Why do I have bonds in my portfolio in this low rate environment? This is a reasonable question given the strong performance of the equity market in recent history. Last week major equity indexes have gone into “correction” (defined as a drop of 10% or more from the index high.) These sudden declines are the reason we have fixed income in most portfolios. Bonds do not typically provide the same long-term returns as equities, but they also protect our portfolio by limiting volatility and providing a ballast in our portfolio. Since the global financial crisis, we have had historically low interest rates and bond returns have not been what investors historically experienced. This has left investors looking for higher returns with two choices, buy more equities or invest in lower credit-quality bonds which typically pay higher interest rates. We have always maintained that a diversified portfolio is a prudent method to manage volatility, and last week is further evidence of that. As of the 3/3/20 close the S&P(TR) is down 6.74% for the year and the Bloomberg Barclays US Agg Bond index is up 4.22% for the year (www.orionadvisor.com) As investors have sold equities due to fear of further declines in stock prices, money has flowed into bonds. This has created more demand for bonds and is why current yields have decreased and the value of your previously held bonds have increased. Bonds are acting as they are supposed to, they are providing a positive return and balancing out the equity portion of your portfolio when equities are under pressure. Our portfolios are designed such that we can take the income from the bond portion of the portfolio to provide your normal monthly distributions for a significant period of time before we would need to sell equities in a down market. For more aggressive investors, a down market can provide an opportunity to reduce their bond exposure and buy more equities. A proper allocation to fixed income and more conservative investments in any portfolio is important given overall risk profile and time horizon.
When we buy bonds or bond funds, we are ‘lending’ money to a Company for a period of time with the promise they will pay us interest and then return our capital to us at a specified date (in its simplest form.) Bonds don’t participate in the equity or market capitalization growth of the Company and are therefore thought of as lower risk (not always accurate.) Historically investors have had the mentality that one can simply “buy bonds” and earn a return with little to no risk. As with most things, fixed income investing isn’t that simple. Just as in the equity market where we can choose to buy large US companies, smaller to mid-size US companies, international, emerging market, and any number of sectors, fixed income investing has decisions to consider as well. We can buy long-term bonds, intermediate term bonds, short-term bonds, international bonds, bonds denominated in foreign currency or bonds of companies with different credit ratings. United States government debt is thought of as lowest risk, while the debt of a start-up company is higher risk and would have to pay a higher interest rate for investors to loan them money. We follow the fixed income market and make changes in your portfolio as interest rates and markets dictate. This recent pullback has demonstrated that asset allocation is working as it should.
The foregoing content reflects the opinions of Atlanta Financial Associates, LLC, provided for informational purposes only. It should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that diversification or any investment plan or strategy will be successful.