Why European Bonds Will Look Great
It’s easy to hate European government bonds. Most pay paltry interest. Others have negative yields. They seem like freeloading guests who refuse to go home. But if you’re looking for a rant, it won’t come from me. If you’ll be retiring in Europe, owning European government bonds in a diversified portfolio will reduce currency risk. After all, you’ll pay your future bills in euros. And those bonds will be welcome when stocks crash hard.
No, government bonds won’t push out yields of 5 percent any time soon. But how we feel about this is relative. For example, in 2014 University College in London conducted something called The Great Brain Experiment. They found that our happiness is relative to expectations. In other words, if we expect something fabulous and the outcome falls short of our expectations, we get bummed out. But if we expect something bad and things turn out better than we expect (even if they’re still somewhat bad) we feel pretty good.
If we’re honest, most of us expect lousy things from European government bonds. And that makes sense. After all, the cumulative five-year return for this iShares European bond market ETF was just 3.14 percent (measured in euros) ending September 30, 2021.
In sharp contrast, the five-year cumulative return for European stocks, as measured by this diversified ETF, was 49.40 percent. Global stocks performed even better, earning a cumulative five-year return of about 86 percent. U.S. stocks soared even higher, earning a cumulative return of about 105 percent, measured in euros.
But we are due for a stomach-flipping crash. And that will hurt a lot of people. After all, stampedes of investors are still rushing into US stocks, based on their strong, recent run (yes, ten years is “recent” when it comes to investing).
Yet, based on their sky-high valuations, US stocks are likely to be among the worst performing sectors over the decade ahead. I’m not saying they’ll crash this year or next. Nobody knows for sure. But based on professor Robert Shiller’s assessment of CAPE ratios, US stocks are destined to limp over the next ten years. The last time US stocks sported such a high CAPE ratio they jumped up and down for a decade without gaining ground (2000-2010).
This brings us back to bonds. When stocks crash 20 percent, 30 percent, 40 percent or more, bond ETFs will look like parachutes in a crashing plane. What’s more, by rebalancing back to our target asset allocation after stocks crash, we can sell bond units to buy cheap stock units. In other words, we can be greedy when others are fearful.
Investors shouldn’t worry about bond interest rates. After all, we shouldn’t own bonds for their interest. Instead, bonds offer stability when stocks go off a cliff. And stocks will plunge off that cliff. So, make sure your portfolio includes stocks and bonds. Select an allocation based on your tolerance for risk…and then stay the course through thick and thin. If you continue to shun bonds because of their paltry interest rates, you’ll need a strong stomach when stocks crash…especially if they don’t recover for several years. The big question is, “Do you have that kind of stomach?” Most of the people who say they do are just fooling themselves.
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.