Quick Family Update: We got a puppy! His name is Odie and he is adorable. We adopted him from a “foster” home full of rescue dogs. He’s five months old and only eight pounds. Even our veterinarian can’t figure out his breed. We think he is some combination of Chihuahua, terrier, mini pincher, and wiener dog.
David Kennon’s Retirement Reality Check
I often extol the virtues of the stock market. Yet, I give very little attention to the bond market. That ends now.
The key to any successful investment strategy is utilizing a disciplined and balanced approach- which includes bonds.
At its core, a bond is simply a loan you are giving to a government entity or a corporation. You are the bank, and they are the borrower.
For example, let’s say the New Jersey turnpike needs to fix potholes in the roads. They might raise money to complete the project by selling bonds to the public. For example, they might say, “If you buy one of our bonds, we will pay you 3% interest for the next five years.”
The portfolios I utilize usually consist of thousands of bonds (using mutual funds, index funds, and exchange traded funds).
It is harder for me to go WAY back in history with the bond markets, because it wasn’t closely tracked until the 70’s.
The Barclay’s U.S. Aggregate Bond Index started in 1975. It currently represents 8,200 bonds with a total value of $15 trillion dollars (43% of the total U.S. bond market).
Between 1975 and 2016 the bond index returned an average of 7.68%. $100,000 in the bond index starting in 1975 would be worth over $2,000,000 now.
The WORST year the index had during that time periods was 1993 where it lost -2.92%. The best year was 1981 where it returned 32.62%. In the past ten years the returns have been:
In fact, in the past 40 years, the bond index has gone down a mere 3 times (-2.92% in 1993, -.92% in 1998 and -2.02% in 2012).
Another nice facet of bonds is that, in general, they are not correlated to the stock market. This means that when the stock market goes down, it does not automatically mean bonds go down as well. In 2001 the S and P 500 was down -22% and the bond index was up +10.26%. In 2008, the S & P was down -37% and the bond market was up +5.24%.
Bear in mind that bond yields (how much interest they pay) are at historic lows. This is directly tied to low interest rates. Many people feel that bonds will return less in the future because interest rates are so low. There is a lot of truth to this. But if bonds only return HALF of what they have returned over the past 40 years, I still think you would be happy.
So, in conclusion, bonds have a place in a diversified, balanced portfolio. While we may not see the high returns of the past 40 years, bonds are less volatile and a good non-correlated asset to employ.
P.S.- For all my highly-technical friends. Here is a link to a whitepaper published by Vanguard. It outlines why the financial media is over-hyping low-interest rates and their connection with bond returns.
Click here: https://personal.vanguard.com/pdf/s807.pdf
The return of principal for bond funds and for funds with significant underlying bond holdings is not guaranteed. Fund shares are subject to the same interest rate, inflation and credit risks associated with the underlying bond holdings.
The value of fixed-income securities may be affected by changing interest rates and changes in credit ratings of the securities.
Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Indexes are unmanaged portfolios and individuals cannot invest directly in an index. Actual results will vary.
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