Vanguard has announced that it is lowered the minimum required investment on the Admiral Shares of its index funds to $3,000, down from $10,000. Basically, if you owned the Investor Shares of one of their 38 index funds, you will own the cheaper Admiral Shares with no effort and no tax issues. You can perform this conversion manually if you don’t want to wait for them to do it for you. Good deal.

Alternatively, you may use this as an opportunity to spread your money across more funds due to this change. This would be bigger news, but a lot more people now own the ETF versions. I still remember in 2010 when Admiral Shares went from a $100,000 minimum investment down to $10,000. Note that this does not apply to Vanguard’s actively-managed funds, which are still at $50,000 for Admiral Shares.

In early November, Fidelity removed all investment minimums on their mutual funds. They also gave every investor in their funds the lowest expense ratio available in any share class, usually the ones for their institutional customers. For example, the Fidelity Inflation-Protected Bond Index Fund (FIPDX) now has an annual expense ratio of 0.05% with a $0 minimum investment, even lower than the Admiral Shares of Vanguard Inflation-Protected Securities Fund (VAIPX) at 0.10% which still requires a $50,000 minimum investment as it is an actively-managed fund.

I still have the majority of my investment portfolio held at Vanguard, but it appears that Fidelity has finally woken up from it’s “Let’s Pretend Index Funds Don’t Matter” slumber. (See Bloomberg interview.) Vanguard may deny it, but I think the current asset-chasing, expansion-minded Vanguard does respond to competition.

The trend continues. Anyone today can build a dirt-cheap index fund portfolio with Vanguard, Fidelity, Schwab, and iShares, and those portfolios keep getting cheaper and cheaper. The hard part will be sticking with your portfolio when you’re balances start shrinking.

When it comes to news, the headline “man bites dog” will get people’s attention, not “dog bites man”. Similarly, a new research paper that questions the idea of “Stocks for the Long Run” will create headlines like the WSJ article Sometimes, It’s Bonds For the Long Run (paywall?) by Jason Zweig.

Prof. McQuarrie has compiled a new database of US bond prices dating all the way back to 1823, including longer-term federal, municipal, and corporate bonds. During this early period, he found that bond returns were much closer to stock returns than from 1900 onward. The WSJ included this chart of rolling 30-year average returns:

Assuming the data is accurate, the returns between US stocks and US bonds from 1823-1900 do look very similar, even somewhat correlated. I don’t know what it was like in the 1800s to buy a share of a company vs. buying a debt instrument. I imagine the environment was very different and that very few average households participated.

However, I also noticed how the 30-year average returns for stocks rarely dipped much below 4% real return over the past 200 years. If you’re telling me to look back at history, that’s also a crazy finding in my opinion. In contrast, holding onto bonds that averaged a negative real return over 30 years? Yikes.

The WSJ article also points out that 30-year Treasury bonds outperformed stocks as recently as from 1981 to 2011. But then I looked up this chart of historical 30-year Treasury yields:

The 30-year Treasury had a yield of about 14% back in 1981. Check out this 1981 NY Times article 30-YEAR U.S. BONDS HIT 15%. The decades-long bull run for bonds fueled by continuously dropping rates doesn’t have much room to go lower. The 30-year Treasury today is 3.35%.

Now, look at the first chart again and notice where the bond returns were negative from 1950 to 1980. The 30-year Treasury didn’t exist in 1950, but the 10-year Treasury equivalent yield in 1950 was about 2%. In 1950, corporate bonds yielded about 3%. Sound familiar? That’s about the same rates as today, so it’s hard to get too excited about long-term bond returns at this point.

It’s an interesting paper to read, but I don’t see anything that would change my portfolio outlook overall. I hold 2/3rd stocks and 1/3rd bonds, which is probably a lot more bonds than is usually recommended for someone my age, but I am also much closer to living off of my portfolio than most people my age. Bonds and cash are important components and everyone should probably own some. Still, if you made me pick, I’d bet on “Stocks for the Long Run”.

Below is a chart that tracks two simple numbers over the years, each with their own vertical scale (click to enlarge):

• The average household’s equity ownership share, as a percentage of total equity and credit (bond) assets. (Left-axis)
• The subsequent 10-year average annual return of the S&P 500 index. (Right-axis)

Kind of eery, right? As the relative demand for stocks goes up, their future return goes down. This is the most up-to-date version of the chart that I’ve seen – credit @TihoBrkan via Abnormal Returns. The first time I recall seeing this chart was 5 years ago in this in-depth Philosophical Economics article.

