Written by Dale Roberts
Friday, January 25th, 2019
Bonds have been given a bad rap over the last few years, and certainly some of that criticism is warranted. Bonds used to pay handsomely. They used to deliver very decent income. That's not the case these days, as we've mostly been in a period of falling rates for bonds, savings accounts and GICs.
But I'm sticking with them, and you can too.
What Are Bonds? What Do They Do?
There are two sides to the bond coin. Bonds deliver income, since they're fixed income investments (just like GICs), but bonds also help manage the risks in your portfolio. They can work like shock absorbers for the portfolio.
Put in a very generous bond component, and you'll create a very conservative portfolio with much less price risk or volatility compared to an all-stock or stock-heavy portfolio. A stock portfolio could fall by 50% in a major correction (as it did during the 2008-2009 correction); a portfolio with a very generous bond component might only fall by 10% - 15%.
If you open up your investment statement and see that you hold a balanced portfolio, that would mean you hold a mix of stocks and bonds. The stocks (companies) are the growth engine, and the bonds once again are the shock absorbers. If you discover you hold an all-stock portfolio but don't like the idea of your portfolio potentially getting cut in half, consider getting one of those funds or portfolios that includes the word balanced.
Bonds Don't Deliver Like They Used To
Many would suggest the main job of bonds is risk management. We don't abandon bonds simply because they don't deliver income like they used to. Your risk tolerance level doesn't change based on bond yields, so I wouldn't kick bonds to the curb based on yield. If you need to manage the portfolio risks, bonds are the tried-and-true tool. It would be great if bonds paid very generous income and could also manage the risks, but that's simply not the case these days.
How Bonds Manage Risk
The way bonds can manage portfolio risk is they have a tendency to go up in value when the stocks are getting hit hard. Investment types will call that an "inverse relationship" of stocks to bonds, but I think of it more like a teeter-totter or seesaw.
If we want to bring in a sports analogy: the stocks are the offense, the bonds play defence.
An investment portfolio is about teamwork and each asset has a job to do.
Now to play defence you might call on GICs for that fixed income component. If you hunt around you can find GIC rates that are more attractive than yields in core bond funds. That said, those GICs don't offer the ability to change in price, meaning they can't do that teeter-totter thing. You may find it more convenient to hold those stocks and bonds together in a balanced portfolio or fund.
Don't give up on bonds just yet. When we experience the next major market correction you'll be more than happy to have them.
Once again, we might come to love our bonds.