Bonds are not as bad as they seem

I see a lot of social media posts that say bonds are drags on accounts and will only lose value over the next decade or so. It’s true that we have been in a long term bull market for the last 40 years or so. That bull market might well be coming to an end soon with rising interest rates in the near future. However, bonds and treasuries provide diversifying power to your portfolio and provide down side protection when you need it most. Bonds, when there is a crash, allow you to re-balance at market lows and buy stocks cheaper by selling your relatively overpriced bonds.

                Stocks have also been on a historic bull run; the bull run ended in march of 2020 due to the covid crisis. But the bear market was extremely short lived and US stocks are again reaching new highs. Which is why we should consider keeping some of our portfolio in boring old bonds as protection against a potential market crash. I’m not promoting bonds per say, as they do have inherent risks about them as do stocks, but the idea that bonds aren’t working just isn’t accurate. Recently, bond funds have gone down while stocks have gone up – that’s typically behavior that we expected given they are negatively correlated assets.

                As we cannot predict the market it’s especially important to determine our asset allocation and keep to it, regardless of market circumstances.

                Swensen stresses the diversifying power of US treasuries and bonds in his book – including protection against financial crises.

“No other asset type comes close to matching the diversifying power created by long-term, non-callable, default-free, full-faith-and-credit obligation of the US government.”

                I believe that he views the diversifying power of as downside protection rather than variance protection. I was able to gather some returns from some older crises and how treasuries and other assets performed.

Asian Crisis (April – September 1998)

Returns from April to September 1998 [%]

Vanguard Long-Term Treasury                       12.7

Vanguard Intermediate Treasury                     9.8

Vanguard Long-Term Inv. Grade                      7.7

Vanguard Intermediate Term Investment Grade        6.9

Vanguard Total Bond Mkt                            6.6

Vanguard Short-Term Treasury                       5.5

Vanguard Long-Term Tax-exempt                      4.6

Vanguard Short-Term Corp                           4.5

Vanguard Int. Term Tax-exempt                      3.9

DFA Two-Year Global                                3.1

Vanguard Limited Term Tax-exempt                   2.9

Vanguard High Yield Corp                          -0.1

Vanguard Europe Index                             -9.6

Vanguard Total Stock Mkt                         -10.5

DFA Intl Large Co.                               -12.5

Vanguard Value Index                             -12.5

Vanguard REITs                                   -14.2

Vanguard International Value                     -16.3

DFA US Large Value                               -17.5

Oppenheimber Real Asset (Commodities)            -17.7

DFA Intl Small                                   -19.8

DFA Intl Small Value                             -20.6

Vanguard Pacific Index                           -21.4

Vanguard Small Cap Index                         -24.2

DFA US Small Value                               -25.3

DFA US Micro cap                                 -26.9

Fidelity New Markets Fund (Emerging Market Bond) -34.2

Vanguard Emerging Market Index                   -35.4

                Since most of the funds I am holding (VT, VB, VSS, VWO, and VOO) performed near the bottom of the list. I tend to hold assets closer to the top for my bond allocation (which is BND and VGIT – Total bond market and Vanguard intermediate treasury ETF).

Black Monday (October 1987)

Vanguard Long-Term Treasury                        5.8

Vanguard Long-Term Inv. Grade                      3.7

Vanguard Total Bond Market                         3.5

LB Intermediate Treasury                           3.0

LB 1-3yr Government                                2.0

Vanguard Short-Term Inv. Grade                     1.6

DFA One-Year                                       1.2

Vanguard Int. Term Tax-exempt                      1.1

Vanguard Long-Term Tax-exempt                      0.8

Vanguard HY Corp                                  -3.5

DJ Wilshire REIT                                 -14.2

MSCI Pacific                                     -15.3

Vanguard International Value                     -17.7

MSCI EAFE                                        -18.5

Russell 1000 Value                               -20.2

Vanguard 500 Index                               -21.7

Russell 3000                                     -22.4

MSCI Europe                                      -23.6

Russell 2000 Value                               -28.3

DFA US Micro                                     -29.2

Vanguard Small Cap Index                         -32.1

US S&L and banking crisis (performance from Oct 1989 – September 1990)

Vanguard Long-Term Treasury                        5.8

Vanguard Long-Term Inv. Grade                      3.7

Vanguard Total Bond Market                         3.5

LB Intermediate Treasury                           3.0

LB 1-3yr Government                                2.0

Vanguard Short-Term Inv. Grade                     1.6

DFA One-Year                                       1.2

Vanguard Int. Term Tax-exempt                      1.1

Vanguard Long-Term Tax-exempt                      0.8

Vanguard HY Corp                                  -3.5

DJ Wilshire REIT                                 -14.2

MSCI Pacific                                     -15.3

Vanguard International Value                     -17.7

MSCI EAFE                                        -18.5

Russell 1000 Value                               -20.2

Vanguard 500 Index                               -21.7

Russell 3000                                     -22.4

MSCI Europe                                      -23.6

Russell 2000 Value                               -28.3

DFA US Micro                                     -29.2

Vanguard Small Cap Index                         -32.1

Great depression (performance September 1929 – June 1932)

Returns – October 1987 [%]

Vanguard Long-Term Treasury                        5.8

Vanguard Long-Term Inv. Grade                      3.7

Vanguard Total Bond Market                         3.5

LB Intermediate Treasury                           3.0

LB 1-3yr Government                                2.0

Vanguard Short-Term Inv. Grade                     1.6

DFA One-Year                                       1.2

Vanguard Int. Term Tax-exempt                      1.1

Vanguard Long-Term Tax-exempt                      0.8

Vanguard HY Corp                                  -3.5

DJ Wilshire REIT                                 -14.2

MSCI Pacific                                     -15.3

Vanguard International Value                     -17.7

MSCI EAFE                                        -18.5

Russell 1000 Value                               -20.2

Vanguard 500 Index                               -21.7

Russell 3000                                     -22.4

MSCI Europe                                      -23.6

Russell 2000 Value                               -28.3

DFA US Micro                                     -29.2

Vanguard Small Cap Index                         -32.1

 

Lessons:

  1. Risks do show up and when they do market declines can accumulate rapidly
  2. High quality bonds provided more protection against equity market declines than low quality bonds (e.g. HY and EM bond)
  3. Long-term treasuries provided greatest protection during periods when there were significant market declines – but this is not always the case (as in 1990 when short-term bonds outperformed).

Summary:

We should be making an asset allocation and keeping to them. Bonds serve a purpose in a diversified portfolio and making sure our risk tolerance is up to date and consistent with our preferences, we are in good shape. Lastly, if you are trying to build wealth and want to invest, try using m1 finance (you’ll get an extra $10 dollars with the referral link) it’s a great platform for long term investing. And finally, if you’re looking for further ways to enhance returns check out our high risk and ultra-high risk newsletter.

If you’re a first-time investor, try checking out the easiest portfolios out there. Or if you’re looking to get out of debt, try getting motivated with my “ The power of Budgeting.”

Note: the m1 referral link gives the reader $10 extra dollars to invest with if they choose to fund a taxable with $100 dollars within 30 days of opening the account or fund an IRA with $500 within 30 days of opening an account. The author of this article will receive a $10 dollar compensation as a result of the reader opening an account. The compensation for both parties occurs 30 days after the deposit occurs and assumes the full amount is retained in the account until the end of 30 days from the deposit day. YNAB offers a free month of use this will be given to both the author and reader if the reader subscribes after the free trial period and buys a month of subscription. The author uses and endorses both YNAB and M1 Finance and both links are affiliate links.

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