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I’VE SPENT THE PAST 10 years or so without any bonds or bond funds in my portfolio. What am I missing? And why did this happen?
Investing in bonds directly was always confusing to me. There are coupon rates, bond ladders, bond ratings and so much more. In the beginning, I just found it easier to ignore all the confusion. I know that bonds, in aggregate, represent a greater investment pool than stocks, but I just kept putting it off.
Somewhere between 2010 and 2015, I finally had time to learn more, but what I learned put me off further. The facts didn’t compel me. At that time, bonds didn’t provide an attractive return, and there was little prospect of things improving. In fact, they got worse.
Aggregate bond indexes have been slightly negative for the past three calendar years, and they’ve averaged just a 1.1% average annual return over the past 10 years. That’s less than the 2.6% average inflation rate over the same period. With bonds, I’d have been investing to lose money, since I view the inflation rate as my breakeven point. And so, I kept putting off bond investing.
Meanwhile, most financial advisors continue to push a balanced portfolio, with a default setting of 60% stocks and 40% bonds. Faced with this advice, I do have fear of missing out, or FOMO, given the relative safety that bonds can provide. The stock market could collapse at any time, after all.
People consider a market correction to be a drop of 10%, and a bear market to be at least twice that—20% or more. Since my returns in the stock market have averaged more than 10% a year for the past 10 years, my bond-free portfolio would still be quite a bit ahead, even if there was another stock bear market. Your experience may differ and, as they say, past returns are no guarantee of future results.
That leaves me still wondering: What about adding some bonds?
These days, bond exchange-traded funds (ETFs) will comfortably eliminate all those educational hurdles I had with bond ladders, ratings, coupon rates and the like. And, just like stocks, total market bond index funds, which are passively managed, compare quite favorably to actively managed bond funds, especially given their lower management fees.
What’s more, it doesn’t take long to find the biggest, cheapest and broadest-based bond ETFs by using search engines and fund screeners. Here are four of the biggest bond ETFs on the market today:
If I wanted to own bonds tomorrow, I’d buy one of these. If I was in doubt, I’d probably buy the biggest—Vanguard’s bond ETF—or maybe the fourth one, which is Schwab’s offering, since Schwab is my primary broker.
They would all perform about equally well and, if it helped me sleep better at night, bonds would be worth buying. If you’ve found some other good bond funds, your recommendations are welcome in the comments section.
For now, though, I’m going to stick to stocks, with a tilt toward large, stable, dividend-paying companies. I’ll completely avoid all debt securities—not just bond funds, but also loaning money to family or trusted friends. But that’s another story.
For the moment, I’m content with my bond-free portfolio. With inflation running hot, the gap between inflation and the current yield on bonds, whether government or corporate debt, remains uncompelling. I don’t mind missing out on these safe—but negative—returns, relative to inflation.
Right now, my bond FOMO is comfortably low. Though I may not sleep well tonight, it won’t be a lack of bonds that keeps me awake.
Steve Spinella is an international Christian ministry worker. He and his wife Laura have been married for more than 40 years. For more of Steve’s writing, check out his blog. His previous article was Trial by Fire.
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My favorite example that makes this point is that, for the 40-year period from 1969 through 2008, the S&P 500 Index returned 9%, and so did 20-year Treasury bonds. Making matters worse, while producing the same returns as long-term Treasuries, the S&P 500 experienced far greater volatility—its annual standard deviation during the period was 15.4% compared to just 10.6% for Treasuries.
That equities could underperform Treasuries for 40 years surprised many people, but it shouldn’t have. No matter how long the horizon, there must be at least some risk stocks will underperform safer investments.
There is indeed a risk that stocks underperform safer investments — otherwise it wouldn’t be risk. Still, when I hear such examples, they strike me as a tad disingenuous. We’re talking about comparing the broad U.S. stock market to one Treasury security. Many folks would have had exposure to the broad stock market over that 40-year stretch. How many folks would have owned 20-year Treasurys and then presumably rolled their money into a new 20-year Treasury at the beginning of each year?
