In my June commentary, I discussed the state of bonds and the impact of record-low interest rates on financial markets. A question that has been posed is, “Why own any bonds in this environment?” What value do they provide?
As previously mentioned, when looking at your portfolio, it is essential to focus on the total return and not the individual performance of each holding. The truth is that bonds always play an important role in your portfolio for a variety of reasons that we cover in this article.
Volatility
Typically, bonds and equities have a low correlation. In other words, bonds tend to increase in value when equities decrease.
Dating back to 1929, in years when the S&P had a negative return, three-month Treasury bills and U.S. Treasury bonds yielded positive returns ~95% of the time. Even corporate bonds, which take higher credit risk, netted positive returns ~70% of the time!
This not only helps reduce volatility but helps you stay the course. Investing often comes down to attrition and being able to ride the waves of volatility.
Income
While bond yields are at historic lows, they still provide a predictable income stream to supplement other sources (e.g., wages, Social Security, pension). Even today, a diversified bond portfolio can yield ~2.75%. While nothing to write home about, it’s significantly higher than cash rates and inflation.
Unless an investor is prepared for little to no return or takes the risk of being 100% in equities, bonds can provide both income and stability.
Rebalancing
Volatility in February and March reached levels not witnessed in nearly 100 years! And while this volatility was scary at times, it brought with it tremendous opportunity.
Investors with a 60% equity and 40% bond portfolio to start the year found themselves closer to a 50% equity and 50% bond allocation by late March, as bonds held their own and equities plummeted. It is times like this when long-term investors can really take advantage.
Since March, the tables have turned, and equity markets have been off to the races. While it is extremely difficult to call a market bottom, investors who rebalanced their portfolio back to 60% equities and 40% bonds were rewarded tremendously.
Far too much emphasis gets placed on trying to find the “bottom.” If markets are down -25% vs. -30%, it doesn’t make much of a difference long term on when you rebalanced.
Does rebalancing always work this easily? No, but it is a proven method that works more often than not. Investors can find it hard to pull the trigger when markets are extremely volatile, but if your risk tolerance hasn’t changed, these opportunities should be embraced.
Sleep Factor
Another big proponent for bonds is what I call “sleep factor.” While bonds do experience periods of underwhelming returns, they play a pivotal role during market declines.
Watching a portfolio decline may test your patience, but owning investments that yield positive returns can help you avoid the pitfall that many investors fall prey to. Far too often, investors sell at or near market bottoms because they were too aggressive or didn’t think to rebalance when markets were riding high.
While I sympathize, there is a better plan that involves holding a portion of your portfolio in bonds.
The chart below illustrates the drawdown of a $2 million portfolio invested in a balanced portfolio (60% equity/40% bonds) versus a 100% equity portfolio in ~30 calendar days earlier this year:
60% equity/40% bonds: Dipped to ~$1.55 million
100% equity: Dipped to ~$1.31 million
Of course, neither scenario is desired, but the difference of a quarter million could equate to several years of retirement and just might make you sleep better at night!
Investing can be hard. Sure, at times it feels easy (e.g., late 1990s and, more recently, 2017 and 2019), but the litmus test comes when volatility spikes. One mistake can equate to years of missed returns. Investors who moved to cash in late March have since missed out on a market that has recovered so much that it equates to roughly five years of normal market returns.
Will markets significantly drop so those investors can buy back in? Who knows? But if so many were wrong then, what makes us think they will get it right the next time?
Discuss your situation with a fee-only financial advisor.
The commentary on this website reflects the personal opinions, viewpoints and analyses of the Divergent Planning, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Divergent Planning, LLC or performance returns of any Divergent Planning, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Divergent Planning, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Divergent Planning, LLC provides links for your convenience to websites produced by other providers or industry related material. Accessing websites through links directs you away from our website. Divergent Planning, LLC is not responsible for errors or omissions in the material on third party websites, and does not necessarily approve of or endorse the information provided. Users who gain access to third party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from use of those websites.
Divergent Planning, LLC is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Divergent Planning, LLC and its representatives are properly licensed or exempt from licensure. This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Divergent Planning, LLC unless a client service agreement is in place.
General Notice to Users: While we appreciate your comments and feedback, please be aware that any form of testimony from current or past clients about their experience with our firm on our website or social media platforms is strictly forbidden under current securities laws.
© Divergent Planning