You don’t hear much about bonds when the stock market is breaking new ground.
That’s because the bond market often behaves in inverse proportion to the stock market. For instance, in 2019, the annual return on the S&P 500 was 31.5 percent while the bond market return was 8.7 percent.
Given such disparate performances, you might wonder why anyone would invest in bonds?
The following scenarios have traditionally been amenable for bond investing.
You’re a retiree
If you’re retired, you likely don’t have many sources of income. Bonds can help fill this gap by paying interest regularly. Certain bonds also provide tax-free income though they pay lower yields than comparatively priced taxed bonds.
Retirees are also vulnerable to the gyrations of the stock market. For instance, in the early 2000s, stocks twice lost about 50 percent of their value.
That’s why many investment analysts recommend a 60 percent/40 percent (between stocks and bonds respectively) or a 75/25 split.
You’re a young investor
Financial experts differ on when to invest in bonds, but Ben Carlson, who writes the blog A Wealth of Common Sense, argues that having money in bonds serves a psychological function.
As he notes, “Investing 100% of your retirement assets in stocks may seem like the right thing to do on paper but very few investors have the intestinal fortitude to pull it off in the real world.”
That is, if investing all of your money in stocks will make you queasy every time there is a pullback, consider putting some money into bonds. If you have a $100,000 portfolio and opt to put 20 percent into bonds, then when the market takes a deep dive—say it goes to $50,000—then your $80,000 invested will go to $40,000, but your money in bonds will likely rise. That relative stability may be enough to convince you to stay the course rather than cut and run.
You’re a middle-aged investor
One rule of investing is to allocate your percentage of stocks versus bonds based on your age. So, if you’re 25, then put 25 percent of your mix into bonds. When you hit 60, then make bonds 60 percent of your asset mix.
But since bond yields are projected to fall over the next few years and the human lifespan keeps climbing, some recommend putting 50 percent of your assets in stocks with the rest split between bonds and cash.
The experts also advocate adjusting that breakdown by five percent either way. So, if the economy turns and bonds are a safe haven, put 30 percent into bonds for a time.
Should I invest in bonds?
The answer to the question above is that yes, you should. But how much you invest is driven by your tolerance for risk and your age.
That said, 2021 may be an unusually bad time to invest in bonds. In 2019, Swan Global Investments published a white paper entitled “The Bleak Future of Bonds,” which posited that fixed-income securities (bonds are the most common but others include CDs and money markets) wouldn’t fare well over the next few years.
The paper noted that the average annual return on bonds from January 1982 to May 2019 was 7.69 percent. “Clearly, bonds have been a good investment for the past 37 years,” the paper noted. Bond markets tend to move in very long cycles, the paper continues. Taking the long view, the paper then states the real return of bonds from January 1946 to December 1981 was -.84 percent. Yields rose as high as 15 percent in 1982, but government expenditures were rising as well,
The paper then cited the Global Financial Crisis of 2007-2009 as another notable event. In the wake of that crisis, the Federal Open Market Committee reduced the federal funds target was reduced from 5.25% to 0.00%-0.25% “as low as they go without being negative,” the report added.
Rates weren’t increased until 2015, but yields on 10-year treasury notes still sit at around 1.5 percent, which is well below historical averages.
“If rates stay low and monetary policy remains loose, then bond holders are stuck with a measly yield barely enough to cover inflation. If rates start increasing, the prices of existing bonds will fall. Neither of these scenarios will provide bonds with the 7.69% rate of return enjoyed over the last three and half decades,” the paper continues.
Swan recommends parking your money elsewhere beside bonds going forward.
The bond market has enjoyed a long run, but there are signs that the run has come to a halt. Presently, bond yields are at historic lows, so it is important to rethink standard investing advice and take a skeptical view of bonds going forward.