There have been significant periods of time, 30-40% in total over the last 100 years when risk free treasury bonds have outperformed stocks – just ask Larry Swedoe
So 100% of all your money is invested in stocks?
My husband and I max out our I-bond quota of 20k total every year. We also add I-bonds to our business account (10k) a year occasonally and try to get in another 5k through the tax refund route. Last year we shoveled some extra money into gift I-bonds that will be assigned over the next few years. Our I-bond ladder is the only bond exposure we own or need.
They are inflation-indexed, not taxed until we cash them out and are exempt from state and local taxes.
Coincidentally, the Feb 28 issue of the Wall Street Journal featured an article by columnist James MacKintosh titled “If History Repeats, Then It’s Time to Buy Bonds.” Some highlights from the article:
“In 1973 and 1980, stocks took a long time to recover, especially after adjusting for inflation.” A bond investor was ahead of a stock investor for 13 years after 1973, and ahead for 7 years after 1980.
This is not a prediction of what will happen today since much depends on how the economy unfolds. But it does indicate that, at todays yields, bonds can smooth out the performance of a volatile all-stock portfolio — something valued by retirees drawing down their nest egg.
It’s also important to consider that, at current yields, bonds are more reasonably priced than stocks and, looking forward, starting valuations matter.
The key takeaway from this post is “the last ten years”, which has been only one of many periods in the financial markets. Yes, bond returns, adjusted for inflation, have been negative over this particular period, while stock returns have been supurb. However, that performance difference is not the reason to hold (or not hold) bonds.
There are periods, for a retiree withdrawing from the portfolio, that bonds serve as a valuable stabilizer for the portfolio. During the period 2008-2010, when stocks nosedived, a retiree holding a diversified portfolio could sell bonds for income and have suffered no ill effects whatsoever from the stock market decline. William Bengen’s classic “4% withdrawal” study conclusively demonstrated that a retirement portfolio invested less than 15-25% in bonds had a higher probability of running out of money over a thirty year withdrawal period than a more conservatively invested portfolio.
In summary, bonds provide safety, because the investor cannot know what the future holds for stocks.
My advisor does not like bond funds or ETF funds as regardless of the yield the value goes up and down with the market, albiet a little less than stocks. He has guided me into municipal bonds mostly and one Ford corporate bond. These have varying maturity, Ford call date is 2031, paying 8.9%, most of the municipal funds are in the 4-5% range. If you buy these in the state you live there is no state income tax which adds a little to your yield. These have worked well for me adding to my dividend income which i live off of and a few have matured to give us a nice cash nest egg to cover the ups and downs of the market. Recently MM fund yields at 4.5% and greater have led me to keep my cash and not buy the funds, bought CJLXX yesterday yielding 4.6% with a .18 fee. Finally seeing some movement on MM, I hate that it took high inflation to get it there though.
I used to have your view, when I was young. But now I fear a big dip that will outlive me, and hurt me while I am still alive. So bonds have crept into my portfolio. I can sleep well again.
(As a side comment, I used to be on a pension committee at a public company, and we debated a comparable (or maybe flip-side) question. Should a fully-funded pension fund invest in stocks at all? (A big and sustained dip in the market might cause you to fall out of fully-funded status.) Or should you just take the safe route and build a portfolio of high quality bonds that won’t grow the portfolio as much, but will make sure you will never ever fall out of fully funded status, and can pay every retiree as they age. One might think that it is safe to go with a diversified portfolio of quality stocks over a long period. However, I believe the consensus that has emerged among fiduciaries is actually to go with the second option.)
That sounds like a very relevant second question. In the best of worlds, bonds would be priced relative to stocks by the [all-knowing] market such that we all should go with whatever product most naturally fits our needs, and many of the comments have advocated just that.
However, a contrarian might suggest that this relationship has been broken somewhere in the last 20 years, and instead ask why it no longer holds. Answers that might be offered could include the federal reserve, financial managers touting “balanced portfolios,” or perhaps some even more efficacious explanation.
I’d been a bonds only individual initially, disparaging chit-chat of stocks back at, and before 1929′, was always a holiday family meals contentious debate.
