to spend a small portion of your investment income to purchase broad index put options, which will drastically increase in value in the event of a bear market… if you are so inclined.

  103. I think i’ve read before that because of the bond’s lower volatility they help when you rebalance your 401k annually. In essence when stocks are down your bonds should be a higher percentage and you are “buying stocks low” and when stocks are up bonds are a lower percentage and you are “selling stocks high” thus smoothing things out.

    I dont see how bonds really fit into a DGI strategy compared to an index based approach with re-balancing. Nevermind that they have crap rates at the moment.

    I’m fortunate enough to have a good match along with pretty much the entire market (minus stocks) for my 401k. Because of that i’m doing a split investing approach with my 401k and taxable acct DGI. I figure it can’t hurt to hedge my bets as i think if done right each strategy is more than viable.

    This was a pretty simplified approach / good read on the subject for anyone just starting out with their 401k (which is inherently different than a DGI approach). It also has some very sage wisdom for younger people.

    http://dl.dropboxusercontent.com/u/29031758/If%20You%20Can.pdf

  104. In the best case scenario you are spot on with investing all your money into Dividend stocks, but with any situation you have a certain level of risk. What if 3 companies you rely on go bankrupt or stop the dividend? Municipal bonds backed by healthy municipalities offer a safe hedge while tax free, for a scenario in which dividend income is slashed during retirement.

  105. Spoonman,

    I’m totally with you. There might be a day when bonds find their way into my portfolio, but for now I’ll stick with what’s working for me and what seems most attractive.

    Thanks for stopping by!

    Cheers.

  106. FI UK,

    That’s a fantastic point there. Indeed, someone who’s retiring early is especially in a position where they need to protect against inflation and promote growth. Although, even traditional retirees are living longer and growth opportunities, which are typically found in stocks, are increasingly important.

    And I’m with you on the margin of safety. I also would love to eventually get to the point where my dividend income exceeds expenses by a fairly healthy margin, creating a buffer. I think this will happen naturally, however. I suspect that at the beginning of FI the spread between dividend income and expenses will be quite tight. But as I age and the growth curve finds itself in my favor I expect dividend growth to far outpace expense growth, and the margin of safety will start to build itself organically. We’ll see how it goes!

    Thanks for stopping by and adding that.

    Best wishes.

  107. RichUncle EL,

    That’s a great point in regards to what happens if a couple of companies go bankrupt or stop paying the dividend. I addressed this scenario here:

    https://www.dividendmantra.com/2014/04/why-i-eventually-want-to-be-invested-in-50-companies-income-diversification/

    Essentially, diversification is your hedge here. However, we all have different views on diversification, safety, and hedging. As such, some would view some allocation to bonds as necessary. I just view bonds right now as a poor substitute for stocks, but that could change in the future.

    Best regards!

  108. That’s a great subject. Although stock market isn’t well developed and attractive in Portugal (where I live) our govt bons pay 2.34% to 3.60% (tax free) depending on how much time we invest.
    Here, a good portfolio would have about 25% in these bonds, I think, for a person around my age (37).

    Cheers

  109. Trader,

    That’s a shame that those low-interest bonds are perhaps your best choice. Those rates are pretty solid for short-term money, but not very good for long-term returns. Although, I don’t know what inflation looks like over in Portugal.

    Thanks for adding your point of view from across the pond. πŸ™‚

    Take care.

  110. I rode the wave down in 08 and only sold non dividends, BAC at 30 and GE when it was obvious those firms were in trouble and would cut dividends (or become completely insolvent). I wish I would have put more money to work at the bottom, but during that time, my employer was having massive layoffs. Because of this, I started saving a lot of liquid cash equivalents to have a years worth of living expenses in case I got the axe next. In hindsight, I wasn’t laid off and wish I would have dumped that 18k in DG stocks at record lows at the time. I would probably have quadrupled that cash and have a fat roll of divies coming in each quarter. There is something to be said for safe, stable investments, and keeping some “dry powder” for emergencies or deployment in market corrections/crashes that offer bargain low prices. Sure, I held on to my core DGI holdings on the way back up and added to them in 2010 and beyond as the recovery and job market became more stable, but had I had some fixed income and emergency cash/MM funds to cover myself and let me sleep at night when folks were losing their jobs and their homes left and right, I would have a much stronger portfolio today. You never know how much a little fixed/stable return is until you REALLY need it!

