- Rising interest rates cause bonds to lose value, but it’s no time to panic.
- Through proper structure and patience, your bond portfolio will experience better returns over the long-term then at the current interest rates.
- Bond portfolios stabilize your portfolio, especially during a down market, and provide a reliable stream of income during retirement.
- Many investors mistakenly sell their bond holdings when interest rates rise, just to avoid a temporary loss.
It’s always interesting to observe the media’s spin on certain financial subjects. Look at today’s high stock market valuations and the supposed end of the bull market in bonds. The consensus is that both stocks and bonds are poised for a decline and that investors must do something in response to these imminent events. The problem with this analysis is that it is made in a vacuum; it’s not made within the context of an individual investor’s long-term investment needs and financial plan. Instead, the headlines are based on short-term reactions to unknown events with the hope of convincing readers and viewers to avoid temporary declines in the market. At Soundmark, that’s something we feel is virtually impossible to do on a consistent basis. In my last post,I talked about current stock valuations and the potential for a market pullback. Let’s now discuss the end of the bond bull market.
Bonds have produced stellar returns over the last 30 years due to falling interest rates and limited inflation. The end of the bond bull market is based on the premise that inflation is on the rise, resulting in higher interest rates, thus reducing the value of bonds investors are holding. Interest rates always move in the opposite direction of bond values, so it can be upsetting to see your bond portfolio lose value as interest rates rise. Though this scenario is definitely possible, remember that no one has a foolproof crystal ball. What seems certain to happen today can change quickly tomorrow.
Critical Role Bonds Play
What all of the headlines fail to consider is that a well-diversified portfolio of stocks and bonds is designed to help you attain your long-term retirement and financial goals. Thus, a bond portfolio serves two purposes:
- It stabilizes your portfolio, especially during a down market.
- It provides a reliable stream of income during your retirement years.
These components do not change in a rising interest-rate environment. Unfortunately, many investors mistakenly sell their bonds during a rising rate environment just to avoid a temporary loss. If a bond portfolio is part of a broader diversified portfolio that’s established through an intelligent financial plan, then there is no need to sell. In a rising interest rate environment, assuming you continue to invest maturing bonds into new bonds, then you will increase the yield of your bond portfolio over time and experience better returns than the current rates offer.
Still not convinced? Remember what happened in the dark days of 2008 when equity markets lost almost half of their value? Bonds played a critical anchoring role during those tumultuous times. Eventually there will be another pullback in the stock market, though hopefully not as dramatic as we had in 2008. Investors holding a portion of their portfolios in high quality bonds will be thankful for the peace of mind that their stock/bond allocation provides.
Creating an intelligent allocation between stocks and bonds is essential for building a retirement portfolio. Younger investors, who have time on their side, should have an aggressive tilt toward equities. This allocation structure maximizes the higher potential return of stocks compared to bonds over the long-term. However, as you approach (and into) retirement, your stock/bond allocation becomes even more critical. A bear market could have a devastating effect on your wealth as you begin the drawdown phase of your portfolio.
At Soundmark, we work with our clients throughout the various stages of their lives to evaluate and adjust their portfolios as they move toward retirement. Our recommendations are based on long-term goals and planning, not on short-term fluctuations. A low-cost and well-diversified bond portfolio is part of this equation and should increase over time as you move into retirement.
If you or anyone you know would like to discuss our approach to long-term planning and investing, please feel free to contact us.
Todd Flynn, CPA, CFP ® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other high-net-worth individuals to help them define their financial goals and implement an ongoing financial planning process.