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Bonds and Stock Market Hedging

Cullen - how do you manage the risk of bonds in a portfolio when stocks also look so risky? I feel like everything in the markets looks bubbly right now, but I also know that sitting in cash is a bad idea.

We rebalance stocks in a countercyclical manner that considers both equity market and macro factors. For instance, a regular 60/40 stock/bond portfolio just rebalances back to 60/40 every year. I think that's stupid because it doesn't account for whether the components are riskier or not. For instance, rebalancing back to 60/40 in the year 2008 is very different from rebalancing back to 60/40 in 2009 because the 60% equity slice is much riskier in 2008 than it is in 2009.

So we rebalance to account for how much risk is in the portfolio components. A similar thing is done in the bond component where we're rebalancing WITHIN the bond portfolio to account for interest rate risk. This way you're managing both your equity market risk and your interest rate risk, but still being passive enough that it's very tax and fee efficient.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche