ARE BONDS A GOOD INVESTMENT?

Volatile markets lead many to rethink their investment strategies and allocations, including bonds. Bonds typically earn more consistent, though lower, returns than stocks and form a cornerstone of most diversified portfolios. However, inflation can make bond yields look less appealing, and rising interest rates can actually result in falling bond prices. It may be tempting to dump your bonds and reallocate funds into markets that seem more lucrative. But let’s take a closer look.

You may have heard of the 60/40 portfolio, in which 60% of the portfolio is invested in stocks (including stock mutual funds, exchange traded funds or individual stocks) and 40% of the portfolio is invested in bonds (including bond mutual funds, ETFs or individual bonds). Because bond prices fell in the first half of 2022, some commentators believe it may be time to move away from or evolve the 60/40 portfolio, instead reallocating more assets to stocks or alternative assets. But bonds still have a place within your investment portfolio. In fact, with the present state of the market, bonds may be more important than ever.

Bonds can allow you to diversify your portfolio, which could help result in more stable performance during market downturns, and may earn positive returns over the long run.

To better understand this, let’s cover a bit of bond basics. Bond prices move in the opposite direction as interest rates, so higher interest rates mean lower bond prices. Interest rates are currently rising. The 10-year Treasury yield is about 3%, nearly twice the yield at the start of the year. While new investors in bonds may welcome these higher yields, existing bond investors saw declines in their bond holdings’ value.

With the Federal Reserve expected to continue raising rates, it might feel intuitive that bond prices are destined to keep falling. What’s important to realize, though, is that bond prices reflect where the market is expected to move. Since the Fed has been signaling interest rate increases for several months, bond prices have already reacted to those expected interest rate increases. From this point forward, bond prices could fall further if the Fed increases interest rates faster or more than expected. On the other hand, bond prices could increase if the Fed doesn’t need to increase interest rates as much as initially expected. In other words, there is room for both positive and negative surprises, which means that bond prices have as much of a chance of rising as falling in the near future.

Maintaining a diverse portfolio of investments can help you weather market volatility. Investing in several asset classes, including bonds of different types such as Treasuries, corporates, and mortgage bonds, is an essential step to consider taking. Bonds may do more than just help reduce losses from stocks, though. For example, in times of severe economic distress, there may be a “flight to quality” in which investors abandon risky assets and seek shelter in U.S. Treasury bonds. This behavior can result in Treasury bond prices going up sharply.