Bonds: Making Clients Take Their Medicine

With the S&P 500 having quadrupled in the past decade, bonds provide ballast against falling stocks.

Credit: Michael Nagle/Bloomberg

Credit: Michael Nagle/Bloomberg

Stand-up comic Rodney Dangerfield used to complain that he got no respect. The same could be said for bonds -- until the stock market falls apart. Then, suddenly, “boring bonds” become “blessed bonds.” On such days, when bonds offer the only up arrows in a client portfolio (have you looked at your portfolio lately?), the relief they offer will rival that of a fresh batch of Pepto Bismol.

The key reasons to provide bonds - safety, diversification, income – remain. However, with the S&P 500 having quadrupled since its March 2009 low, advisors should remind clients that the best time to buy insurance is before it’s needed.

Bonds rarely achieve high-flying returns, particularly when the stock market is booming. Nonetheless, most advisors sensibly insist that investors have bonds in their portfolio to limit downside when stocks fall.

Bryan Whelan, a Los Angeles-based portfolio manager at TCW’s fixed income group, which manages $180 billion in fixed income assets, says most investors rely on stock and bonds as their two primary investments and “the two will hedge each other.” In the long run, bonds offer lower returns than equities, but demonstrate “negative correlation” to stocks, he points out. Hence, when stock prices plunge, bond price tend to rise and vice versa.

For example, Whelan noted when the S&P stock index plunged 37% in 2008, bonds gained 5%. Prior to that, when the S&P index fell 9% in 2003, bonds rose 12%. Or conversely when the Dow Jones Index skyrocketed 32% in 2013, bonds dipped 2%.

Investing in fixed income bonds in one’s portfolio “helps save the clients from themselves,” explained Matthew Peck, a Plymouth, Mass.-based founding partner of SHP Wealth Management. “If they experience massive losses of 10%, they might overreact,” he said.

For example, if the stock market dips 5%, but their overall portfolio is only down 2.5% because of their bond portfolio, they won’t get bent out of shape or do anything rash to their portfolio, Peck suggests.

Since bonds can be varied and include governmental bonds, corporate bonds, high-yield bonds and international bonds, clients can diversify in the space and still get a 3% to 4% return, Peck says.

In 2018, the Barclays US Aggregate Bond Index rose just 0.01% or essentially nothing but compared to the Dow Jones Industrial Average’s 5.6% decline, it did fine, thank you.

In fact, Whelan is downright optimistic about investing in bonds currently. Given an environment of low inflation, relatively low interest rates, and easy monetary policy, “the return environment we’ve been in will be hard to replace going forward, for stocks, bonds and commodities,” he said.

When stocks decline, “investors invariably search out safe heavens and the bond market is that safe heaven. When the market starts to forecast lower interest rates, due to a slowing economy, bond prices go up,” Whelan added.

When investors try to limit their investment in fixed bonds and plunge more money into the stock market, because equities outperform bonds over a decade’s time, Whalen retorts that, “Past performance is no indication of future results. Everyone thinks they can take the risk, until they’re down 30%,” he noted.

Deciding on what percentage of one’s portfolio consists of stocks and bonds is determined by one’s risk tolerance, age and long-term retirement plan. Peck said that most 25-year-old clients, with a 40-year horizon on retirement, may have a portfolio consisting of mostly stocks. But most 55-year-old clients have 60% stocks and 40% bonds. By the time they hit 65 or potentially retirement age, they’ll be 70% in bonds and 30% in stocks.

Boiled down to one word, Whalen cited that fixed income bonds offer: “stability. Stability isn’t sexy,” he quipped, but it’s necessary to balance one’s portfolio. But Peck sees the role of fixed income bonds as providing “diversification. You’re still getting growth above inflation, with less volatility.”

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