A reader writes in, asking:

“What is your view on owning TIPS ladder (Bogleheads preferred) or short term TIPS fund when the majority of expenses are covered by pension and/or social security which are COLA adjusted.

One view I read is from Charles Ellis, who views all sources of stable retirement income (pension, social security) as bond like assets, essentially an indirect TIPS ladder.”

On the “should Social Security or a pension be treated as a bond” topic, my answer is that, no, they aren’t bonds. They are clearly fixed-income. But they are not bonds. (For a more full explanation, please see Social Security: It is an Asset, But Not a Bond.)

The case in which Social Security or an inflation-adjusted pension entirely covers spending needs is just a subset of the broader category of cases in which the household is spending at a very low rate from the portfolio in retirement. That is, for this purpose, we can lump together all cases in which a household is spending anywhere from zero to roughly 2% of the portfolio per year.

In cases like that, there is a huge range of asset allocations that would be reasonable. The household does not need high returns, so they can use a very conservative allocation. On the other hand, the volatility of an aggressive portfolio would not put their well-being at risk either, so an aggressive allocation would also be acceptable. Or anywhere in between.

In other words, at this point, it becomes entirely a matter of preferences. The retirement spending goal has been entirely satisfied. So now the question becomes:

• Should we use an aggressive allocation, in order to increase the expected bequest to heirs?
• Or should we use a conservative allocation, in order to not have to experience as much volatility?

Either answer is acceptable.

And because a very broad range of allocation (from highly aggressive to highly conservative) is reasonable, all the various sub-topics within the asset allocation topic become even less important.

Should this household own a ladder of individual TIPS? Sure, if that appeals to them. Or not.

Should they own a short-term TIPS fund? Again, sure, if that sounds good to them.

They could use a single LifeStrategy fund or iShares Core Allocation ETF.

Or they could use a “VT + TIPS” portfolio like I do. Or they could use a three-fund portfolio, with the bond fund being any of several different bond funds (short-term TIPS, intermediate-term TIPS, short-term nominal Treasuries, intermediate-term nominal Treasuries, a total bond fund, etc.). Or they could use any of 1,000 other more complicated portfolios, if one such portfolio appeals to them for a particular reason.

In general, when creating or assessing a portfolio, we want to be sure of five things:

1. The portfolio is diversified (no huge allocation to a single stock).
2. The portfolio’s risk level is appropriate for the household’s circumstances.
3. The portfolio is simple enough to manage.
4. The portfolio does not include anything with unreasonably high costs.
5. The portfolio is reasonably tax-efficient.

For any given household, there are going to be many potential options that satisfy all five requirements. There is no perfect portfolio, but there are countless perfectly fine portfolios.

And specifically for a retiree household with a very low spending rate, requirement #2 on the list becomes less of a limiting factor than it often might be, so now there is an even broader range of acceptable portfolios.

First a brief announcement: The 2025 edition of Social Security Made Simple is now available. Relative to the previous (2022) edition, there are of course the inflation adjustments to various dollar amounts. There’s now also a brief discussion of child-in-care spousal benefits and mother/father benefits. And the book now reflects the recent changes made by the Social Security Fairness Act of 2023 (i.e., elimination of WEP/GPO).

Thank you to everybody who supports this blog by buying the books, gifting them to loved ones, posting reviews on Amazon, and so on.

And now on to today’s topic: what to do during a stock market downturn.

As of the close of trading on Friday (4/4), the US stock market (as represented by Vanguard Total Stock Market ETF) was down 8.14% in the last 5 days and down 14.1% year-to-date.

The Stock Market Doesn’t Care About Your Politics

Because this recent decline was kicked off by the new Trump tariffs and responding actions by other countries, many people are responding in ways that are informed by their political views. (You can see it happening in real time at the Bogleheads forum, for instance. And if it’s happening there — a place that’s known for being nonpolitical and populated with buy-and-hold investors — you can bet lots of other people are making similar changes.)

But the stock market didn’t suddenly become predictable, just because you either really like or really don’t like the tariffs. That is, fundamentally, not how this whole stock market thing works.

