Home Money Investment Mind on Money: Bonds should be part of diverse investment portfolio

Mind on Money: Bonds should be part of diverse investment portfolio

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There’s been some high profile financial press lately proclaiming “The Bull Market in Bonds is Over.” Most investment strategists I follow regularly postulate that bonds, U.S. bonds in particular, have been in a bull market trend since for a whopping 37 years, dating back to the hyper inflationary period of the 70’s that was finally boldly addressed by Reagan era Fed chairman Paul Volcker.

This is before my time, so I guess it could be said that I have no experience based frame of reference for anything but a bull market in bonds. While bonds certainly haven’t posted positive performance in every year of my career, which dates back to 1993, I can’t deny that for most of my career bonds have served as a fairly low-stress part of client investment strategies. Despite this, I do have a frame of reference for something I have experienced for most of my career as well, which is: Individual investors tend to not like bonds.

I’m not entirely sure why. Bonds in general are intended to occupy a less volatile part of an investment strategy. In investment speak, this less volatile purpose is construed by us financial advisor types to involve less risk. Despite this lower target risk profile, bonds have managed to post positive returns during most years in my career. One would think this would make bonds attractive to those who are investing for retirement or saving for other future goals, but rarely do I have clients coming in asking for more bonds for their portfolio.

Some of this phenomenon I believe is associated with a general lack of understanding the bond market. After all, the stock market gets all the attention, and nobody sits on the back deck sharing a drink with their neighbors talking about how much money they made in their bonds last year. 

Instead the bond discussion tends to involve technical terms like duration, yield, coupon, maturity, call. I must admit, it can be kind of intimidating.    And if these bond things are supposed to be the less risky part of a portfolio, then why do they sometimes go down, sometimes for no discernible reason?  

So why I may not completely understand the investor apathy to bonds, I can empathize with some of it. Which is why I was concerned when I started seeing these “bond bull market” headlines over the past few weeks. With the stock market making new highs almost daily, these headlines were certain to lead more investors wanting to neglect bonds all together, which for many is likely to be a mistake.

As I also expect interest rates to continue to rise, it may be true that bonds won’t have their best year in 2018. I think however, it is important to keep the potential losses from bonds in perspective. Assuming no credit related issue, if a short or medium-term bond paying say 3 percent has a bad year, we might see that bond lose four to seven percent in price or statement value. When we include the payments from the bond, the bond may break even or lose four or five percent.   

Certainly not a desirable result for a lower volatility part of the portfolio, but when compared to what can happen during a stock market correction or even a crash, the potential bond losses pale in comparison.

So, I won’t be in a rush to dump my bonds because of a headline. A truly diversified portfolio, does not assure positive results, but will help manage risk, will include some allocation to bonds and while bonds may not win the investment popularity contest this year, sooner or later most investors will be glad their diversification included some exposure to bonds.

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