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Why now is probably the wrong time to shift your equities to bonds

I get it.  The stock market is nuts.  You’re not making much money and neither am I.  What is an investor to do?  Move away from equities to bonds?

Not so fast.

I think you should avoid selling your equities and moving into bonds right now.

Before I get more into that, in a recent Globe and Mail article, I read National Bank Financial chief economist and chief strategist Stéfane Marion stated demographics are to blame for the shift away from equities.  Based on research Marion was able to obtain, over the last 15 months, over $200-billion (U.S.) has left equity funds and over $250-billion has flowed into bond funds.  This can be partially explained not because of the 2008 financial crisis and more risk-averse investors but because the age of the workforce is increasing and as a result there is a flight to safety.

If this is true (and there could be some truth to this) do you really want to be moving from equities into bonds with this herd?  If you’ve already done this, that’s fine but here’s a few reasons why I’m not going along with you:

  • I’m not near retirement age.  I don’t have the same flight to safety needs.  I won’t retire for another 20 years.  Even then, I hope to live another 30 years.  30 years is a long investment period even if it’s in retirement.  Retirees can benefit from equities as painful as equities feel right now, at least this is my view.
  • While bonds can provide a reliable stream of income be mindful bonds over long investment periods provide lower returns than equities.  Bonds provide returns just ahead of the rate of inflation and according to an excerpt from Warren Buffett’s recent letter to shareholders not even:

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”

  • Interest rates remain near historical lows.  When interest rates rise, bond prices fall.   When rates do climb in another couple of years (who knows when it will really happen) bond values will fall.  If your objective is to buy low and sell high, this is not the best time to buy bonds.  With more money from the herd flowing into bonds, bond prices rise.

If your objective is to use bonds, as part of a long term financial plan, I see no issue with rebalancing your portfolio with buying a few bonds now and again.  That makes sense.  However, with many stocks and equities in general beaten up over the last couple of years, I just don’t see why you’d be making an exodus from equities into bonds right now.  You are welcome to put the blame on demographics or anything else, that’s fine.  For me, I’m not following the herd and instead when the opportunities present themselves I’m doing the opposite - buying equities.

What do you think?

Filed in: Asset Allocation

36 Responses to "Why now is probably the wrong time to shift your equities to bonds"

  1. Echo says:

    Another theory could be that bonds performed really well in 2011, so investors moved a lot of money into bonds in 2012 – because we know how the herd loves to chase past performance, right?

    Fear is a powerful emotion that drives investors to make irrational decisions. People feel much safer buying bonds than buying stocks, especially with the recent crash so fresh in their minds.

    • Fear is a very powerful motivator indeed. I hope when the next crisis strikes, I can withstand the emotional pressures that go with selling equities like so many others have done when the pain threshold gets too high.

  2. Rob says:

    Canadian Money Saver had a fascinating article about two widows, both widowed at the same time and surprising both received the same amount. Widow nr 1 following her late husbands advice invested only on safe bonds, the other following again her late husbands wishes bought and held a bunch of blue chip dividend paying stocks. Fast forward 35 years widow nr 1 is running out of money due to inflation, widow nr 2 has seen her net worth increase from 300,000 to 2.5 mil and income is ahead of inflation. Personally the only bond I hold is in my wife’s LIRSP, and that is a 30 year gov. Bond yielding 6%. When it renews it will be I will move it into equities.

    To me a flight to safety is solid dividend paying stocks

    Rob

    • “To me a flight to safety is solid dividend paying stocks.” Well said.

      I’d add to that, a diversified portfolio of 30+ dividend paying stocks is a flight to safety. I hope to own about 40 established dividend-paying stocks at some point, all DRIPping adding more shares upon shares every month and quarter. Then my retirement plan will be on autopilot. :) Halfway there actually!

  3. geodelover says:

    The book, Stocks for the Long Run, makes a good case as to why to purchase equities instead of bonds if your investment period is at least 10 years. Since 1800, it has been very rare for bonds to outperform equities over any 10 year period and it has been non-existent over any 30 year period.

  4. Bonds have two real advantages:

    1) the longer duration ones yield more than the cost of capital. Ie. you can buy bonds that yield 3% with money you got for 1.5%
    2) They have a negative beta – meaning they move opposite stocks.

    In my opinion those advantages aren’t worth it. Interest rate risk makes 1) a mirage, and 2) can be had via other means I describe here:
    http://www.offroadfinance.com/2012/07/23/a-speculative-alternative-to-investing-part-4-hedging-beta-neutral-spreads/

    • Long-bonds are good but you have to watch out for those when interest rates rise. I own XBB as an all-in-one bond ETF, that’s enough for me. Thanks for the link to your article, I will have to check that out!