The stock market responds to available information. And it does so pretty darned quickly. Do you know something that the market collectively does not know? Do you somehow know whether Trump will keep these tariffs as-is, raise them, or lower them (and by how much and when)? And do you know how other world leaders will respond? Frankly I doubt even Trump’s chief of staff knows the answer to those questions. And if you don’t know those answers, you shouldn’t be making stock market predictions based on the tariffs.

Check Your Risk Tolerance

Now, when things are scary, is the time to evaluate your risk tolerance.

If you’re losing sleep or feeling ill over what is, so far, a decline of less than 15%, the blunt truth is that your asset allocation was way too risky for you.

Just in my own investment history, we’ve seen two declines of roughly 50% (2000-2002 and 2007-2009). You have to be prepared for that sort of experience, with respect to any money that you have allocated to the stock market.

And if you’re thinking, “this time is different!” yes, you’re right. This time is always different. That’s the key thing to understand.

In early 2020, we saw an extremely quick decline, coupled with a pandemic. That was certainly a new and scary experience.

In 2008-2009, we saw a quick and large decline, coupled with major financial institutions collapsing and a non-trivial possibility of the whole thing becoming system-wide if too many large institutions failed. That was a new and scary experience.

In 2000-2002, we saw a large decline that just kept on going and was coupled with things like major accounting fraud scandals. Could we trust that the market wasn’t just a scam, rigged against the little guy? It was a new and scary experience.

That’s how these things go. A significant market decline doesn’t happen out of thin air. Such declines are generally accompanied by some scary real-world event.

If you’re going to invest in the stock market, you have to be prepared to see large declines from time to time, coupled with something scary going on.

Rebalance (or Not)

In addition to evaluating your risk tolerance, now is a good time to rebalance — if your plan calls for such.

Over an extended period of time, the general effect of rebalancing is that it reduces returns and reduces risk, relative to a portfolio that is never rebalanced. That’s because, more often than not, it’s the stock part of the portfolio that has risen above the intended percentage, and so rebalancing most of the time means selling stocks and buying bonds.

Right now, it would be the opposite. The point of rebalancing today would be to increase expected returns.

Rebalancing isn’t necessarily mandatory. Depending on your circumstances, it could be reasonable to have an investment policy statement that calls for rebalancing out of stocks when the stock allocation gets too high but does not call for rebalancing into stocks when the stock allocation is below the targeted level.

Tax-Loss Harvest

If you have investments in a taxable account, now may be an opportunity to tax-loss harvest.

As always, be careful of the wash sale rules. (And as always, I do not have the answer as to whether two funds count as substantially identical or not, because there’s no IRS guidance on the matter.)

Reevaluate Your Plans

Market declines are also a good time to reevaluate your plans. Does this change mean we need to cut spending? Does it mean we should be pushing back our planned retirement date?

Roth Conversions

Finally, Roth conversions, if using money from a taxable account (rather than from the tax-deferred account itself) to pay the tax, become a slightly better deal during a market downturn, because you’re converting a greater number of shares per dollar of taxes paid. But that wording probably makes it sound like a bigger deal than it is. It’s not that you’re paying a lower tax rate on the conversion. You’re just getting slightly more “oomph” out of the “use taxable dollars to pay the tax on the conversion” concept.

Over the last year, one thing I have noticed is far greater money market balances than I used to see in people’s portfolios. I’m encountering lots of people who are using money market funds for the entire fixed-income side of their portfolio — or nearly so.

And it’s easy to understand the line of thinking here. For instance, take a look at the yield curve for nominal Treasuries (as of 8/22/24):

The shortest maturities have the highest yields.

And, naturally, we see the same pattern with mutual funds. For example (again as of 8/22/24):

• Vanguard Federal Money Market Fund has an SEC yield of 5.25%.
• Vanguard Short-Term Treasury Index Fund has an SEC yield of 4.15%.
• Vanguard Intermediate-Term Treasury Fund has an SEC yield of 3.82%.
• Vanguard Long-Term Treasury Fund has an SEC yield of 4.09%.

