“Bonds make bad times better.”
This is the message from investing guru Paul Merriman who is an authority on index investing, asset allocation and active money management.
It was interesting to read Merriman’s recent take on bonds in this MarketWatch article. His article gave me some pause for thought to revisit why I actually do not hold bonds in my portfolio right now. Here are some excerpts from the article and my thoughts to his comments.
“If you want to make the most money, you should invest in stocks. But if you want to keep the money you made in stocks, you should invest in bonds.”
I suspect what Merriman means is along the lines of what Andrew Hallam has preached for many years when it comes to bonds: bonds are parachutes when equity markets fall; bonds will cushion the portfolio landing. Although I do not have a considerable number of years vested in my pension plan, I do consider this a growing “bond” and for that reason I do not invest in bonds right now.
“For most people, the reason to own bonds is to mitigate equity losses during major market declines. Without this mitigation (and sometimes even with it), investors tend to panic when stock prices fall. Instead of considering the possibility of buying more stocks at depressed prices, these skittish investors sell.”
I’ve mentioned a number of times on this blog that I tend to look at major market declines as a wonderful opportunity to buy stocks. I’ve had many conversations with people over the years that look at me like I have two heads when I talk about this. They may never appreciate what I mean but I’ll stay true to my plan: when dividend paying stocks and equity indexed ETFs fall in price I try and buy more.
Bonds seem to make bad times better for investors by protecting investors from themselves when equities tank. If you need bonds in your portfolio to help you do that then by all means hold them to help you stay the course.
What’s your take on bonds? How do they help you?
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
All portfolios should contain some bonds. I have 30% in bonds, even with a DC pension plan from work.
It appears that bonds may tank with rising interest rate and all, but you never know. Bonds are a huge hedge against deflation. You think we may not experience it? You never know…
Thanks for the comment R. I think depending upon your tolerance for risk, you don’t need bonds. The reality is though, some bonds are usually helpful because they act like parachutes for your portfolio when the market tanks. Investors need that with a total return approach to cushion the blow.
Deflation? Might happen…you do never know!
One more thought to chew on. I see the money I currently have in bonds as ammunition for any future market corrections. If and when it happens I will start firing at those undervalued equities. I’m very underweight with them but I keep them for a rainy day.
Good points as well…and I think whatever you need to do to keep “powder dry” for those days when equities tank is a good plan.
I think the decision to hold bonds depends, at least in part, on your investment horizon. I’ve got about 12-15 years until retirement. That’s a while, but not long enough to make me feel comfortable taking on an all equity portfolio. So I keep a healthy percentage of short bonds to ensure a market crash could only exact so much damage. They don’t make much in terms of return, but they act as a storage vessel for equity profits and as an immediately available source of funds for rebalancing when my equity etfs fall in price. Not to mention they help me sleep a little better. 😉
Thanks for the comment Juan and everyone has their comfort level with equity risk. Good on you to keep your bonds short. The reality is, bonds aren’t necessarily meant to be a money maker. They are meant to protect you from yourself and sleeping better is part of that.
I had a lot of stripped coupon bonds which yielded 9.75 percent annually for 18-20 years, held in my RRSP. They have all matured now and I can’t bring myself to invest in any bonds.
My husband’s defined contribution plan at his work has an allocation of 10 percent in bonds. I thought about it last month but decided not to increase that percentage.
Geez, that’s some great yield on bonds Barbara. My wife and I both have pension, albeit certainly not gold-plated so we consider this our “bonds” and go with 100% equities in our personal accounts. I try not to think about those pensions and wish to save enough to come close to living off the dividends and distributions in our 50s and 60s. There’s always uncertainty with jobs and we need to look after ourselves.
Depends on the bond Mark. Rates aren’t changing on most of my bonds. (not ETF’s)
Debentures have been mentioned a couple of times. Now that’s a complicated animal.
True certainly not all bonds are created equal was my message. I don’t know very much about debentures, another instrument to secure capital though.
No bonds here too, I just have some exposure to Debentures through CEF, but there are another kind of beasts.
I will consider them, perhaps, when I will be officially retired according to the gvt.
