Last year, investors were earning pretty nice returns in the stock market but not much in the bond market. If you have bonds in your portfolio, you may have wondered if they were worth keeping around, especially if you’re new to investing.
Classic investment advice has always said that bonds are an important part of a balanced portfolio, but let’s face it - when the S&P stock index rises nearly 27% in a single year, bonds can seem like just a drag on your portfolio.
Our colleagues at Goldman Sachs Asset Management recently reported that bonds are starting to “behave more like themselves” in the changing market climate of 2022. It’s probably easier to understand the classic investment advice and appreciate the role of bonds today.
In a nutshell, bonds are loans, while stocks are ownership of pieces of a company. (If you’re new to bonds, you might want to check out our primer on how bonds work.) They play different roles in a portfolio. Two of the main jobs of bonds are to provide income and stability.
Let’s talk first about income. When you own bonds, you get interest payments every year at a fixed rate. This can provide a steady flow of income. But last year, interest rates were at historic lows. And after two decades of largely falling rates, the Federal Reserve lowered rates even further to support the economy through the pandemic.
With ultra-low interest rates, some investors saw their bond income drop and may have wondered if these fixed-income investments were worth holding on to.
This year, interest rates are heading back up, as the Fed hikes rates to put the brakes on inflation. New bonds – with higher interest rates – can pay out more income.
The strong performance of the 2021 market meant investors weren’t focusing on looking for asset classes with more stability.
When stocks are bobbing and weaving (volatility) or just going down, bonds – which are traditionally less volatile – can offset risk and reduce your portfolio losses.
If you’ve taken a look at your portfolio these days, you’ve probably noticed that the stock market has experienced some dips early in 2022. What happened to bonds? Unusually, bond returns also went down during this time. (We say “unusually” because these two asset classes have only dropped together a few times in history.)
But even in early 2022, bonds’ returns decreased less, so you were still likely to end up with a larger balance in your portfolio if you had a mix of both stocks and bonds than if you were invested in the stock market alone.
What could happen if the dips continue? Well, history suggests that stocks and bonds won’t continue to move in the same direction for long. And while history isn’t a guarantee for the future, it can be a useful guide. Over the past three decades, when the stock market has dropped at least 15%, bonds have generally provided positive returns.
Something else to keep in mind: Stability isn’t all about defending against stock volatility.
When you buy a bond, the entity who issues it promises to pay you back for the original sum of the loan (principal or face value) by a certain date. That’s different from investing in stocks, where you expect a return, but the issuer doesn’t make any promises.
So, with bonds, whether or not you make a profit, you’re likely to get your original money back. And that can be comforting.
The bottom line? Bonds might not have the star quality of growth stocks on the rise, but our Asset Management experts believe they continue to have important roles to play.
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