# Why 40% bonds allocation from Canadian Couch Potato?



## recklessrick (Jun 16, 2013)

Anyone know that? Is it just to be all-around coverage regardless of age? I'm tempted to start mine at 20% because I have 15-25 years to go before I start drawing income and I'd like to have the best chance at growth with equities in my portfolio... as I get closer to drawing, I'll plan on moving to more fixed income like bonds for less risk.


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## jnorman5 (Aug 21, 2011)

I am in the same boat as yourself. I am young and do not require income for 25+ years. I am choosing to go with a 25% bond allocation, but my "insurance" policy is that my wife as a DB pension which could be considered fixed income as well.


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## leeder (Jan 28, 2012)

The couch potato model is just a model. It is subject to change based on your risk tolerance. CCP uses the 60-40 model because that's the most common allocation for balanced funds. Thus, it is most suitable for those who want growth but can't tolerate sudden large drops in the equity market.


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## liquidfinance (Jan 28, 2011)

At the minute aren't we risking potential drops in both bond prices and equities?

I know that could be the case any time but couldn't the fed situation be setting us up for the perfect storm.


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## leeder (Jan 28, 2012)

@ liquidfinance: Yes, you are right. But fixed income historically tends to drop way less dramatically than equities. I mean, YTD on XBB, which includes the yield, has dropped close to 3%. In turbulent times, equities would drop way more violently. In my opinion, recent weakness in the stock market is an overreaction. After all, reducing bond buybacks mean the economy is starting to do well. Investors should consider choosing this 'perfect storm' moment to rebalance their portfolios, in my opinion.


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## snowbeavers (Mar 19, 2013)

The main reasons for having a substantial bond percentage in your portfolio is to reduce volatility/risk but also more importantly, provide a safety net in hard economic times which will inevitably happen. When it does, you will be glad that you have some bonds in your portfolio as bond prices tend to increase when stocks go down. So when stocks drop in price, people tend to flock to bonds, raising their demand. This allows for you to properly rebalance your portfolio and selling high (from bonds) and buying low (stocks). 

Although bond prices have dropped 3% this year, they still provide a substantial dividend payout which has reduced the actual drop to around 1% (depending on what type of bond ETF you have). 

A good rule of thumb written in various investment books is to keep your bond allocation relative to your age. If you are 25, then 25% in bonds would be fine, depending on your risk tolerance. 

Personally, I have been buying bonds right now and enjoying the discounted rate


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## recklessrick (Jun 16, 2013)

I do agree that, based on my reading, bonds are important to hold and I don't want to ignore them. I like the idea of sticking with them at 20% right given my investing length. I'm ok with some turbulence because I can weather it for the long run.


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## tinypotato (Jul 27, 2010)

One approach may be to eventually get to 40% but not right away. With higher rates seemingly coming up, maybe allocate current $ to equities and in future years / buys start allocating it to the bonds. That way you aren't getting into the bonds when rates are low.

The Couch Potato is intended to avoid mkt timing, but I think it's a reasonable trade off in these circumstances if you don't really need to reduce volatility in the short term.

Also, another way to look at it is, its probably more important to reduce volatility when you have more $...when starting out, even if mkt goes down, you're going down from a smaller base...


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## favelle75 (Feb 6, 2013)

If bonds are only returning 2-3%, why not just go HISA or GIC? Why even bother with the risk of a bond?


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## snowbeavers (Mar 19, 2013)

I guess you could if you were worried about the short-term but couch potato portfolios are designed for the long haul and over the last 80 years or so, bonds have returned an average of 5.5%. I wouldn't want to get into market timing and paying transaction fees to move money from GICs or HISAs when bonds suddenly start paying more. Saying that, I always make sure I have some liquid cash available in case illness, emergencies, etc to cover 6-8 months living expenses.


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## Rusty O'Toole (Feb 1, 2012)

I don't know what Couch Potato's reasoning is. Some experts believe asset allocation is the secret of enhanced performance with low risk over a period of years.

This means selling fixed income and investing the money in equities when equities are down, as in 2009. And doing the reverse when equities are up and bonds are down.

I'm thinking with the stock market reaching for new highs it might be smart to keep 50% in cash or fixed income and be ready to rebalance if stocks take a dive. Going to all stocks in a real gnarly drop of 40% or 50%.


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## doctrine (Sep 30, 2011)

To me, with interest and bond yields where they are, I'd rather just have a cash option or perhaps at most something like XSB which is all investment grade. Longer bonds can be more volatile in a market crash, and in my opinion the primary reason for keeping a high % of bonds would be to rebalance those over to a stock index in a market crash to take advantage of the low prices. Nothing wrong with this strategy at all; executed through 2008-09 would have been quite successful, if you had the guts to rebalance especially into US stocks, which everyone really hated at the time.