Like contemptoranous crypto no doubt. Old institutions like worldly valued monetary exchanges are certainly debatable.
Mex, Spanish, Portage’s, Caribbean, Cuban, Brazilian, Peruvian exchanges etc have always favored on a small scale & preferred the international Dollar.Soros broke the Silver Cert. in the UK iirc, nearly 30+yrs ago. This is all aged memories.
In the 80s(80-82) Mass Muni Bonds were paying 10/11%.
What could go wrong. It’s a pensioners analyst groups decision.
Bonds used to be somewhat* of a predictable ballast.
Data dictated it. They’d never lost more than 11% annually
Unknowingly, to me these Ma. Munis were both ST & callable.
That was like a lightning strike, it rarely happened.
I guess it was like Luis Reneari(sp)and his new MBS in Europe, Iceland, Greenland, Finland, Norway, Sweden & that area.
All were unaware, more astutely put.
Then I heard about the Wilshire 5000 & SP500 right after the calling*(dispersions)luckily, A 50/50, all eggs in 1 basket thing.
I looked at your blogs SteveS.
I missed Green-Light-Laser surgery, thats my fall back plan.
I’m sure you can find the information if I missed it noted.
Good luck…..
Good for you. I appreciate this contrarian take. I also have few bonds, although I’m in my 40s. Up until about now, I, like you, did not find bonds compelling. Now that interest rates have increased, they’ve become more interesting. You may look at TIPS which are safe but will guarantee you’ll beat inflation.
On the other hand, if you don’t want or need bonds, then let it ride! It’s possible that you’ll have enough money to retire on without needing the “safety” of bonds. Also, Social Security, for example, acts as an inflation protected bond. And if you’re planning to leave money as an inheritance (whether to your heirs or charity), then you can let that money continue to gain in equities.
A point of clarification: The inflation adjustment in TIPS bonds will guarantee that you match, not beat, inflation. The only way to beat inflation with US TIPS bonds is if the real yield established at auction is positive.
Currently, 10-year US TIPS yield around 1.5%. So, current bonds will beat inflation, but the upside is limited. The real return on US stocks since 1970 has averaged about 5.9% according to researchers at Credit Suisse.
Check out VTIP for inflation protection and low interest rate sensitivity.
Thanks for your article and perspective.
For me shifting into a prudent allocation of bonds vs stocks is nothing more than a risk management analysis.
If you’re fortunate enough to have “won the game” it’s probably wise to stop playing (or maybe play a little less?).
You are certainly pushing back with the conventional wisdom. But my question is more like, suppose you have the opportunity to play two games. In one you’ve always lost up until now. After you’ve played the other one for a while and “won [some],” should you reallocate and play the one where you’ve always lost? Unfortunately, you will also pay if you stop playing…
I’m comfortable with a pretty high stock allocation, but not 100% at our life stage (or yours, measured by the fact you’ve been married 40+ years). Some good options from others in the comments. Would stocks beat them? Very likely, but that’s not why we own bonds (or CDs, etc).
A few bond funds have weaseled their way into my portfolio. They’ve been a losing proposition.
My TIPS fund has fluctuated wildly, some months dividend free, some with sizable dividends. But the price per share has dropped substantially.
My index funds are down. My well-established dividend aristocrats have held up better. In my opinion you haven’t missed much.
With the real return of Treasury Inflation Protected Bonds greater than 1.5% at all maturities, it is very easy to buy a bond ladder of TIP’s that will provide you with a stream of income that will exceed inflation, as measured by the CPI-U, for as long as the next thirty years.
One year U.S. Treasury bills yield 5.11% and they are free of state income. T Bills are very easy to buy at most brokers. I’m happy with a 5.11% essentially risk-free return for a portion of my money.
That sounds much better, for sure!
You need bonds to avoid SORR. A retiree with no bonds runs a very strong chance of portfolio depletion before death. The goal as Bernstein says in retirement is not to optimize returns, but not to die poor. Wait till the next 50% decline; you might lose sleep
Hear! Hear!