    Love your website and insight, I started my journey around the same time as you in sunny Manatee County FL and then found your site eventually thought the Div-Net folks. Your site hit “close to home” I should say as I have followed along through the years. Good luck and good health to you up North!

  111. Jason, this could be the worst time in history to buy bonds. I bought 100 shares of JPM today at 3% div rate. Abov current bond rate and what will my YOC be in 10 yrs?

  112. no bonds – I agree.
    however, I do use naked puts and covered calls to provide a boost to income.
    Its a great way to add a low beta income stream to my divi

    cheers
    t

  113. DiggidyDan,

    I can certainly understand it being difficult to add to stocks when everything is going crazy around you. Your situation is the same as what many companies face in times of stress like that, as they tend to stop or slow down buybacks just as the share prices become most advantageous. However, I don’t think you need to maximize every single opportunity in life. Furthermore, staying relatively consistent over the course of many, many years is really where it’s at, rather than trying to back up the truck during certain periods. At least, that’s my strategy.

    Appreciate the support and readership very much. And I do miss it down there in Florida. I was right around the corner from Manatee there. No state income taxes, beautiful weather, lots of sunshine, palm trees, beautiful beaches…but my crazy family lives up here in Michigan. What are ya gonna do? πŸ™‚

    Thanks for stopping by!

    Cheers.

  114. DD,

    Couldn’t agree more. If you look at the historical trend of the 10-year, this is about as low as it has ever been. That doesn’t bode well for bond investors looking out over the long haul.

    Nice job staying consistent. And I hope JPM turns out to be a great holding for you!

    Best regards.

  115. DM – I am just looking for an alternative ideas to BRKB. It the only stock I own that doesn’t have a dividend, so it stands out. However, it has been a good performer for me and I do like Buffett.

  116. paperboy,

    Well, I don’t think you necessarily have to sell BRK.B. If it’s performing for you and is meeting your needs, then why not keep it?

    If you want to replace it with a dividend growth stock, it would be impossible to pick just one company that operates just like it. Rather, you have an insurer/conglomerate with wholly owned subsidiaries and holdings in many major corporations. I look at my entire portfolio as a mini-Berkshire, so I couldn’t pick just one stock to replace it with.

    Of stocks that I find attractively valued right now, you might want to take a look at PM, AFL, TGT, WMT, BAX, or IBM.

    I hope that helps!

    Best wishes.

  117. Excellent analysis, and i completly agree with your reasoning. As you know, im 100% allocated to stocks, and i plan on being that way “forever”.

    The only wrinkle ill add is that there have been a few times in history (emphasis on few) when bonds made more sense than stocks. 1982. 2000. Basically, any time the market got wayyyy ahead of itself.

    Should the s&p 500 get to a p/e of 30 or so AND the bond market yield 6% or more, it may be time to switch allocations. However, we are a long way off from that happening…..until then, in 100% stocks.

  118. Brian,

    I think a 100% allocation to stocks makes a lot of sense, as long as you can handle the volatility. They outperform bonds over most stretches, as you clearly point out. πŸ™‚

    I don’t know if I’ll ever invest in bonds. I’m open to it, but the situation would have to be right. I think your situation of far overvalued stocks and attractive bonds would probably be the impetus for such a change. I’d have to see the 10-year eclipse 5% before I even think about bonds. That’s a long way off.

    Thanks for stopping by!

    Best regards.

  119. Thanks! I will check these stocks out. I also agree with your assessment regarding BRKB.

  120. Pingback: Weekend reading: RRSP mistakes, perfect portfolio, and more | AAFS Insurance
  121. Me too… (no bonds). At the moment that is: if and when yields rise to something that gives you a chance of beating inflation, then I will buy some. Deflation is my worry, but, well, you can’t defend against everything, can you?