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## favelle75 (Feb 6, 2013)

snowbeavers said:


> I guess you could if you were worried about the short-term but couch potato portfolios are designed for the long haul and over the last 80 years or so, bonds have returned an average of 5.5%. I wouldn't want to get into market timing and paying transaction fees to move money from GICs or HISAs when bonds suddenly start paying more. Saying that, I always make sure I have some liquid cash available in case illness, emergencies, etc to cover 6-8 months living expenses.


Thanks for the reply snowbeav. Would the 80-year average of a GIC also be up around 5-6%?

Also, I never understood having cash for emergencies. Why not just sell some stock? If one is diversified enough and an emergency came up, couldn't that person just sell an equity in their portfolio that is up (buy low sell high)?


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## leeder (Jan 28, 2012)

favelle75 said:


> If bonds are only returning 2-3%, why not just go HISA or GIC? Why even bother with the risk of a bond?


That's a good question in this day and age when interest rates are rising. However, I believe bond and bond funds have, in the long-term, outperformed GICs (laddered) and HISA. People who have longer term outlook and can bear with this interest sensitive environment should stay invested in bonds.



Rusty O'Toole said:


> I don't know what Couch Potato's reasoning is. Some experts believe asset allocation is the secret of enhanced performance with low risk over a period of years.
> 
> This means selling fixed income and investing the money in equities when equities are down, as in 2009. And doing the reverse when equities are up and bonds are down.
> 
> I'm thinking with the stock market reaching for new highs it might be smart to keep 50% in cash or fixed income and be ready to rebalance if stocks take a dive. Going to all stocks in a real gnarly drop of 40% or 50%.


His latest post says it all: "My model portfolios are all based on a mix of 60% equity and 40% bonds, which isn’t appropriate for everyone. The right mix of stocks and bonds for you depends on your current savings rate and your ability, willingness and need to take risk." There is no right or wrong answer to how you allocate your investments, as long as you can sleep at night. As I mentioned before, the 60-40 ratio appears in many balanced funds. This allocation is also more likely to allow common investors to sleep well at night, compared to those who assume more risk by dialing down the fixed income component. 



favelle75 said:


> Also, I never understood having cash for emergencies. Why not just sell some stock? If one is diversified enough and an emergency came up, couldn't that person just sell an equity in their portfolio that is up (buy low sell high)?


Selling shares have tax implications, while there are no tax implications with withdrawing money from a HISA. Besides, imagine we have another 2008-09 situation when the stock market crashed. You'd be realizing losses if you require money to cover your living expenses or fund emergencies. I think the better question to everyone is, how much are you keeping in your HISA for regular savings/emergency fund versus how much are you invested?


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## snowbeavers (Mar 19, 2013)

> Thanks for the reply snowbeav. Would the 80-year average of a GIC also be up around 5-6%?
> 
> Also, I never understood having cash for emergencies. Why not just sell some stock? If one is diversified enough and an emergency came up, couldn't that person just sell an equity in their portfolio that is up (buy low sell high)?


Nowhere close to that. In fact, if GICs are held outside of tax-sheltered accounts, a study found them to have negative returns (after tax) from 1974-2003 for Canadians. See this for more info


> for longer maturity 3-year and 5-year GICs – for which the quoted interest rates are
> typically greater -- the breakeven tax rate was only slightly higher. We conclude
> by arguing that for many Canadians, the strategy of rolling over so-called riskfree GICs outside of a tax shelter is a sure way to destroy long-term wealth.


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## favelle75 (Feb 6, 2013)

leeder said:


> Selling shares have tax implications, while there are no tax implications with withdrawing money from a HISA. Besides, imagine we have another 2008-09 situation when the stock market crashed. You'd be realizing losses if you require money to cover your living expenses or fund emergencies. I think the better question to everyone is, how much are you keeping in your HISA for regular savings/emergency fund versus how much are you invested?


Well depending on how much instant cash you need or how bad your emergency is, why not just grab it from equities within your TFSA?


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## Xoron (Jun 22, 2010)

Rusty O'Toole said:


> I don't know what Couch Potato's reasoning is. Some experts believe asset allocation is the secret of enhanced performance with low risk over a period of years.
> 
> This means selling fixed income and investing the money in equities when equities are down, as in 2009. And doing the reverse when equities are up and bonds are down.
> 
> I'm thinking with the stock market reaching for new highs it might be smart to keep 50% in cash or fixed income and be ready to rebalance if stocks take a dive. Going to all stocks in a real gnarly drop of 40% or 50%.


It's call sector rotation investing:
http://www.investopedia.com/articles/trading/05/020305.asp

But this sounds an awful lot like trying to time the market to me. Sure, it can work, but who can consistently guess where the economy (and hence the markets) are going?


