Should I Invest In Bonds Right Now – Note that bonds are now officially in a bear market. What does this mean and how does it affect potential bond investors? For decades, a 60/40 stock/bond mix was the standard for conservative investors. Similar charts in Vanguard show that a 40% allocation to bonds in 1926 greatly reduced the frequency and severity of declines without reducing returns (about 1.5% per year). These charts are also designed so that investors should stay primarily in stocks when they are young, but add bonds as they get older and near retirement.
So why the articles over the years arguing that the 60/40 stock/bond ratio no longer works, and that bonds don’t make sense as part of your portfolio? The simple answer is that bonds have performed so well that their primary source of income—the coupons they pay—is so low that they no longer fill the role of a safe investment with little yield. Long-term (100-year) bonds have an average return of about 5%, about half that of stocks. Bonds exemplified by the Vanguard Total Bond Market Index ETF (NASDAQ:NASDAQ:NASDAQ:NASDAQ:BND ) start with a 2022 coupon yield of 1.7%. For this reason, prudent cash investors tend to hold money market funds or short-term CDs while waiting for better opportunities.
Should I Invest In Bonds Right Now
The 40-year bond market essentially eliminated bond yields and their role as many investments. A few years ago, Bill Gross, the former bond king and inventor of buying total yield bonds, admitted that much of his success came from the luck of matching the big bond market during his career. The big bond bull market began in 1981 with the 10-year yield around 16%, which continued to decline with surprising tenacity until March 8, 2020, when the 10-year yield fell to .32%.
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The chart below shows the long-term history of 10-year Treasuries going back to the 1960s. Its rapid growth since 1981 includes hyperinflation in the 1970s. If you flip through this chart, you’ll get a picture of the bond market from 1981 to 2021. Notice where it starts. You can see the real low for interest rates on March 8, 2020 (the peak of the bond bull market), when the 10-year note fell to .318%. Then interest rates fell during this period. Investors should make a mental map of this chart and keep it in mind when considering interest rates and bonds:
On January 21st, seven and a half months ago, I published this article on bonds, arguing that all fixed-term bonds offered such small returns that they weren’t worth the risk of rising interest rates. At that time, individual bonds or diversified Vanguard Total Bond Market ETFs are not good for short-term or long-term investors. If you stick to bonds, you know this advice is timely. However, now that the Fed has raised rates, bonds are worth a second look.
The inverse relationship between bond prices and interest rates is useful when understanding the relationship between stocks and bonds. Warren Buffett describes stocks as “stock bonds,” according to this 1977 article titled “Wealth.”
Buffett considers stocks to be special bonds because they are permanent (which bonds aren’t, with one or two rare exceptions) and because they have the potential to increase their earnings and profits in the future, bonds cannot. Bonds are generally considered safer, and stocks offer higher returns over the long term. Rising inflation is bad for bonds and stocks, while falling inflation is good for both.
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. A better question might be: How often do stocks and bonds move in opposite directions? Despite that avant-garde distribution chart, such cases were rare. Except for short periods of days and weeks, bonds and stocks rarely move in opposite directions. Bonds win big when safety is key. Stocks do better with economic growth and moderate inflation.
The crash of 1929 and the early years of the inflationary depression of the 1930s proved that holding high-quality bonds was very beneficial. It’s like the old Wall Street bond-buying that ditched stocks and bought bonds before the crash, because bond prices actually went up, and the dollar went further because of hyperinflation. During the major bear markets of 2000-2003 and 2007-2009, large bond positions were a safe haven, protecting investors from 50% of market losses. Bonds didn’t help much during the inflationary period of the 1970s, when the same rate of increase drove down the price/earnings ratio of stocks and also drove down the prices of bonds issued at lower prices.
Interestingly, during the great bull market from 1982 to the early 2000s, stocks outperformed, but so did bonds. The fact that they are so closely related shows how strong the impact of bearish rates is on stocks and bonds. It’s easier to measure accurately for the S&P 500 than for bonds. The stock is up 18.66% annually from its 1982-2000 low. You haven’t done too badly with the 10-year Treasury, however, which has returned about 16% annually since the low in September 1981.
You can say that the difference in the yield of about 3% on stocks is an extra premium for non-bond returns and dividends, or you can call it a risk premium for stocks that you’re willing to sacrifice for greater safety. . Another way to look at bonds is that the S&P 500 price-to-earnings ratio was 7.73 on January 1, 1982, but rose to 29.04 by January 1, 2000. This means that the S&P P/E ratio has grown by about 7% annually. In a bull market, interest rates quadrupled. This is the income and yield less than the minimum yield on the bond.
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Note that the 2022 bond has trended in the direction of equities so far today, stalling a bit in a bear market, both of which have pushed interest rates higher.
Vanguard Total Bond Market ETF is designed to track the performance of the Bloomberg U.S. Total Float Adjusted Bond Index. He invests by sampling the index, but still holds more than 10,000 bonds. With a focus on quality and a low expense ratio of .03%, BND is a good choice for investors who want their bond allocations handled conveniently by professionals.
The key number to note in the first chart is that the average yield more than doubled year over year, from 1.7% to 3.4%. Remember that bond prices and interest rates are negatively correlated. During the same period, the total bond market ETF’s return was 10.80%, even with active coupons.
Fixed Income Characteristics 12/31/2021 BND 12/31/21 9/13/22 Maturity Rate 1.7 3.4 Average Coupon 2.6 2.6 Average Effective Maturity 8.8 8.9 Average Time 6.9 Click
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The BND has high-grade bonds, with 74% in treasuries and companies rated AAA or AA, but 26% of its holdings are rated A or BBB. It’s still safe. Investors who want complete safety from their bond positions may choose the highest quality.
Credit Quality Distribution (% of Amount) as of 9/13/2022 US Government 67.1 AAA 3.8% AA 3.0% A 11.7% BBB 14.4% Click to enlarge.
The last table (below) deserves special attention. Although the portfolio has an average maturity of 8.9 years, it consists of maturing bonds. The typical shape of this distribution is an asymmetric “bar” with 44.3% from 1 to 5 years and 32.2% from 5 to 10 years. The curve then dips between 10 and 20 years and slowly rises between 20 and 25 years and above 25 years. BNDs have a relatively long term, with an average target of 5-10 years.
Issued from 12/31/2021 to maturity BND Under 1 year 1.1% 1-5 years 44.3% 5-10 years 32.2% 10-15 years 100.0% Click to enlarge
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Many of the above observations make me love private bonds. Bonds in my wallet aim to provide reasonable returns with absolute safety. For this reason, I like to keep my treasuries with CDs that have some government insurance. I choose to invest myself and I’m about to turn 78 and I like time periods of 10 years or less. The conclusion lays out some strategies for my preferred approach to buying private bonds.
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