Again, the shortest maturities have the highest yields.

Combine that with the fact that shorter duration also means less price volatility (money market funds explicitly seek zero price volatility, even), and it’s easy to see why people are opting for money market rather than riskier bonds with lower yields.

But I think it is helpful to back up and ask: why would the market allow us to get a higher yield for less risk? Why aren’t huge investors coming in and buying up enough very short-term Treasuries in order to push the yields down (or selling intermediate-term Treasuries enough to push their yields upward)?

Why would the market, collectively, be as interested in a 5-year Treasury bond with a 3.72%  yield as in a 1-month Treasury with a 5.51% yield?

One answer is that the market expects interest rates to fall. (And, based on the yield curve, it appears to have been expecting such since last summer.) In other words, the market does not expect that investors buying today will be able to keep rolling over those 1-month Treasury bills at a 5.51% rate for the entire next 5 years.

Will that actually happen? I don’t know.

But it’s important to recognize that sticking solely with super short-term fixed-income isn’t an automatic “win.” If you want, you have the option to “lock in” today’s rates, for a longer period of time. That isn’t necessarily a win either, but it isn’t automatically detrimental.

(As I wrote recently, for our own portfolio, the entirety of the fixed-income balance is currently in long-term individual TIPS, which, given their current yields of roughly 2% above inflation, we’d be happy to simply hold to maturity. I do not know how or when interest rates will change, but I do know that I’ll be quite satisfied with the bond portion of our portfolio earning a 2% real return for the next 25-30 years.)

One of the most common questions I see in my email inbox, on the Bogleheads forum, and on Bogleheads reddit is something along these lines:

“I bought Vanguard Total Bond Market Index Fund (or ETF) as my core bond holding several years ago. Its performance has been enthusiastically lackluster. Is this fund still suitable for use as the bond part of my portfolio?”

Vanguard Total Bond Market ETF (BND) has had a roughly 16% cumulative return over the last 10 years (annualized return of 1.5%). Given 32% cumulative inflation (2.82% annualized) over the same period, that’s not great. And compared to the mind-blowing 222% cumulative (12.43% annualized) return that Vanguard Total Stock Market ETF has provided over the last 10 years, it does indeed feel very lackluster.

But it’s not as if this unimpressive performance is the fund’s fault. Per Morningstar, it has been in the top half of funds in its category over the period in question. In other words, the fund has been managed just fine.

And it’s not as if “total bond” funds have been particularly bad. It’s been an uninspiring period for basically any type of bond fund. For instance:

• Vanguard Short-Term Treasury Fund (lower risk than a “total bond” fund) has had an annualized return of 1.05% over the last 10 years.
• Vanguard Intermediate-Term Treasury Fund (lower risk than a total bond fund but higher risk than a short-term Treasury fund) has had an annualized return of 1.26% over the last 10 years.
• Vanguard Intermediate-Term Investment Grade Fund (higher risk than a total bond fund) has had an annualized return of 2.49% over the last 10 years.

Why have bond funds struggled?

Bond funds have struggled simply because interest rates went up. For any given bond, when market interest rates for similar bonds rise by a given percentage, the price of that bond will fall by approximately the bond’s duration multiplied by the increase in interest rates.

Interest rates for intermediate-term bonds have risen by about 2% (for both Treasury bonds and investment-grade corporate bonds) over the last 10 years. Vanguard Total Bond Market has an average duration of about 6 years. So, for a fund with an average duration of 6 years, a 2% increase in rates means that the decline in price gobbled up roughly 12% -worth of return. And interest rates were fairly low to begin with (about 2.2% for 7-year Treasury bonds as of July 2014), so that rising-rates headwind was quite a hurdle to overcome.

In other words, bonds did what they do, in a period of rising rates. Nothing particularly strange about this. It admittedly doesn’t feel great, compared to the inflation we’ve had and compared to the superstar returns that we would have earned if the money we’d had invested in bonds would have been invested in stocks instead. But it’s not as if “bond funds are broken” or “bonds are obsolete” or anything like that.

