Bonds as a Ballast
“Why would I even consider holding bonds in my portfolio if the interest earned does not even exceed inflation?”
“If the government immediately jumps to easy fiscal and monetary policy, buying assets in quantitative easing at the first sign of a downturn, why would I hold anything other than equities?”
These questions, or questions similar in nature have been circulating quite frequently lately. Looking back at the markets just over a year ago, such comments are certainly justifiable, but it is comments such as these that are a hallmark of bull markets. More specifically, these comments highlight the sentiment of many investors who to a certain degree have turned their nose to the concept of risk. These same market participants are likely those who are quick to go to cash or gold in a downturn, or otherwise shift their investment approach drastically in reaction to shorter term market moves.
There absolutely is merit to questioning the benefit of bonds considering the interest they produce currently, and a central facet arguing in favor of bonds is the tendency for bonds to smooth the volatility swings within a portfolio. Whether or not a bond allocation generates income, the current environment likely allows for bonds to serve as a ballast for a portfolio, preserving its principle.
Per a recent Weekly Market Commentary from LPL Research, “if we’re expecting higher Treasury yields and low-to-negative returns for core fixed income, why would anyone want to own bonds? Frankly, in case something bad happens to cause equity markets to sell off. Core bonds, and more specifically Treasury securities, have shown to be the best diversifier to equity market declines.” [1]
Of course, bonds still are not for everyone - if you have a multi-decade time horizon, chances are you will not “need” bonds in your portfolio, depending on your risk tolerance coupled with your timeframe.
It is important to still be cognizant of our near-term inflationary pressure. Even if you do in fact reach the conclusion that there is an appropriate level of bonds in your overall allocation, when a given bond reaches maturity in your portfolio, the purchasing power of your principle may be eroded due to inflation. As the Weekly Market Commentary from LPL Research continues, “when you consider stocks are in the second year of a bull market which, historically, has brought increased volatility, core fixed income can help dampen and potentially offset some of those losses. While we still like equities over bonds over the course of the year, we do think high-quality fixed income continues to serve a purpose in portfolios”.
Each investor holds a unique scenario with respect to their inputs and expectations. There is no cookie-cutter solution for an investor, at least not one that in my view is absolutely optimized for a given investor - but regardless of whether bonds are appropriate in your portfolio, sometimes it can be useful to take a step back and think about what the catalysts of the investment theories and questions that keep you up at night are. If we did not have such a rapid and substantial bounce from the market lows in March last year, questions like “why should I hold bonds?” would never cross your mind in the first place.
As always, we as investors need to know what we own and why. The intricacy of this relationship is the discipline to not jump at every trend in the market at a moment’s notice. There is also discipline that must be exercised when a specific strategy or allocation does not work in the same way that it once did. Bonds, and specifically the prototypical 60/40 allocation does not generate the same level of income compared to the past. There is no guarantee that this will always be the case, and there is a high probability that it will not be. This also does not mean that bonds are useless and that every investor regardless of asset level, risk tolerance, and time horizon should abandon fixed income entirely. Investing itself is an intricate practice, and those intricacies are highly dependent on the individual investor’s unique scenario when considered as a whole.
Disclosures & Sources:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Content in this material is for general information only and is not indebted to provide specific advice or recommendation for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
The Financial Consultants at Vintage Wealth Advisors are registered representatives with, and securities offered through, LPL Financial, Member FINRA/SIPC. Investment advice and financial planning offered through Financial Advocates Investment Management, DBA Vintage Wealth Advisors, a registered investment advisor. Financial Advocates Investment Management, Vintage Wealth Advisors, and LPL Financial are separate entities.