THE IMPACT OF BONDS ON YOUR PORTFOLIO

Bonds lower your long term investment returns

SUMMARY:

Bonds are supposed to lower risk in your portfolio. Bonds are supposed to be a "safe" asset. Bonds are supposed to provide a cushion during bear markets like the one we are now experiencing in 2022. All of this sounds comforting. But, what does the data show? Do bonds really help our portfolios? How much cushion do they provide?

Bonds or fixed income assets are supposed to provide a predictable return and a measure of safety. The main reason to be in “safe” assets (cash, money market funds, bonds, etc.) is due to the risk of losing money in other asset classes like stocks and commodities.

Since the stock market always has a risk of losing value in the short term, you are advised to keep a portion of your long-term investments in bonds or fixed income products. One problem with that approach is that bonds can and do lose money. In 2022, bonds are down roughly 15% due to the increase in interest rates. When interest rates rise, the value of bonds go down.

There are various approaches to determine how much of your long-term investments should be in bonds or fixed income. The standard “rule of thumb” people like to use is 60/40 where 60% of your investments would be in the stock market and 40% of your money would be in bonds or fixed income securities. Financial advisors will also tell you that the percentage split should vary based on your age. For example, if you are 35 years old, they would advise you to allocate a higher percentage of your assets to stocks and a smaller percentage of money to bonds because you are 30 years away from retirement and, therefore, have more time to wait for a stock market recovery after a bear market crash. And, conversely, if you are older and would likely be spending some of your investments sooner, you would be advised to keep a smaller percentage of your assets in stocks. Rather than a percentage allocation to cash and fixed income assets, the best way to determine the split is the timeline of when you would need access to the money. That is a topic for another day. For today’s example, we will be using the standard 60/40 split between stocks and bonds.

Bond Returns vs. Stock Returns

Let’s compare the historical returns of the stock market with the returns of the bond market. For the stock market, we will be using the return data for the S&P 500, and we are including annual dividends. For the bond market, we will use 10-Year Treasury securities, and we are including price changes in addition to interest payments. Here is the data for the last 50 years – from 1972 through 2021.

	​50 Year Avg. Return	Current Return
S&P 500 (with dividends)	10.50%	9.10%
​10 Yr. Treas. (with price chgs.)	7.20%	4.30%
60/40 Portfolio	9.20%	7.20%

So, over a 50-year timeframe, you would have earned 3.3% more each year (10.5 vs. 7.2) if you had all your money invested in the stock market vs. all of your money invested in the bond market. A 60/40 split between stocks and bonds would have lowered your returns by 1.3% per year (10.5 vs. 9.2). What seems like a small difference (1.3% per year) makes a huge difference in your investments over a 50-year period. An all-stock portfolio with a beginning value of $100,000 would grow to $14.7 million over a 50-year period with an annual return of 10.5%. This is a great example of the power of compounding. A 60/40 portfolio with the same starting value would grow to $8.2 million with a return of 9.2%. You would have 80% more dollars or $6.5 million. That is a lot of money.

When we look at current returns for stocks and bonds, the results are even more significant. Stock returns are now lower than the 50-year average because dividend payouts are much lower than they were 40 years ago. And current 10-year treasury notes pay about 4.3% in annual interest. The 50-year average for bond rates above were higher because they included the high inflation and high interest rate environments of the 1970’s and 1980’s where bond payouts often exceeded 10% per year. Using current rates of return, the 60/40 portfolio would cost you 1.9% per year compared to an all stock portfolio (9.1% vs. 7.2%).

If the 60/40 portfolio provides much more safety and security during market crashes, it might be worth the lower returns. But how much safety and security does a 60/40 portfolio provide?

Let’s look at the major bear markets of the last 50 years.

The 60/40 Portfolio in Bear Markets

The 60/40 portfolio does provide some cushion during bear markets, but just over 1% per year on average. We are looking at the complete bear market cycle here which represents the time from the prior price peak to the end of the bear market when price recovers to the prior peak. So, the only returns from stocks would be annual dividends. Bond yields are measured based on both annual interest plus any changes in price of the bonds. So bonds, do help a little bit in bear markets but only by about 1% per year. In the current bear market of 2022, bonds are not providing any benefit.

	Annual Return	Annual Return	Annual Return	60/40 vs.
	S&P 500	10 Yr. Treas.	60/40 Portfolio	All Stocks
2007 - 2013	2.1%	5.2%	3.3%	1.2%
2000 - 2007	1.6%	6.2%	3.4%	1.8%
1973 - 1980	4.6%	6.5%	5.4%	0.8%
Average	2.8%	​6.0%	4.0%	1.3%

The 60/40 Portfolio in Bull Markets

Not surprisingly, the 60/40 portfolio weighs down investment returns during bull markets. Again, we are including price appreciation plus dividends in the stock market returns. Bond yields are measured based on both annual interest plus any changes in price of the bonds. A 60/40 portfolio costs you almost 4% per year in returns compared to a portfolio of 100% stocks. Notice how high stock returns are during these decade long bull markets – over 17% per year. And notice how high bond returns were in the 1980’s and 1990’s as yields were much higher and bond prices appreciated due to a steady decline in interest rates.

	Annual Return	Annual Return	Annual Return	60/40 vs.
	S&P 500	10 Yr. Treas.	60/40 Portfolio	All Stocks
2012 - 2021	17.0%	2.0%	11.0%	-6.0%
1990's	17.9%	8.2%	14.0%	-3.9%
1980's	16.7%	13.1%	15.3%	-1.4%
Average	17.2%	7.8%	13.5%	-3.8%

If you need access to your investments in the next few years, you should not be investing that money in the stock market. Those funds would not qualify as long-term investments. For money that you do not plan on accessing for 5 or 10 or 20 years or more, your investment returns will be higher in a 100% stock portfolio vs. a 60/40 stock and bond portfolio. But I am sure many of you are concerned about your peace of mind and the comfort of owning bonds. The problem is that bonds provide only an illusion of safety as the previous analysis shows. In 2022, long-term bonds have decreased about 20% in value or just about the same as the stock market. The point is that fixed income investments are not the best way to protect your portfolio from stock market collapses. The financial professionals will tell you so, but it just isn’t true. There is a small benefit (1% per year) to the 60/40 portfolio in bear markets but a bigger cost (4% per year) during bull markets. It is simply not a good solution to the problem of bear markets. Our Beyond Buy & Hold system is a direct and better solution to the problem. You can participate fully and aggressively in bull markets and sidestep bear market collapses without the cost and the illusion of safety of bonds.

Be well,

Phil

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