Paul: I’m not a bond expert, so it’s always possible that I am totally out to lunch. Which part don’t you understand? Thanks.

And you could take them to meet Warren Buffett and he could impart oodles and oodles of wisdom on them and it will never change their minds.

Granted, you will find more of the “totally-risk-averse” people in the older categories of the population. While financial education is severely lacking, the message about asset allocation is making the rounds at least in the information generation.

While most people who are actively interested in investing (say, enough to read and participate in blogs) are comfortable with risk/return and asset allocation theories – there are as many, if not more, who view their finances as a big black hole. No word of a lie.

There are some investors who will actually come out and say “I have no idea about anything to do with investments, and I never will and I never want to – here is my portfolio and savings, just handle it for me – that’s what I pay you to do.” And then there are others who are totally self-sufficient and could teach financial advisors a thing or two. But the non-self-sufficient investors vastly outnumber the DIY’ers.

And then you have people who have sadly been burned by an advisor or have been ripped off through some other financial scheme or what have you. Depending on the severity of the situation, they may never trust anyone or anything ever again with respect to their money.

To sum it up, given that the debt markets are roughly 21 times the size of equity markets, the data and what I have seen from dealing with all sorts of investors would support that there stands to be a great deal of people not exposed to equities. (It blows me away too!)

In any case, to address the short term bonds. First off, I’m a shorter bond kind a guy myself – I’m just stirring up some healthy dialogue! – and short term bonds do carry less risk in almost all cases. My point is that you are taking a bet with your fixed income (not a big one, mind you – a good one) by choosing to narrow in on a certain way of picking your short term investments. Anytime you make a call, are you not potentially making a “bet” (not in the gambling sense strictly speaking, but you know what I mean).

Of course hindsight is 20/20 but in the early 80′s, you might think twice about just staying short when long term bonds were paying double digit interest rates.

So perhaps the risk is opportunity cost or the risk of not diversifying? What if interest rates gradually decrease (at a snail’s pace) for an extended period of time? The longer bonds may have been a better buy.

If we pretend that interest rates were to creep lower and lower until they were at (this is a stretch) 0.5% and short term bonds were issued at 0.5% for argument’s sake then if/when interest rates inflected (is that a word?) a 0.25% increase has a bigger effect on 0.5% that on a 5% bond. Bonds become more sensitive to interest rate changes when yields are low. If you had a portfolio of short-, medium- and long- term bonds then you lessen that particular kind of pain, as some of the longer bonds, while increasing when interest rates were going down and decreasing when interest rates come back up, would still pay your coupon payments as long as you hold the bond. You could just sit on it and collect your payments (relatively) worry free.

I suppose that was a really convoluted way of saying that if bonds are paying what might be the long term going rate, people may be happy holding longer bonds and not worrying about interest rate movements and just collecting their interest payments.

Or, if they don’t want to make bets and are in it for the long term perhaps they would just index both equities and fixed income.

CC – I’m enjoying this thread!

You can justifiably take the position that investing only in short bonds and RRBs is pretty narrow. That’s not under discussion here. It’s whether it is justified for most investors to take a position in MBS. My point is that the negative characteristics of MBS outweighs the positive benefits of a slightly higher yield. Of course, that doesn’t mean nobody should touch these things.

However, I am curious why you think avoiding long bonds is taking more risk? If anything, I would have thought it is lowering risk, since long bonds are more sensitive to interest rate changes.

Maybe all they can stomach are debt instruments – and that being the case, are they not entitled to select the degree of risk/reward that’s appropriate for them? Even though it might be restricted to the left most quarter of the spectrum?

Donal Trump might tell you that he personally only invests in real estate – does that mean everyone should?

Isn’t the decision to stick to short bonds and RRB’s narrowing down the fixed-income universe and hence potentially taking more risk than an indexation strategy WRT the fixed income portion?

No, I think your point is well taken for certain types of investors – but are there other types of investors out there? I think so.