We have been closely following the conflict in Ukraine. While the situation is evolving rapidly, it appears for the moment that Russia remains steadfast in its desire to prosecute this ill-advised offensive while Ukraine remains steadfast in its desire to defend the country. If recent decades of history are any guide, the Russians will be unsuccessful attempting a long-term occupation, but in the meantime, they can inflict a great deal of damage.
Bonds are getting a lot of negative press these days, and some of that negative press is rightfully earned. Bond yields are as low as they’ve been at any time going back at least to the early 1960s. More importantly, given the relatively high inflation we’re experiencing, most bonds are currently experiencing negative real returns. This means that the purchasing power of money invested in bonds could decline, at least slightly, as time goes on.
So why in the world would somebody own bonds? The answer is that 100 percent of every investment portfolio in the world has to be invested — in something. Most people should not — or cannot — invest their portfolio 100 percent in stocks, even if stocks are likely to beat bonds (and most other asset classes) in the long run. Even if an investor does have an iron constitution and can handle the volatility of an all-equity portfolio, there can still be problems around retirement known as sequence of returns risk, where a big stock drawdown can mean investors must sell their equities while markets are depressed. This can impair retirement plans even if the market has an attractive return over the full retirement period.
Every dollar not invested in stocks has to go somewhere else. You can’t just stick money in cash and say it’s “off the table.” That capital is still acting as a drag on your portfolio in most markets and therefore must be included in your returns. Diversifiers such as real estate, gold, or other commodities may be part of the answer, but they are likely to have no real return greater than inflation in the long run.
Even today, bonds are not hopeless. Bonds can perform entirely adequately in environments of rising interest rates and bond yields, such as the period from 1962 to 1982. The performance is not stellar, but bonds do what they need to do, which is mitigate the volatility of equities, especially in big equity drawdowns.
When you watched the news of the invasion in Ukraine last week, did you worry about your stock portfolio? Did you wish you had more bonds in your portfolio? Did you even momentarily think about going to all cash? If so, then you should seriously consider a little more defense (aka more bonds) in your portfolio. The time you need to decide on a less risky portfolio is before the bad news comes out, not after. Bonds have an important portfolio role in bad times, which is why it’s a good idea to get them in place when things are good.
Gene Gard is Chief Investment Officer at Telarray, a Memphis-based wealth management firm that helps families navigate investment, tax, estate, and retirement decisions. Ask him your question at ggard@telarrayadvisors.com or sign up for the next free online seminar on the Events tab at telarrayadvisors.com.