  122. Forever Investor,

    I don’t really fear deflation. I believe we’ve only seen one period of deflation since going off the gold standard. With the way money is being printed I’d fear inflation more, but I really don’t fear inflation thanks to the built-in inflation protection that equities generally provide to a point.

    Of course, I’m no macroeconomic genius. Just my take on it.

    But I’m with you. I’m not totally against bonds. But rates would have to be much more attractive than they are currently for me to get interested in fixed income.

    Best wishes!

  123. I do have some index bond fund that is in my IRA, my investment plan that I currently have call for an 80% stock and 20% bond allocation. I believe having diversification but everyone has different investment plan and ideas. I might change my plan in the future, but for now I will stick with my 80/20 allocation. I might consider adding some REIT index funds in the future while still investing in large cap dividend stocks.

  124. J,

    Thanks for adding that!

    You definitely have to find what works for you. Some people prefer exposure to fixed income no matter what. As long as it’s working for you and your goals then that’s really what matters. πŸ™‚

    Best regards.

  125. I wasn’t able to read all 134 comments but in Buffeett’s 1979 letter he mentioned this exact issue as it relates to insurance companies:

    “Ironically, many insurance companies have decided that a one-year auto policy is inappropriate during a time of inflation, and six-month policies have been brought in as replacements. β€œHow,” say many of the insurance managers, β€œcan we be expected to look forward twelve months and estimate such imponderables as hospital costs, auto parts prices, etc.?” But, having decided that one year is too long a period for which to set a fixed price for insurance in an inflationary world, they then have turned around, taken the proceeds from the sale of that six-month policy, and sold the money at a fixed price for thirty or forty years”

  126. Evan,

    Haha, classic Buffett. I’ve never actually read that particular paragraph before but it is pretty funny. Illogical logic, I suppose.

    Thanks for sharing!

    Have a great weekend.

    Cheers.

  127. i am curious why you are totally in taxable accounts.
    I have done very well with my roth and the increases are not taxable.
    About half of my investments are in taxable accounts.
    I also have zero bonds even though I have been retired for over 20 years.

    Always Young

  128. Jason,

    When you go to finally retire from working, you may want to talk to Social Security about “freezing” it at that time. Otherwise your benefits will be reduced each year. At the very least talk to them to find out your options on it so as not to get reduced benefits. Not matter what we really think of SS, it’s still another savings bucket or leg of the stool.

  129. Ron L,

    I’m not familiar with “freezing” Social Security like that. SS bases your eventual benefit on your highest 30 years of income, as I understand it. Can you provide some additional information directly from the Social Security Administration on this?

    That would be great if I could do something like that, though as I understand it, my eventual benefits will be negatively impacted if I don’t have working income for a number of years.

    Thanks so much!

    Cheers.

  130. Good investment or not – many of us have cash value life insurance that we purchased when we were younger. Since most insurance companies are highly invested in bonds I like to consider that part of my portfolio as fixed income.

  131. Great post, wery interesting, quite contrarian! πŸ™‚

    If I just look at my investment portfolio, I am (by chance) following the ‘Buffett Way’, ie 90% in equity, 10% in bonds. However, this doesn’t include any cash I have, nor my investment property, so I could probably make it 100% equity but you did mention something about sleeping well at night!

    I’ll review in 5 years, by which time I’ll be 50 – I’ll see how my tolerance to risk is then!

  132. Gerg,

    I’ve never looked at cash value life insurance like that, but I’m glad it’s working out for you. πŸ™‚

    I don’t plan on taking out life insurance, though. The wealth I build over the course of my life will likely exceed what most people consider an acceptable life insurance policy, and will go to my family and possibly charity as well when I pass on.

    Thanks for sharing!

    Cheers.

  133. weenie1,

    Sounds like you and Buffett have something in common. I think the more one has in common with Buffett, the better. Well, except for age, I suppose. πŸ™‚

    But sleeping well at night is definitely very important. If the risk you’re taking on is keeping you up, it’s best to scale back. And it’s certainly plausible and reasonable that one’s risk tolerance will naturally recede as they age.

    Thanks for stopping by! Glad you enjoyed the post. πŸ™‚

    Best wishes.

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