An Asset Class You Can’t Ignore
There is no doubt about it…
You aren’t going to get rich owning government bonds these days.
As a saver and investor, you know the reason…
When I entered the workforce in the mid-1990s, I could take my savings and invest the money into a 10-year Treasury that was guaranteed to pay me more than 7%.
Today, that same 10-year Treasury yields all of 1.33%.
Today’s interest rates aren’t just low relative to those of the 1990s.
They’re low compared with any point in documented history.
We have records on interest rates that date back 5,000 years.
You and I are now living and investing in an interest rate environment that is lower than it was at any time in those 5,000 years!
With rates this low, it begs the question…
Does it make any sense to own bonds today?
My answer to that question is a resounding yes!
Let me explain…
Bonds Are There for You When You Need Them Most
We have a lot of new investors in the stock market these days.
A recent Charles Schwab survey revealed that 15% of U.S. stock market investors got their start in 2020 after the COVID-19-induced market crash.
That means 15% of people who own stocks today don’t have more than 18 months of experience in the market.
Furthermore, these folks have ridden the stock market only one way – straight up at a very rapid clip!
As you can see in the above chart, it has been a heck of a stock market run.
But at some point, possibly surprisingly soon, all of these new investors are going to find out that stocks can go the other way too – often at a distressingly rapid pace.
When that happens, these new investors are going to learn the value of having a portion of their portfolios invested in high-quality, income-producing bonds.
A bad 18 months for a stock-only portfolio could see 50% of your wealth wiped out.
I lived through that during the financial crisis of 2008 and 2009, and I can tell you it was not pleasant for stock-only portfolios.
And don’t forget that in March 2020 the entire stock market dropped 33% in a little more than a month!
The reality is that you need a portfolio built to let you sleep at night when drops like these happen.
That is where the diversifying benefits of bonds are crucial.
While a bad stretch in the stock market can be a 33%-to-50% drop, a bad stretch for a high-quality bond portfolio sees it generate a steady income stream with no capital loss at all.
Even better, having that income from bonds provides you with cash flow to buy discounted stocks as the stock market tanks.
You can even reallocate some of the principal portion of that bond portfolio to stocks when the market is offering up the mouthwatering bargains that appear when everyone is in panic mode.
If you dig into how Warren Buffett currently has his conglomerate Berkshire Hathaway (NYSE: BRK-B) positioned, you will see that he is sitting on a portfolio that consists of…
- $307 billion worth of stocks (65%)
- $160 billion worth of cash and fixed income (35%).
While that significant fixed income in Buffett’s portfolio isn’t making him a lot of money these days, it certainly gives him a massive amount of dry powder to exploit the next great buying opportunity coming around the corner.
Clearly, Buffett sees the diversifying value of holding bonds – even at today’s interest rates.
The one caveat I would present about bonds for investors today (and I’m sure Buffett would too) is to not lock in for long durations.
With interest rates likely to rise (and perhaps significantly so), it is important to stick with bonds that will mature within the next couple of years.
You don’t want to be locked into long-term bonds in a rising rate environment.
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