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## My Own Advisor (Sep 24, 2012)

I like some bonds in the RRSP, for long-term investing, but that's it. Everything else is equities.

We keep some cash as an emergency fund, then we have a savings fund, then we have our daily chequing account to live from/pay bills from.

We try to get stuff invested and stay invested as much as possible. Cash is a loser to inflation, bonds right now aren't far behind...


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## andrewf (Mar 1, 2010)

snowbeavers said:


> Nowhere close to that. In fact, if GICs are held outside of tax-sheltered accounts, a study found them to have negative returns (after tax) from 1974-2003 for Canadians. See this for more info


The same math applies to bonds held in taxable accounts. For high marginal tax rates, real returns are near zero or negative. Currently bonds have a lower after tax yield than GICs.


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## MoneyGal (Apr 24, 2009)

leeder said:


> The couch potato model is just a model. It is subject to change based on your risk tolerance. C*CP uses the 60-40 model because that's the most common allocation for balanced funds*. Thus, it is most suitable for those who want growth but can't tolerate sudden large drops in the equity market.


OK, but the question you might want to consider asking is, "why is a 60/40 split the most common allocation for balanced funds?"

The theoretical framework for building a diversified portfolio dates back to the work of Markowitz in the 1950’s (and later, Sharpe). Markowitz used the classical market-capitalization-weighted portfolio. 60/40 was the global universe of investable markets.

/financial trivia


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## My Own Advisor (Sep 24, 2012)

Thanks MG, I had no idea of the origins...


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## MoneyGal (Apr 24, 2009)

So, given my answer, the underlying premise was "you should invest in the total investable universe." Is the next question investors want to ask, what is the investable universe today? 

(Alternate way of asking the same question: what is the role of alternative investments in today's investment portfolios?)


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## leeder (Jan 28, 2012)

Thanks, Moneygal. Never knew that as well about the background of 60-40. I'd say this mix still holds well for common investors today. At the end of the day, this ratio provides better upside than someone who is fully invested in fixed income and provides better downside protection than a someone fully invested in the equity market.


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## leeder (Jan 28, 2012)

favelle75 said:


> Well depending on how much instant cash you need or how bad your emergency is, why not just grab it from equities within your TFSA?


It's not as easy and quick to withdraw money from your TFSA in a discount brokerage as having cash in your HISA. With discount brokerages like TD Waterhouse, you have to phone them to get access to your money. Also, keep in mind that withdrawals made from TFSA cannot be re-contributed back within the year of withdrawal. No such issue with the cash account outside your TFSA, especially if it's in a HISA.


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## Eclectic12 (Oct 20, 2010)

leeder said:


> It's not as easy and quick to withdraw money from your TFSA in a discount brokerage as having cash in your HISA.
> ... No such issue with the cash account outside your TFSA, especially if it's in a HISA.


Maybe ... but then again, maybe not. The details of the specific accounts are going to mean that YMMV. 

I'll have to check my records but as I recall, I had access to the cash transferred out of my TFSA brokerage account, with the same delays as my taxable HISA account. For the accounts I have, I recall it as next business day but it's been almost a year since my last TFSA transfer out.

Then too - if the HISA is at a different financial institution where there isn't ATM or chequing account type access, the EFT transfer to somewhere the cash can be accessed is also likely to be next business day (or longer).




leeder said:


> ... With discount brokerages like TD Waterhouse, you have to phone them to get access to your money.


True ... but from my experience, this has usually been only a bit longer than the time it's taken me to go online or on the phone to arrange the next day HISA transfer. 




leeder said:


> Also, keep in mind that withdrawals made from TFSA cannot be re-contributed back within the year of withdrawal. No such issue with the cash account outside your TFSA, especially if it's in a HISA.


+1 ... though this is more of a TFSA versus non-TFSA thing so I don't see any special advantage for a HISA versus say, a chequing account. It's just more likely that any spare cash will be in the HISA to get a better interest rate.


Cheers


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## Rusty O'Toole (Feb 1, 2012)

Xoron said:


> It's call sector rotation investing:
> http://www.investopedia.com/articles/trading/05/020305.asp
> 
> But this sounds an awful lot like trying to time the market to me. Sure, it can work, but who can consistently guess where the economy (and hence the markets) are going?


You don't guess. You rebalance at regular intervals according to a pre arranged plan.


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## Xoron (Jun 22, 2010)

Rusty O'Toole said:


> You don't guess. You rebalance at regular intervals according to a pre arranged plan.


No, that's just re-balancing back to your designated percentages.

Sector rotation is moving between bonds, defensive stocks and growth stocks, depending on where you are in the business cycle. Macro economics, predicting where the stock market is going and going overweight in one of those areas.


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