Since then, this 2016 academic paper by Yang and Zhang found that “Household Equity Share” was a better predictive tool than the CAPE or PE10 ratio. Most recently, OfDollarsandData had a thoughtful piece on why using this correlation to time the market would be very difficult (you’d have to be out of the market for a long time, and during some great bull markets). Here’s another way to show this relationship:

(I’m not sure the x-axis labels on this last chart are correct, as it doesn’t agree with the first chart that tops out at 55% household equity share.)

This will be an interesting chart to track over time. Overall, it is yet another indicator that points to the average return of US stocks for the next 10 years to be rather muted (in the low single digits!). But again, anything could happen – both higher or lower – in the short-term.

A recurring theme in my asset allocation philosophy is to stick with simple and safe bonds in your portfolio. The problem is, there will be other bonds that outperform safe, shorter-term US Treasury bonds and you might start to question your decision. I try to remind myself to consider how they fit into your entire portfolio. I would rather take on risk with stocks due to their big upside potential and use bonds for stability in times of stress.

Here is an older WSJ article The Case for Minimizing Risk in Your Bond Holdings by William Bernstein on the subject. If you run into a paywall, I discuss the article here.

Recently, there have been more articles about the riskier bond options out there.

Corporate bonds – hidden risks? Credit ratings agencies continue to have the conflict of interest where they are paid by the bond issuers themselves – remember the financial crisis and those AAA-rated subprime bonds? These days, companies are loading up on debt, but they still really really really want their bonds to be rated as “investment-grade”. More than 50% of the corporate bond market is now rated BBB, just barely “investment grade” as opposed to “junk”, according to the Bloomberg article A $1 Trillion Powder Keg Threatens the Corporate Bond Market:

That’s a lot of borderline debt that will eventually have to be refinanced at higher rates.

Actively-managed bond funds – what’s really inside? In addition, I recommend reading this Forbes interview with bond manager Jeffrey Gundlach: The Bond King Speaks: Doubleline CEO Jeffrey Gundlach Offers His Best Investing Advice. There are many interesting insights, and here are some excerpts on bond index funds and the active bond fund competition:

On the fixed-income side, active bond managers have by and large outperformed the intermediate-term bond benchmark, the Barclays Bloomberg Aggregate Bond Index (the “Agg”).

What helps the active manager to outperform the index is that it’s quite possible in bonds to do things very differently from what’s in the traditional bond indexes. The Agg has no foreign bonds, certainly no emerging markets bonds, no below-investment-grade bonds, no bank loans, no structured finance to speak of like ABS or CMBS, all of which are viable asset classes. But the index doesn’t include them. Active bond managers can buy these things and increasingly over the last couple of decades have done so.

Active funds are being measured against an investment-grade U.S.-only index. The active funds can own tons of emerging markets, junk bonds, bank loans — some of them even own 10 or 15% equities. Obviously, if a manager is allowed to own equities against the bond index in a world where bond returns over the last two years are nearly zero on a total return basis, you can see there’s a lot of ways that bond managers can game an index more than a stock manager.

Is a stock manager really going to measure themselves against the S&P 500 and own 50% bonds? I doubt it. The industry’s evolved in a way that has given us an advantage.

That’s probably going to turn into the opposite soon, where these activities outside of the boundaries of U.S.-only, intermediate-grade only bonds will start hurting. Junk bonds are getting crushed. Investment-grade corporate bonds are doing horribly over the last year. Typically, these are systematically overweighted by the majority of active bond managers. Not us, not Doubleline.

You could categorize the industry fairly accurately with a broad stroke by saying most firms are perpetually overweight corporate credit, underweight treasuries and they even have some stocks with below-investment-grade ratings. When you get to a world where the lower quality material like junk bonds or emerging markets are starting to come under stress due to falling equity prices, and perhaps a slowing global economy, well, suddenly, these games that are often played don’t help.

As noted recently, Total Bond ETFs that track the AGG index have 60-80% of their holdings that are backed by the US government, and the rest are investment grade US corporate bonds. Overall it is mostly high-quality stuff. Meanwhile, an actively-managed bond fund can include riskier corporate bonds, complex asset-based securities, or bonds from Emerging Markets countries with much higher yields. Basically, bond managers can take on a lot of extra risk and get paid for it while the party lasts. This will make them look like they are beating the AGG benchmark, while their holdings are nothing like the benchmark.

With actively-managed bond funds, it’s always a question of the manager adding enough value to compensate for the higher expenses. Bill Gross used the be “Bond King”. Now it’s Gundlach. Maybe Gundlach will continue to successfully time his purchases in and out of various bonds. I choose not to depend on a specific manager’s skill. Instead, I stick with US Treasury bonds, investment-grade municipal bonds from a conservative bond manager, or FDIC-insured bank certificates of deposit for the bond portion of my portfolio.

