Why do we Own Bonds?
Written by: Ryan Bouchey
It’s a question we often hear from clients – “Why do we own bonds?” This became a common theme at the start of 2018 as interest rates were rising and the price of bonds were declining. The general rule of thumb is the price of bonds move in the opposite direction of interest rates. As rates rise, market value goes down and vice versa. With interest rates on the rise in 2018 and the price of bonds falling (albeit minimally in the grand scheme of things) the question “why do we hold bonds” kept being asked. Many folks felt they’d be better off just holding cash.
Let’s look at how bonds have performed versus stocks over the past 12 Months:
As you can see the U.S. Bond Index, or “the Agg”(red, stable line) is up almost 10% over the course of the past 12 months while the S&P 500 index (blue, volatile line) is up just over 2%. What I love most about this graph, and I think it’s just coincidence, is that every time the S&P looks to break through the Agg index, it quickly reverses course on the downside. I wish I had an explanation for this other than this is what the stock market does –expect the unexpected. Would you believe that since January 26th, 2018 the S&P 500 is up only 1%? Did anyone think this was possible at the start of 2018? Based on my conversations, both with the leading money managers in the world and with clients, no one expected this.
The bond market has been on the rise this year due to falling interest rates. The 10-Year Treasury Yield peaked in November 2018 at just over 3.2%. Today it sits under 1.6%. Did anyone anticipate this happening when rates were rising last year – probably not. To be quite honest the future direction of interest rates is nearly impossible to predict. Which is probably the best answer to the question “why do we own bonds”?
I’ll leave you with one last chart. Since January 1st, 2018, both the U.S. bond index and S&P 500 are nearly identical. Both are up just over 8.6%. The chart is a perfect illustration and real time lesson for the benefits of diversification while also answering why own bonds when it feels like we shouldn’t. Both bonds (red) and stocks (blue) got you to the same point, but which line are you more comfortable with?
It’s never a bad time to re-evaluate your tolerance for risk. As investors we’re all hardwired a little differently. It’s human nature after all. The long-term nature of stocks makes them less risky than they may appear, however it comes with the price of short-term volatility. Bonds can help offset this, and even provide superior returns when stocks move sideways like they have these past 12-18 months. There’s no formula for an investors proper tolerance for risk, but if you have questions about it, we can help.