Is it time to reduce your portfolio's exposure to bonds?

In the face of eventually rising interest rates, bond investors worry that their returns could suffer. Given that today’s interest rates are considerably lower than historical averages and expected to rise in the future, would now be a good time to sell some of the bonds in your portfolio?

M. Spencer Green/AP/File
Traders work in the ten-year bond pit on the floor of the CME Group in Chicago. Investors worry that rising interest rates could reduce the value of bond investments, but does that mean i's time to sell?

For the last half-decade, investors have been continually concerned about rising interest rates and the effect they may have on the bond portion of their investment portfolio. The fear is that if interest rates rise, the bonds currently held by investors will be outdated and provide investment returns that are less than what new bonds issued at the higher yields would return.

There is validity to this concern – if an investor could buy a bond yielding 4% on the open market, why would anyone buy a bond that yields only 3%, unless they could do so at a significant discount? Given that today’s interest rates are considerably lower than historical averages and expected to rise in the future, would now be a good time to sell some of the bonds in your portfolio?

Consider the timing

First, let’s consider one of the most basic principles of investing – that markets are unpredictable. Are we certain that interest rates will rise, and are we confident this rate increase will happen soon? I’d contend the answer to both questions is no. Actually, the majority of investors have believed interest rates would rise since the first round of quantitative easing took place in 2009, and have suspected rates would rise in every calendar year since.  Quite simply, this has not happened. In fact, interest rates are currently lower than they were during the majority of 2009 despite five years of buzz about interest rate hikes.

During this five-year period, how have bonds performed? From 2009 through 2013, the Barclays Aggregate Bond Index (AGG) returned 5.93%, 6.54%, 7.84%, 4.22%, and -2.02%, respectively. Bonds only declined once during the five-year period, by a relatively nominal -2.02%, and still averaged a compound rate of return of 4.86%—not bad for the conservative portion of a portfolio.

Additionally, various bond categories have done even better than the Aggregate Bond Index, which consists of just U.S. government and corporate bond holdings. For instance, emerging market bonds (EMB) achieved a compounded return of 9.30%, while high yield bonds (HYG) returned 12.26% annually over the same five-year span. An investor whose bond portfolio was diversified among a range of asset categories has far from suffered since the expectation of a rate increases began.

Will you miss the stability of bonds?

Let’s also consider the consistency of bonds. Since 1980, the Aggregate Bond Index has achieved a positive return an astonishing 31 out of 34 years (91% of the time!). Given this data, perhaps bonds aren’t as likely to decline in value as some investors think.

Equally amazing, although the bond index has achieved an annual return as high as 32.65% during this time period (in 1982), the largest loss it ever suffered in a calendar year over the same period was just -2.92% (in 1994). Over the entire 34-year period, the index obtained an average annual gain of 8.42%. Bottom line: Over the last 34 years, bonds have offered a lot of return for relatively little risk.

Diversification: the most important factor

Not putting all your eggs in one basket is another basic principal of investing, and the primary motivation for having a significant portion of your portfolio allocated in bonds. It is important to remember that for an investor with a long-term perspective, equities will likely provide the majority of investment growth and return in a portfolio while bonds are needed to reduce volatility and risk. For example, while a portfolio that was 100% stocks suffered a 38.6% loss in 2008, a portfolio that was 50% stocks and 50% bonds suffered a loss of only 14.5% the same year—still not pleasant, but much more manageable.

Bonds reduce risk in a portfolio because their return has a low correlation to the return of stocks. How low? Since 1928, both the S&P 500 and the 10-year treasury note have lost value during a calendar year only three times (in 1931, 1941 and 1969). That is less than 4% of all annual periods!

Further, since the Barclays Aggregate Bonds Index was created in 1973, the index has never decreased in value in the same year as the S&P 500. Amazing, but true. Clearly, bonds are fulfilling their role as a diversifier and reducing the volatility in your portfolio.

There is always a role for bonds

Despite the continuous threat of rising interest rates, bonds have continued to perform. More importantly, history illustrates that mixing bonds with stocks smoothes out the investment results of your portfolio. Don’t get sucked in by the media buzz. Bonds are too valuable an asset to disregard.

The post Is It Time to Reduce the Bond Exposure in Your Portfolio? appeared first on NerdWallet News.

Learn more about Lon on NerdWallet’s Ask an Advisor.

You've read  of  free articles. Subscribe to continue.
Real news can be honest, hopeful, credible, constructive.
What is the Monitor difference? Tackling the tough headlines – with humanity. Listening to sources – with respect. Seeing the story that others are missing by reporting what so often gets overlooked: the values that connect us. That’s Monitor reporting – news that changes how you see the world.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to

QR Code to Is it time to reduce your portfolio's exposure to bonds?
Read this article in
QR Code to Subscription page
Start your subscription today