The Value of Bonds
/I love to organize—papers, closets, financial lives, and anything else that I can get my hands on. To me, it’s exciting to take chaos and create order. Being an organizer, I’m also a chronic declutterer, always on the lookout for things I can get rid of.
Because of this tendency, I have been known to get rid of things only to need them again later. And, yes, this may be a sore subject for my husband since his things get caught up in my decluttering as well. I can’t help it, though . . . I don’t want to keep something around that isn’t useful or adding value to my life. In a way, I’m seeing this same attitude play out in investment portfolios. Investors are having a hard time seeing the value of bonds right now.
As many know, bond prices and interest rates have an inverse relationship. When interest rates rise, the price of a bond will fall, everything else being equal. For example, if I buy a bond with a 3% rate and interest rates go to 4%, no one is going to want to buy my bond since they can purchase a new bond at 4%. Therefore, if I want to sell my 3% bond, I have to discount the price, so the buyer gets the same value as a bond paying the current 4% rate. The opposite is true for falling rates: Bonds paying higher interest rates become more valuable, so investors see bond prices rise.
Interest rates fell as a response to the pandemic. As we move through recovery, the Federal Reserve has indicated they will implement rate hikes this year. That’s causing investors to question their bond holdings. Why should they hang on to bonds, or take profits out of stocks and buy more bonds, when there is a good chance the price will fall?
Like my husband reminding me why we need to keep something I’m wanting to pitch, this is where we have to help investors remember why we have bonds in the first place. First and foremost, bonds provide diversification against stocks. In general, bonds are less volatile, so they provide ballast for stocks to lower the overall portfolio risk. Keeping your portfolio in line with your risk tolerance means you are better able to stay invested over the long term.
Of course, bonds also provide income. For many retirees, that income is used for living expenses. Cash flow is extremely important at this phase of life, so the steady income from bonds is attractive.
Although income may not be important for those who are still working, bonds held outside of retirement accounts can be a secondary level of liquidity for pre-retirees. Therefore, if you experience a job loss or unexpected financial crisis, bonds are often the go-to source for cash.
Bonds remain an integral part of a balanced portfolio, so we are here to remind you why you want to keep something you may want to pitch.
- Juli Erhart-Graves, CFP®, Worley Erhart-Graves Financial Advisors
