Posted By 
By Mark Seed, myownadvisor
Special to Financial Independence Hub
It has been said bonds make bad times better.
Is this the reason to own bonds?
Welcome to another Then and Now post, a continuation of my series where I revisit some older blogposts and either rip them to shreds (because my thinking has totally changed on such subjects) or I’ll confirm my position on various personal finance topics or specific stock and ETF investments.
Since my last Then and Now post (whereby I shared I sold out of all Johnson & Johnson (JNJ) stock to buy other equities in recent years), I figured it might be interesting to review this post and update my thinking from a few years ago before the pandemic hit – on bonds.
Then – on bonds
Back in 2015 when the original post was shared, I referenced this quote that frames my own portfolio management approach when it comes to my bias to owning stocks over bonds:
“If you want to make the most money, you should invest in stocks. But if you want to keep the money you made in stocks, you should invest in bonds.” – Paul Merriman.
Bonds are essentially parachutes when equity markets fall; bonds will cushion the portfolio landing. And equity markets can fail big at times!
While I understand there are different ways to measure the “equity risk premium,” the summary IMO is the same: the risk premium is the measure of the additional return that investors demand or expect for taking on a particular kind of risk, relative to some alternative.
Buy a bond and hold it until it matures and you know what you will get back.
Invest in equities and the range of outcomes is wide.
With equities, you could make a lot of money, but you could lose a lot.
Equities have to have a higher expected return to compensate investors for taking on this risk.
Otherwise, if the risk premium is not there – why bother with stocks at all?
Now – on bonds
That’s the rub these days, for many investors. Why invest in stocks when interest rates are higher and you can earn 4-5% essentially risk-free?
Of course, there is no way of knowing how equities or bonds will perform until returns for each happen. You can consider rebalancing your portfolio from time to time between stocks and bonds because you expect equities will do better longer-term but that doesn’t mean they will short-term.
Which brings me back to this: risk is the price of the entry ticket to buy and hold stocks.
I continue to have a heavy bias to stocks in our personal portfolio since I’ve been contributing to a small workplace defined benefit pension plan for the last 20+ years. I continue to treat that pension like a big bond – since it will eventually provide guaranteed income in my mid-60s.
For most people, asset accumulators or not, the reason to own bonds is to mitigate equity losses during major market declines. Without this mitigation plan in place, we see time and again some investors panic – they sell stocks when those prices fall instead of buying them when they are on sale.
I’ve mentioned a number of times on this blog that I tend to look at major market declines as a wonderful opportunity to buy (more) stocks. I’ll continue to do so as much as I can …
Then and Now – Revisiting the need for bonds summary
In closing, there are some great reasons to own bonds:
- Bonds can help your investing behaviour – riding out stock market volatility.
- Bonds can be used to rebalance your portfolio; keep your portfolio aligned to your investing risk tolerance, and help you adjust it back to its target asset allocation (i.e., keeping a balanced mix of stocks and bonds).
- Bonds can be used for spending purposes – where some fixed income is “king” for major, upcoming expenses or spending.
- Finally, bonds can help protect against deflation – since inflation is a killer for bonds long-term.
The main reason I would keep any bonds (although I still don’t have any right now) is if I were saving for a major purchase in a few years (e.g., secondary residence?) and I would like to rely on some form of fixed income between now and then to help secure that purchase. Otherwise, a higher-interest savings account in the short-term will do that.
Bonds seem to make bad times better for investors by protecting investors from themselves. If you need bonds in your portfolio to help you do that then by all means hold them to help you stay the course.
What’s your take on bonds? How do they help you?
Mark Seed is a passionate DIY investor who lives in Ottawa. He invests in Canadian and U.S. dividend paying stocks and low-cost Exchange Traded Funds on his quest to own a $1 million portfolio for an early retirement. You can follow Mark’s insights and perspectives on investing, and much more, by visiting My Own Advisor. This blog originally appeared on his site on May 21, 2024 and is republished on the Hub with his permission.
