The Bloomberg Barclays US Aggregate Bond Index finished the first quarter of 2021 with a -3.37% return and the yield on the 10-Year Treasury Note is just 1.74%1. With such low yields and poor recent performance, many investors are wondering if they should continue to hold bonds.
The sentiment is completely understandable, especially for “more seasoned” investors who remember 10-Year Treasury notes yielding 6-8% throughout the 1990s2. Much has changed in both the US and global economies since then and we do not expect rates to be that high again any time soon. However, we think bonds are still an important part of a diversified portfolio.
Don’t overlook the word “diversified” in that last sentence. Yes, US bonds were down 3.37% last quarter, but US stocks were up 6.35%1. Similarly, a year ago US stocks were down 20.90% but US bonds were up 3.15%. These indexes don’t always move inversely, but the point here is to illustrate the principle that bonds are often good to hold when stocks are down.
It is also worth noting that the Bloomberg Barclays US Aggregate Bond Index encompasses the entire bond market in the US which includes government, municipal, corporate and agency bonds with maturities ranging from just months to 30 years. In the portfolios we manage for our clients, we are not trying to replicate the bond market as a whole.
Generally speaking, we prefer to hold intermediate term treasury bonds and corporate bonds with some global and high yielding bonds mixed in. From here we will customize based on client situations. For example, taxable accounts for a client with a high tax bracket will get municipal bonds instead of corporates and any client who is taking income from their portfolio will have a good portion of their bond portfolio in short-term bonds.
You’ll notice that missing from this list are long-term bonds. With interest rates near all-time lows, we do not want to be holding long-term bonds since, as interest rates rise bond prices go lower. This relationship is felt more in long-term bonds. Last quarter, 30-Year Treasury bond yields rose 75 basis points to 2.39%. This led the Bloomberg Barclays US Government Bond Index – Long to be down 13.39%1.
There are other points to be considered, such as the benefit of having bonds to sell to rebalance into stocks during periods of market turbulence. There is also the reality that there is not a good alternative to bonds unless you are willing to take on a lot more risk. However, the one thing we want to leave you with is that we still believe bonds have an important role in a diversified portfolio. We believe the bond portion of the portfolios we manage for our clients take a moderate, diversified and low cost approach that can serve their purpose regardless of the short-term fluctuation of the markets.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification and rebalancing does not protect against market risk.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs.
1Dimensional Fund Advisors, Quarterly Market Review Q1 2021. US stocks is the Russell 3000 Index, US bonds is the Bloomberg Barclays US Aggregate Bond Index.
Chart source: https://ofdollarsanddata.com/why-buy-bonds-now/