One of the major building blocks of your portfolio is probably a bond mutual fund or ETF. The most popular bond benchmark is the Bloomberg Barclays Aggregate Bond Index (AGG), which basically tracks all U.S. taxable investment-grade bonds. These popular index funds all track some variation of this index:

• Vanguard Total Bond Market Fund (VBTLX/VBMFX) and ETF (BND). The biggest bond mutual fund. This fund is also inside all Vanguard Target Retirement 20XX or LifeStrategy All-In-One funds.
• iShares Core U.S. Aggregate Bond ETF (AGG). The biggest bond ETF.
• Schwab U.S. Aggregate Bond ETF (SCHZ).

What’s inside a Total Bond fund? A recent Vanguard Blog post provides some insight into the components that make up the Barclays U.S. Aggregate Index from 1977 to 2017:

• US Treasury. Bonds issued and backed by the US government, including Treasury notes and bonds. (Nominal only, TIPS are not included.)
• US Government-related. Securities issued by a Federal Agency or a government-sponsored enterprise like Fannie Mae or Freddie Mac. These are either explicitly or implicitly backed by the US government.
• Securitized (MBS). Mortgage-backed securities, backed by residential mortgages and packaged by Ginnie Mae, Fannie Mae, Freddie Mac, and others including private issuers.
• Securitized (ex-MBS). Asset-backed Securities, backed by things such as consumer auto loans, credit card debt, and home equity loans.
• US Corporate. Securities issued by corporations with investment-grade ratings from the major ratings agencies.

The first thing to note is that the bottom three layers are essentially all backed by the US government. When considered in this chart format, you can see that these bottom three layers consistently make up about 60% to 80% of the AGG. Thus, historically you can estimate that roughly 2/3rds of the index is backed by the US government and 1/3rd is privately-backed by securitized assets or corporations.

How much more does a Total Bond fund yield than a Treasury Index fund? Here’s how much the AGG Total Bond index yields above a Treasury index historically:

So the ingredients are little riskier overall than 100% US Treasury bonds, but you also earn a little higher yield.

Which is better? For the most part, I agree with this William Bernstein list of what kinds of bonds should be in an individual portfolio. I slightly prefer either 100% Treasuries, municipal bonds, or bank CDs – all depending on the after-tax yield. The idea is to pick the safest bonds that are hopefully the least correlated with your stocks. For example, the expectation is that Treasuries are more likely to go up when stocks are dropping.

But for the most part, I think a total bond fund is just fine as well. You can see it’s still pretty safe and you get extra interest in exchange for the extra risk that the market has decided is the proper compensation.

First things first – Buying a low-cost total bond index fund is very likely to return more over the long run than an expensive actively-managed bond fund. Choosing between Treasuries and a Total Bond fund is a secondary decision.

Bottom line. Lots of people own bond funds and ETFs that track the US Aggregate Index (AGG). These charts help show you what’s held inside such Total US Bond funds and how much more they yield than 100% Treasury bonds.

When you’re deciding where to invest your money, a good starting point is to consider every single business that you can invest in around the world. I still find it amazing that with a few clicks, you can own a share of Alibaba in China, Nestle from Switzerland, and Apple in the US.

Inside a post about investing in Emerging Markets stocks at Bps & Pieces, I came across this chart that tracks how all the investable stocks in the world could be broken down by total value (“market cap”) between the US, non-US Developed Markets, and Emerging Markets since 1990 (click to enlarge):

How much international stocks should you own? There is not a consensus amongst “experts” as to the optimal ratio, but I personally don’t deviate from this breakdown very much. My portfolio stock allocation has been set at 50% US and 50% non-US (including both Developed and Emerging Markets) for a while. Vanguard and Fidelity, which manage huge retirement funds, have settled on something closer to 70% US and the rest international.

Keep in mind that investable value is not the same as gross domestic product (GDP). China’s GDP is roughly 60% that of the US, but the total investable business value in China only makes up about 5.5% that of the US (about the same as Canada). Foreigners can’t invest in every public business in every country, and many countries don’t have stable public markets in the first place. In many ways, 50% US might even be too little if you really wanted to track the world’s business value.

Again, I go back to the classic Jack Bogle quote: “Don’t look for the needle in the haystack. Just buy the haystack.” I don’t know which companies will be the most successful in the future, or in which country they will be located. If it’s in the US, I will own them. If it’s not, I will hopefully own them as well. I hope that stable and transparent equity markets spread across the globe over time. I just want to sit back as a part-owner and earn a share of the profits.

If you care about valuations, you are probably aware that right now the US is “expensive” based on historical prices. Emerging Markets and Developed non-US are “cheaper”. But as usual, that is because US businesses are making lots of money (especially after tax cuts) and look strong, while the rest of the world has struggled on relative basis. Cheaper valuations could be taken as another reason to at least invest some of your holdings into international stocks.