How 'long-term' are we talking about?

Aug 02, 2012

How long-term is long-term?  Everyone says they are long-term -- but the question of time horizon is a tricky one.

Certainly a good deal of your portfolio can be very long-term buy and hold oriented.  But what if your portfolio is structured poorly?  You can rationalize almost anything saying 'yes but it's long-term so I don't care about that' and if you are long-term, then you don't actually admit to mistakes until its been many years -- and that can be catastrophic if you portfolio strategy is flawed.  

The bond market is good for understanding return and risk because its so structured.   10-year bonds are clearly a lot more volatile than 5-year bonds.  20-30 year bonds move around a lot as they are quite volatile (often more volatile than stocks).

So let's back up to November 2011.  Is the time from November 2011 to today long-term?   Most would probably say no.   However, an awful lot has happened in terms of movement since then.   So we have two very different ideas.   One is acting in a useful and realistic timeframe.   The other is essentailly ignoring 8-9 months of movement and claiming nothing can be done about such a short timeframe. A core-tactical portfolio structure acknowledges there is some validity in both ideas. Multi-faceted portfolios may not lead the world in performance -- but they will help you reach your goals.

On November 30, 2011 --- the stated Yield-To-Maturity of one of iShares main intermediate investment-grade bond funds (LQD) was listed at 4.3%.   A treasury bond fund with similar duration (IEF) was listed at 1.8%.

Since that date, LQD has achieved a total return of 12.5%.   IEF is up 6.2%.    So each has achieved a return that is 3x its stated yield --- and its only been 8 months.

Looking at an extreme case,  a long-term treasury bond fund (EDV) is up +65% over the last 12 months.   A year ago it yielded 4%.   So the actual achieved return in that case was 15x the stated yield to maturity.

For the amount of times we hear about how low yields are -- very little is said about the uselessness of YTM as a predictor of INTERMEDIATE-term return.   I guess its just not 'long-term' enough.   It is the sensitivity to changes in interest rates (duration) that dominates the return.   The best way to both grow (and protect) a portfolio is to blend stocks and bonds together in a way with both the long AND intermediate term in mind.

We are involved in stocks in the first place because over the long-run, stocks are a good way to grow capital.   So we are long-term just like everyone else.   However, the long-run orientation is frankly a 'given' --- what we are really talking about is the intermediate-term tactical moves and in this regard, the returns and volatilities of intermediate moves are substantial.    Saying TLT has a yield to maturity of 3.0% is an interesting piece of information --- it is just not in any way a reliable indicator of the 6-18 month total return.  

Below is a quick snapshot of various bond funds stated YTM's from November 30, 2011 and their ACTUAL total return since that date.   If back then you thought YTM was an accurate predictor -- you're 'only' off by 3x in 8 months.

Summary:   It helps to understand the basic mechanics of portfolio management.    Indeed, portfolio structure and PM techniques are just as important as anything in investing.   Bonds are a useful way to understand different ideas like volatility.   We want to be in equities long-term and for the core long-term portfolio, it is perfectly reasonable to do that.   But there is clearly more opportunity than that in the intermediate-term timeframe. 



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