Bonds With Added Benefits
The young man walks into the car dealership and says, “I like that BMW in the corner. How fast does it go?” The salesperson says, “Well, it accelerates from 0-100 km/h in about 5 seconds and it has a top speed of about 250 km/h.”
Eyeing the car, the young man then asks if the service department could remove the brakes. “Why would you do that?” the salesperson asks. “The car would be far too dangerous then. You wouldn’t be able to stop.”
Brakes aren’t designed to make a car go faster. But they increase the odds that the driver will get to his or her destination. Bonds, when combined with stocks in an investment portfolio, serve much the same purpose. Before groaning that bonds are for suckers, please hear me out. Bonds aren’t intended to make your portfolio grow faster. Instead, they’re safety features designed to stop you from wrapping your portfolio around a pole.
First, let’s address the elephant on the screen. Bonds earn horrible returns. The two bond ETFs I recommended for Europeans in my book, Millionaire Expat, included the iShares Euro Government Bond 3-7 yr. ETF (CE71) and the iShares Euro Government Bond 1-3 yr. ETF (CBE3). Over the 3 years ending February 28, 2020, they recorded total returns of 4.21 percent and -0.67 percent respectively, measured in Euros. We figure bonds (like brakes) aren’t important while we’re racing solo around the track.
At some point, however, we enter roads with obstacles. I didn’t include bond ETFs in my book’s portfolio models to boost investment income or profits. Instead, I included bond ETFs to protect investors from market crashes. For example, during consecutive multiple year stock market drops (like 2000, 2001 and 2002), investment accounts didn’t just hit potholes…they went off cliffs. Global stocks fell almost 50 percent from March 31, 2000 to March 31, 2003. That was enough to make plenty of would-be stoics scramble, battered and bruised from their investment vehicles. At the time, plenty of media reports called this a prologue for another 1929. You can see why people ran.
But those with bond market indexes wouldn’t have seen their hard-earned money fall by 50 percent. And that increased odds of them reaching their retirement destination. It increased the odds that they didn’t give up…that they kept adding money…that they rebalanced their portfolio and bought stocks on the cheap.
You might argue that bond interest rates will continue to drop. But if you know what bonds will pay in the years 2024, 2031 or 2038 stop reading this. If you can see the future, go out and save somebody’s life.
In truth, nobody can see the future. None of us know how stocks or bonds will perform this year or next. But here’s what we know: When stocks have historically gone on multiple year declines, government bond indexes have never fallen as far. Sometimes, they even rise.
But here’s the tricky part. You might think you could handle multiple year drops without bonds in your portfolio. And that might be true. But you’ll never know until it happens. In this case, it’s much like getting cancer, losing your sight or losing a limb. You might believe you know how you would respond. However, odds are high you could be wrong.
When it comes to emotions, with respect to our investments, most people think they have courage that they don’t. That’s why if you think you could handle an investment portfolio with 100 percent stocks select something with 80 percent stocks and 20 percent bonds. If you think you could handle a portfolio with 70 percent stocks and 30 percent bonds, select a portfolio with 60 percent stocks and 40 percent bonds.
After all, if you haven’t seen your portfolio drop hard at least three years in a row, you don’t know what you don’t know. And a big crash is coming. Big crashes always do.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.