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Why Bonds?

“Why do I have these crummy bonds in my portfolio?” or “Everyone knows that interest rates are going up, so shouldn’t we sell our bonds now?”  As a financial advisor, I get these questions from time to time.  Why?  It's because people read, watch, and listen to “experts” on the financial media and believe them.  At the end of 2013, experts were predicting that the interest rate paid on ten-year US Treasury bonds was going to increase by the end of 2014.  The ten-year US Treasury bond rate was 3.03% on December 31, 2013.  What is it today?  Around 2.24%.  So much for the experts.

Why do people focus on what the future holds for bonds?  In many cases, it is because they don’t look at the assets in their portfolios as parts of a whole.  They obsess over each asset in their portfolio without consideration of how each asset in a well-constructed and well-diversified portfolio compliments the other assets in their portfolio.

We recommend that investors hold a diversified portfolio of stocks AND bonds because stocks have historically provided growth for a portfolio (with significant ups and downs) while the right kind of bonds have reduced the overall decline in portfolios when significant stock market declines occur.  For example, in 2008, a 100% stock portfolio that we construct for clients declined about 50%.  During that same year a 50% stock/ 50% bond portfolio that we construct declined about 25%.  The short to intermediate government bonds that we hold did their job-they reduced the loss due to the stock decline.

Fran Kinniry made a similar point in a recent article.  He showed that when we experience “a period of bottom decile returns for US equities” (a stock market crash to the rest of us) treasury bonds have provided a positive return.  Just when we needed it the most, bonds provided a measure of stability in our portfolios.  This balance helps us more easily maintain our long-term investment plan.  Evidence shows that investors who stick with a well thought out investment plan, through the many highs and lows of an investing lifetime, are most likely to reach their financial goals.

For some 2014 interest rate forecasts please read this Forbes article.

Read Fran Kinniry’s Vanguard article on the importance of bonds in a portfolio.

 

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