We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...
Who Needs Bonds? Probably You
08/18/2017 2:52 am EST
Bonds have been a pretty reliable source of gains for years now, but there’s more uncertainty now that rates have increased three times in the last year, suggests fund expert Janet Brown, money manager and editor of NoLoad FundX.
You may worry that bonds will become more risky as interest rates continue to rise, and you may even start to wonder if bonds still have a place in your portfolio.
Whether interest rates are rising or falling, most people still need to own bonds. Even though bonds have historically gained less than stocks, they play a crucial role in your investment success.
In fact, earlier this year when we asked investors what’s held them back, many said they regret that they didn’t own enough bonds over the years. Here are three ways bonds can add value:
1. Bonds are a proven way to manage risk
Stock markets are volatile, and bonds remain your best defense. Bonds typically don’t move in tandem with stocks. They can rise when stocks fall, as we saw in 2008, and those gains can provide an important buffer that helps you preserve your capital. Cash doesn’t cut it: it doesn’t yield enough to offer as much of a cushion in down markets.
2. Bonds can help you avoid emotional mistakes
Market declines can also take an emotional toll. You’re more apt to panic when markets fall and take action based on fear, and this can really hurt your returns. Because bonds can provide some stability in turbulent markets, they can help you stay on track and avoid letting emotions lead you astray.
3. Bonds can add to your returns
When rates rise, bond prices typically fall, but there are still opportunities for gains. As we noted last month, your investment gains are total returns, which aren’t based on prices alone.
Total returns include the change in price as well as any distributions of capital gains or income dividends, and dividends from bonds can offset lower prices.
And, as rates rise, bond fund managers can roll maturing bonds into new bonds with higher yields.
Some bonds tend to hold up better than others when rates rise, as we’ve seen this past year. Corporate bonds, high-yield bonds, and floating-rate securities had good gains for the trailing 12 months, while government bonds lost ground.
Remember that even a bad year for bonds usually isn’t that bad. Over the last 20 years, the Bloomberg Barclays Aggregate Bond index’s worst calendar year was a -2% loss in 2013.
How You Invest in Bonds Matters
Once you’ve recognized that you still need bonds, the question becomes how should you invest in bonds when you can’t predict what will happen with interest rates?
Our answer is to invest based on what we know today and adapt as markets change. That’s what our Flexible Income strategy is designed to do, and it has a strong track record of capitalizing on changing bond markets while also keeping risk under control.
As interest rates have inched up in the last year, our strategy kept us invested in strong performing high-yield, strategic and floating-rate funds. These funds have done quite well, while the Bloomberg Barclays Aggregate Bond index ended up with losses.
In the event of a broad bond market sell-off, however, our strategy could Upgrade the entire portfolio into short-term bond funds, which are considered the safest area of the fixed income arena. This is one way that our approach manages risk, and it’s worked.
During the 2008 financial crisis—the most severe bond market decline in the last decade—the strategy led us to own primarily short- and intermediate-term government bond funds, which held up better than other bond funds. As a result, our Monthly Flexible Income Portfolio ended 2008 with up 1%, while some bond funds had double-digit losses.
The portfolio as of July 31, 2017 held positions in Fidelity Floating Rate High Income (FFRHX), Osterweis Strategic (OSTIX), PIMCO Income (PONDX), PIMCO Low Duration Income (PFIDX), Fidelity Capital & Income (FAGIX), Fidelity High Income (SPHIX), Janus Henderson High-Yield (JAHYX), Fidelity Real Estate Income (FRIFX) and Vanguard Wellesley Income (VWINX).
See the August issue of NoLoad FundX to see exactly how much we have invested in each of these positions and to know when to change your portfolio. Positions are reviewed monthly, and the portfolio will change over time.
This portfolio continues to return steady gains with shorter duration (a measure of interest rate sensitivity) and less volatility than the Bloomberg Barclays Aggregate Bond index. We added this portfolio to NoLoad FundX in August 2005 to help investors know which bond funds to own now and when to move on to other funds.
It is designed to adapt to changing bond markets, including periods of rising and falling interest rates. It has many tools at its disposal, including corporate and government funds, higher and lower quality funds and global and domestic funds. It can also invest in a select group of low volatility equity funds.
Past performance is no assurance of future results. All investments involve risk. Invest only after carefully examining a fund’s prospectus.
Related Articles on BONDS
The Vanguard High-Yield Tax-Exempt Fund (VWAHX) seeks a high and sustainable level of income that&rs...
Bonds have been a pretty reliable source of gains for years now, but there’s more uncertainty ...
We are adding a new position to our funds, a Canadian ETF investing in loonie-denominated floating r...