  5. First of all, I am not sure if I would buy any bonds per se since the people who are making the money are the brokers. But it doesn’t mean I wouldn’t sell some equities right now. In fact, I just closed out all my “bullish” positions on equities. While I think that the dividend strategy is interesting and cool, I do see it going into the bubble stage in next few years (and it seems like everyone else is doing it – talking about following the herd!). I think that one has to be a swing trader (combined with value investing strategy) to do well rather than just buy and hold “dividend” stocks. And I am not so sure about the cookie-cutter advice of I have enough years before I cash in my stocks, so I don’t care about up and downs. In my opinion, every down hurts! That’s why all successful traders/investors would say that the first rule of trading/investing is “cutting losses”.

    • Hey John,

      I am very bullish on equities right now. Like you, I couldn’t care less about the ups and downs. If anything, when equities fall, I’m on the hunt to buy more of them. Doing so with BMO in 2008, is looking like a very wise move today :)

      Thanks for your comment!

  6. Mark, while I agree with your point in part, unfortunately many people are going to read this post and assume that means holding bonds is a bad investment – which is not what I think you are saying. I’ll avoid even getting into that argument. What I think you are saying is – it would be a bad idea to sell your stocks and rush to buy bonds in a panic.

    I agree with that point. To sell equities in a panic and buy bonds because you feel bonds are safer than stocks, when bonds are trading at premium, is definitely NOT a good idea. If you are selling equities to rebalance your portfolio, or adding to bonds (as I recently did) to maintain your asset allocation, then I think that IS a GOOD idea.

    I could make the counter-argument to this post. Just as many investors are currently selling their bonds to buy equities, while equities are rising, because they feel equities are safer than bonds. Well maybe so, I have no idea, but I recall many people did this in 2007 and 2008.

    My point being, any sudden shift to your asset allocation, because you believe bonds are not a good investment or otherwise, and equities are a good investment or otherwise, is market timing.

    • Hey Ninja,

      Nice to see we agree, although you are right, my post was not to say bonds are bad investments rather panicking and selling your equities to move into bonds, especially now, is not a smart move IMO.

      Sudden shifts in allocation are not good, but my caveat to this is, if equities fall always buy more! Thoughts?

  7. Kanwal Sarai says:

    People are told to move their asset allocation to bonds/GICs/Term Deposits as they move closer to retirement. Because these are supposed to be “safer” investments and less volatile. But with a GIC your capital never grows, and neither does the rate of return because it is fixed. What happens is, in retirement people end up eating into their capital which further decreases their savings.

    If people started investing in dividend stocks in their 20s, by the time they hit retirement, they should have enough dividends coming in without having to touch their capital (sell stocks), and over time the dividends should continue to increase. In my opinion solid dividend paying stocks will provide more income over time than bonds/GICs/Term Deposits.

    • Great comment: “If people started investing in dividend stocks in their 20s, by the time they hit retirement, they should have enough dividends coming in without having to touch their capital (sell stocks)”…

      I didn’t start in my 20s, but definitely playing catch up! :)

  8. You’ll find good yield along with relative safety in bank stocks (~4%) and telcos/utilities (~5%). Bond won’t be on my horizon for many years due to low interest rates. Besides, dividends are taxed at a lower rate!

  9. Joe says:

    Higher yield junk bond index fund, anybody? e.g. XHY

  10. Mark,

    One thought is corporate bonds. What may surprise many people is the returns (can) offer excellent returns with less risk. Example.

    Here is a story from the Globe & Mail about a year ago

    Nortel filed for bankruptcy protection in January, 2009, and has since been shedding assets at an impressive pace. Fourth quarter results, released in early March, showed that revenue shrivelled to a mere $28-million – down from fourth quarter revenue of more than $2-billion as recently as 2008.
    More related to this story

    Patent sale marks end of line for once-mighty Nortel

    The company has said repeatedly that the creditor protection proceedings will likely render the common shares and preferred shares worthless. However, Bloomberg News reported that Nortel’s 2016 10.75 per cent bonds, due 2016, are in another realm: They rose to 93 cents on the dollar on Monday in New York.

    The problem is the Do it yourself crowd does not understand corporate bond prices etc. The other is outside one’s RRSPs any gains can be treated as capital gains…My understanding is ETFs can’t, income is taxed at the highest rate.

    Brian

    • Hey Brian,

      Good call on the corporate bonds…they are yielding more. Do you own any in your portfolio and if so, what is your allocation to corporate bonds if you don’t mind sharing? I only own XBB myself, my all-in-one bond ETF.

  11. Scott says:

    At the end of the day – people are just sick and tired of losing money!

  12. We are similar age to you and also have a long ways off from retirement. We have invested in a few bonds to balance out our portfolio but we aren’t heavily invested in them. We try not to do any investing with emotions as this is the best way to make a financial decision.

    • I like using a few bonds to balance out the portfolio, but I think an exodus from equities to bonds, especially right now, is a bad idea. Equities are for the most part, at decent prices. Time to buy equities, not sell :)

  13. Rob says:

    @My Own Advisor

    Thanks, I,m slowly moving away from DRIP stocks partially because I don,t live in Canada , and DRIPs can be a headache to manage, but mostly because I prefer the flexibility of brokerage account.

    Rob

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