Much of the historical discussion about risk – when it pertains to investing - has been centered around stocks (although I don’t believe the word is used correctly, but I digress). One could argue that they have dominated the headlines for centuries as akin to gambling. Conversely, when the discussion turns to bonds – the word safety usually comes to mind for the average investor. But what happens when safety in bonds doesn’t feel – well, safe?
Before we delve into the core thoughts of this little essay, the perception of bonds as safe can get confusing for the average person. Why? My experience as a financial planner has revealed that most individuals don’t understand how bonds work. Their view is that all bonds (fixed income) work like a Certificate of Deposit (CD) at a local bank. Meaning – you place a dollar amount into the CD, you get interest back – and the principal (the dollar amount invested) doesn’t fluctuate. Once it matures, you get your money back plus the interest earned. This is correct for CD’s but other fixed income (Treasury bonds, Corporate bonds, Municipal bonds) usually does not work that way. In a word, they “fluctuate,” which is when the perception becomes reality and - it doesn’t feel safe anymore.
As evidence, the chart below reveals the average intra-year declines for bonds versus the calendar year returns.
What you are observing is that the US Aggregate Bond Index, on average since 1976 has temporarily declined about 3.1% per year (shown in red) at some point during the calendar year. However, this does not equate to the returns ending that year as a negative. As I mentioned – it fluctuates. In black are the calendar year returns, which have been positive 42 of the past 46 years.
And finally, to the point of this essay – look at the last two years of returns for bonds. Go ahead, I’ll wait here for you. Yes, you are reading it correctly – not only was the calendar year return negative for 2021, but the intra-year decline for bonds as of September 23, 2022, has been a negative 14%. The largest on record. If the bond market just moves sideways for the rest of the year, bonds will have seen their first consecutive calendar-year declines on record, since 1976. Hence – it doesn’t feel safe.
Now, I could leave you with those factoids to ponder (and stew in angst) however, there is a brighter side to this feeling of insecurity for investors of fixed income – it is temporary. And if your financial planner has properly diversified your portfolio (to match your financial plan), last year your equity holdings offset the fixed income drop – unfortunately there is nowhere to hide so far this year. By the way, a definition of knowing you have a diversified portfolio is – there is always something you own that you don’t like. Why? Because it doesn’t feel safe now.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment.
All investments include a risk of loss that clients should be prepared to bear. The principal risks of Melone Private Wealth strategies are disclosed in the publicly available Form ADV Part 2A.
The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
Although bonds generally present less short-term risk and volatility risk than stocks, bonds contain interest rate risks; the risk of issuer default; issuer credit risk; liquidity risk; and inflation risk.