Looking Forward

A total bond fund is still a very reasonable core bond holding, in my opinion — as would be a short-term Treasury fund, intermediate-term Treasury fund, short or intermediate-term TIPS fund, collection of individual CDs, or a ladder of individual TIPS.

There many different reasonable choices. If you want to have a specific amount of purchasing power available on a specific date, you need individual TIPS, held to maturity (or I-Bonds). But for anybody who just wants bonds to be “the thing in the portfolio that’s less risky than stocks, while still providing some return,” then any reasonably low-risk, low-cost bond fund would be acceptable.

I don’t believe there’s any magic in asset allocation, and that’s as applicable with bonds as it is with stocks. Riskier bonds tend to be rewarded with higher returns over time. The safer you want your bonds to be, the less return they’ll probably give you over time.

Right now, we have an “inverted yield curve” (meaning shorter-term bonds actually have higher yields than longer-term bonds). That’s uncommon because short-term bonds are lower-risk than long-term bonds. It may look like a free lunch (i.e., higher yields with lower risk), but really it’s the bond market’s way of saying “we expect interest rates to fall.” That is, right now, the market sees longer-term bonds as an opportunity to lock in unusually high interest rates, whereas shorter-term bonds give you higher rates for now but with the risk that you’ll be earning lower yields again soon if interest rates fall.

What actually will happen with interest rates going forward? I have no idea. That’s why I still think both short-term or intermediate-term bond funds are a reasonable choice. Or long-term TIPS if held to maturity.

A reader writes in, asking:

“I am curious for your take on the age-in-bonds rule of asset allocation. It seems to me that maybe it’s a bit out of date, and today higher stock allocations are called for.”

I have never particularly been a fan of the “age in bonds” rule. But that’s not because I think that it needs to be adjusted to “age minus 20” or anything like that. Rather, I think that age is simply not a very good stand-in for risk tolerance.

For example: consider my wife and me. When we were 25, our incomes were pretty modest. Our assets were very modest. Our Roth IRAs were definitely not intended to function as emergency funds, but it wasn’t at all out of the question that if a large unexpected expense came up, that’s where we’d be going for the cash necessary to pay the bill. It would have been either raid the Roth IRAs or put it on a credit card. Point being, despite being young, we simply had a limited financial ability to take on risk.

Today, we’re both age 40. And there’s no question that our ability to take risk is greater than it was at age 25. We’re still far enough from retiring that a market decline wouldn’t throw off our plans in any meaningful way. We now have considerably higher household income. After 15 more years of saving and investment returns our assets are dramatically greater than they were at that time. And now the portfolio isn’t doing double-duty as an emergency fund in the way that it was at age 25. We are now more financially secure in every way.

15 years older, but with much greater ability to take on risk in the portfolio. And there’s nothing remotely weird about that set of circumstances. That is in fact the normal path for a household’s finances to take, over that particular age range.

Or consider this example: Jimmy and Bob are two unmarried retirees, who have completely identical finances (identical portfolios, identical Social Security income, both spending let’s say 4% from the portfolio per year, etc.). The only difference is that Jimmy is age 65 while Bob is age 95.

Bob has a greater ability to take on risk than Jimmy does. At age 65, Jimmy’s portfolio is still overwhelmingly a retirement portfolio (i.e., intended largely for the purpose of funding his own spending during retirement). For Bob at age 95 with a 4% spending rate, there’s functionally zero chance of running out of money during his lifetime; a large portion of his portfolio is now a bequest portfolio.

Again, the older person has a greater ability to take on risk. And again, there’s nothing particularly weird/unusual about that hypothetical. It’s not rare for it to become clear at some point that the portfolio is, to a significant extent, now being invested on behalf of one’s intended heirs rather than on behalf of one’s own self.

All of this isn’t to say that the ability to take risk always goes up with age, because that’s definitely not true either. Rather, there are specific times in a person’s life where a risky portfolio is simply more dangerous, such as:

• Very early in the career when the portfolio is also the emergency fund and income/assets are very limited, and
• In the few years right before and right after retiring.

