Bogle: Better to Play It Safe in Bonds

Benz: One hugely vexing issue for a lot of investors is what to do with their bond money. In 2014, we've had very good returns from the bond market, but I think investors are still trying to feel their way given these widespread expectations that yields will eventually go up. What's your counsel to investors against this backdrop?

Bogle: If you buy a bond today--a good bond and not a junk bond that is fairly assured of paying its coupons, which is where the value is created--it shouldn't surprise anybody to know that the odds are at least 91%, I would say, that your return on that bond will be about 3% over the next 10 years. And if it's a 10-year bond and it gets paid off at the end, you know that's going to be the case. So, it's a good rule. And we are looking at basically not speculating in the bond market but signing a contract, in effect, saying, "I understand that I will get 3% a year for the next 10 years, and I think that's a good deal." Whether it is or not is a wholly different question; but it's very close to a contractual guarantee.

So, why would you have bonds of any type? I think nearly all investors will keep their behavior and temptation to do something in times of high market volatility. That temptation will be reduced if you have what we used to call an anchor to windward, something like that. A little dry powder might be another way of looking at it. So, it simply reduces the volatility of the portfolio--with the almost certain knowledge that it will reduce the return of your total portfolio over time. You're getting less volatility; you're going to get lower return.

I think most people need that for X percent of their portfolio. I happen to think you need it more when you are older and less when you are younger. And certainly, a young person starting his or her 401(k) today should be 100% in stocks. If the market goes down 50%, they've lost $50 of their $100 investment. So, it may look like a lot to them then, but they'll be OK, I promise.

So, I like it as a conservative investment, but I worry about [higher-yielding bonds]. It's totally obvious that the higher-yielding and, therefore, the longer-term maturities will be a better long-term investment--10-year investment--than the intermediate or the short, descending right down there in yield. And yet, they have a lot more volatility. I think that our Treasury fund is up 25% this year. Just thinking about the mathematics of a big change in the yield on a 25-year bond: Each 1% reduction in interest rates increases the value of the bond by about 17%.

Benz: Long duration.

Bogle: Yes, long duration. So, economically, it's the right decision to buy that Treasury for 10 years, but psychologically I don't think most people should. I do myself. I'm in the psychological group; I do most of mine intermediate--and intermediate munis have been fabulous this year.

Benz: Munis, in general, have been really good. We've seen a lot of interest in some of the more credit-sensitive bond categories. It looks like that's where some investors appear to be parking their money. We've seen interest in high yields, off and on. We've seen interest in bank-loan investments and some of these other more credit-sensitive categories. What are your thoughts on this? Is this a smart move, investors adding to these categories at this time?

Bogle: Well, they're taking a big risk. And honestly, I confess to you, I think what goes on in the very short-term bank-loan funds, on how the liquidity turns to be there, I don't like that. Maybe it's because I don't understand it well enough, but I don't like the risk; it's pretty difficult to measure. On high-yield bonds: Well, there are high-yield bonds funds and there are high-yield bond funds. At Vanguard, Earl McEvoy at Wellington ran our high-yield fund for many years, and he was always the most conservative high-yield manager.

Now, we had it both ways, because he could buy the lowest-yielding high-yield bonds and, therefore, presumably the highest quality. But our expense ratio was so low that he had the same yield that the other bond managers had taking a lot of risk. So, I'd say be very careful, be very diversified, and don't go all the way out.