Bummed About Your Bonds?

By Paul A. Ruedi

People generally purchase bonds to be the stabilizing asset in their portfolio. Unfortunately, this year bond investors have seen the value of their bonds or bond funds drop due to rising interest rates. This leaves many people wondering why they are invested in bonds in the first place. But if investors had a good reason to own bonds to begin with, that reason probably still applies.

A quick glance at some of the most widely-used bond funds shows they have taken a dip in response to interest rates, with diversified bond funds like the Vanguard Total Bond ETF down around 5% just this year. Not only that, there is a fear bond prices could fall even further in response to future interest rate rises. Is the “safe” asset no longer safe?

Though they are used as the stabilizing asset in many investment portfolios, it is important to remember that bonds will fluctuate in value in response to market forces. However, these fluctuations in value are relatively small compared to what could happen to the stock portion of a portfolio. If the purpose of bonds in a portfolio is to make sure you do not have to sell from your stock portfolio while it is down 30% or more, they still achieve that purpose.

Yes, bonds are down, but nowhere near as far down as a stock portfolio’s potential decline during a bear market. If retired investors keep several years’ worth of spending in bonds to draw from in the event of a bear market, even if those bonds are down slightly it doesn’t make a big difference from a planning perspective. They are still able to rely on their bonds to ride out the storm and give the stock portion of their portfolio time to recover.

If there is somewhat of a silver lining in falling bond prices, it is that as your bonds mature, your money can be reinvested in bonds at higher rates. Of course, I had to mention it is only “somewhat” of silver lining because most of this return is stripped away by inflation and taxes. But it has always been this way. Bonds have always produced practically zero return net of inflation and taxes. You don’t own bonds for the return; you own them so you have something to draw from when the stock market tanks. If that is your reason for owning bonds, it still makes sense to own them.

Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.