I think, rather than any age-based rule, it’s prudent to actually look at your own household’s specific circumstances: how harmful would a major stock market decline be, for you, right now? And the answer to that question (regardless of your age) pretty well informs the question of what asset allocation is likely to be appropriate. (And as always I’ll note that for any one household, there’s not one single allocation that’s “correct.” There’s a whole range of allocations that would be reasonable.)

A reader writes in, asking:

“I’m not sure if you would consider a blog post or similar regarding cash (CD’s, Short Term Treasuries, Money Market, etc) but after reading and following your portfolio recommendations I’m curious if you have opinions on cash and how much to keep at any given time. I recognize all situations are different but you’ve always done a good job of laying out the options. My specific situation is: recently retired but my wife is working for another 2 years at which point we will both be retired.”

Firstly, I’m going to assume for the sake of this article that you already have a sufficient emergency fund in place or do not need an emergency fund. That is, we’re assuming that you already have a way to cover an unexpected major expense without incurring financial disaster. The question is simply: what part of the non-emergency-fund portfolio should be invested in cash?

And I’m also going to set aside the case of a “tactical” cash allocation (i.e., holding cash with the goal of investing it at just the right time after a downturn), because I’m not optimistic about the ability to do that in any useful way. Instead, I’m focusing on a static cash allocation (i.e., holding cash, with the intent of it being an ongoing part of the allocation).

The following chart from PortfolioVisualizer shows a $1,000,000 initial portfolio balance, neither adding to nor spending from the portfolio over time. This is from January 1987 – January 2024. (January 1987 is the earliest date for which PortfolioVisualizer has “total US bond market” data.)

The blue line represents a portfolio of 40% total US stock market, 20% total international stock market, and 40% total US bond market. The red line represents of portfolio of 41% total US stock market, 20% total international stock market, 29% total US bond market, and 10% cash.* (The 1% increase in stock allocation is to keep the overall risk level similar.)

Here’s the PortfolioVisualizer link, in case you want to examine the numerical metrics or adjust any variables on your own.

To me, those look functionally the same.

Now let’s look at a portfolio from which we’re spending. The following chart from PortfolioVisualizer shows a $1,000,000 initial portfolio balance, using a “4%” rule type of spending strategy (i.e., spending $40,000 in the first year and then adjusting that spending upward with inflation). Again, this is from January 1987 – January 2024. And the asset allocations are the same as above. So this is a pretty significant cash allocation: 2.5 years worth of spending (10% of the portfolio, when spending 4% in the first year).

Here’s the PortfolioVisualizer link, in case you want to examine the numerical metrics or adjust any variables on your own.

Again, they’re very similar. And I think we can at least agree that, if the cash did make a meaningful difference, it was not in a useful direction.

And I get a similar set of conclusions whenever I run Monte Carlo simulations, whether via PortfolioVisualizer or RightCapital. Swapping out a chunk of the bonds for cash (and then adjusting the stock allocation upward a smidge, to make an apples-to-apples comparison) is…fine.

There’s nothing magical about cash. Whatever we can achieve by shifting a chunk of the portfolio from bonds into cash, we can probably achieve by just slightly bumping up the overall fixed-income allocation instead. This is just another case of “Asset Allocation Isn’t Magic.” There are lots of different asset allocations that will get you to a given level of risk and expected return, and any such allocation tends to be about as good as another.

Personally, I tend to opt for the simplest route (i.e., whichever allocation involves the fewest number of total funds or the least rebalancing).

But one relevant caveat is that, if cash specifically, relative to other types of fixed-income, helps you feel better about your portfolio (i.e., it makes bad days/months/years in the market feel less stressful because you know “I’ve got ___ years of cash, ready to tap into, if needed”) then that’s a compelling point in favor of a cash holding. But from a purely financial perspective, there doesn’t appear to be any specific need for a big cash allocation.

*PortfolioVisualizer uses 3-month Treasury Bills as the return for “cash.”