I have also a difficulty to evaluate this kind of vehicle, and when you don’t understand one, you don’t invest in it.
Fair points about not investing in something you don’t fully understand. Think of bonds like an IOU, except the rate on the IOU can change.
Thanks for the compliment but I suspect there are plenty of smart(er) investors out there.
I did what you are doing while I was working and building an asset base, and still DRIP what I can. Bonds make up ~25% of holdings currently. The other ~25% is in GIC’s and HISA, although with higher rate GIC’s maturing have to consider alternatives vs where rates are now.
Nice article, Mark.
I like the metaphor of parachute during a market crash – bonds do provide and play a role in portfolios – and it really depends on each investor’s risk tolerance. I think theres space for some bond allocation in almost every investor, even though I have lately liquidated my bond funds. We still hold Canadian bonds in my wife’s account – but its a very small percentage compared to the overall portfolio.
R2R
I also like the metaphor of parachutes for portfolios. You’re not going to get any decent kind of return on bonds, they are barely beating inflation, but that’s not really why you own bonds in the first place. Thanks for the comment R2R.
I have about 30% of our RRSPs in convertible debentures but no bonds per se. These all pay 6-8% semi-annually. I’m comfortable with that but I do have an indexed DB pension so I can take on a bit more risk. The TFSAs are mostly ETFs with a smattering of individual stocks. Like Mark, I have several of my holdings DRIPing so by design I “buy” more when prices fall and have from time to time bought into a down market. I almost never sell much. I focus more on the income generated rather than the net worth of the overall portfolio.
We are the same Lloyd and I’ve learned to focus on cash flow vs. net worth. Take today for example, I don’t care if the markets fall 200 points or 2,000 points. I will simply look to buy more stocks when I have money to invest. I DO care however if my cash flow from dividends and distributions has the potential to be cut significantly.
Good article and timely with the discussion on the thread.
I now hold bonds for the reasons you referenced by John Merriman and Andrew Hallam. As I mentioned before it is also because we have won the race to FI and now seek a higher level of capital preservation, and simply do not need the higher returns and risk that goes along with a higher equity ratio. (At least at this point in our retirement.)
Basically, bonds “should” help cushion down equity cycles and give us access to capital at that time for income withdrawals and to re balance (buy more equities when they are down and when our asset allocation requires more of them). We also hold GIC’s, and have a HISA for similar reasons and helps form a “cash wedge” approach, giving us a little more protection and flexibility. It’;s interesting that bonds may be getting a bad rap from some who haven’t looked into them much. It’s likely most folks wouldn’t expect a 7% return from VAB in the past year for example.
Even though my wife has a good pension we prefer to look at this as a separate “relatively secure” income stream, and not a bond. For me the most important question is how much of our total invest able assets are we willing to lose, and the pension has absolutely no bearing whatsoever on this, when in retirement we cannot replace the capital lost. Our answer is much less than 50% and therefore necessitates lower exposure to equities, and a FI component.
Looking at history and the various charts available this approach appears appropriate for us but only time will tell if it is.
Thanks for posting this article Mark. Hopefully we can hear some other takes on bonds in a portfolio.
If I lose my workplace pension Deane you can bet I will own more bonds 🙂
It will be interesting to see if my tune changes between now and retirement on bonds, I suspect it will, but for now, all equities and buying when I can.
Given you have “won the race” I don’t blame you for capital preservation. Again, smart investors like you only take on the risk they can manage.
A HISA to help form a “cash wedge” makes perfect sense to me.
I hope to hear from others on this subject as well.
I do not hold bonds anymore.
It makes my investing plans simpler (35%Can equities, 45%US equities and 20%Int. equities)
It makes no sense to hold bonds while having a debt (65k$ mortgage @ 3.49% in own situation)
On the long run, it’s a drag
I may consider adding short bonds when I have no more debt, over 1M$ of invested assets, not able to work anymore (relying on investments only for a living)
This is where I think bonds can come in Le Barbu, for me, when I’m not working and I need more capital preservation. I need capital growth now and for the next 15 years. This puts bonds on low priority for me right now.