Q: Why do I have bonds in my portfolio and what do they accomplish?
A: One of the most common questions people ask during periods of market volatility is, “Why do I own bonds when stocks seem to generate much better returns?” It’s a great question. Bonds rarely attract the same attention as stocks during strong markets, but they play an important role in helping you to achieve your long-term financial goals. And bonds certainly have been in the news lately.
Bonds are designed to provide stability, generate income, and diversify your portfolio. While stocks typically drive long-term growth, bonds help manage risk and create a smoother investment experience. Think of them as the ballast of a ship, they help keep your portfolio steady when market winds pick up.
The primary role of your fixed income is not to outperform stocks. Instead, bonds help offset some of the risks associated with stock investing. Historically, high-quality bonds have often experienced smaller price swings than stocks and have frequently held up better during periods of market stress. This diversification benefit can help reduce the overall portfolio volatility and make it easier to stay invested during difficult markets.
When your portfolio contains both stocks and bonds, you may experience a smoother ride than someone who is 100% in equities. This stability can be especially valuable during retirement or when investors may need access to their money to cover a short-term goal.
What happens across the life of a bond?
While all investments involve risk, high-quality bonds have historically been used as a tool for capital preservation. When you purchase a bond and hold it to maturity, you generally receive regular interest payments and the return of principal assuming the issuer remains financially sound.
This feature makes bonds particularly attractive for money that may be needed over the next several years. Rather than exposing your assets entirely to stock market fluctuations, bonds can provide a level of predictability that supports your future spending needs.
Beware: not all bonds are the same. Some investors think of bonds as a single asset class, but there are significant differences among bond types. Treasury bonds are backed by the U.S. government and are generally considered among the highest-quality investments available. Municipal bonds may offer tax advantages. Investment-grade corporate bonds can generate higher income while maintaining strong credit quality. Brokered CDs will typically provide FDIC insurance and add to the level of diversification in your fixed income portfolio.
Because different types of bonds can perform differently depending on economic and market conditions, diversification within a fixed income portfolio can be just as important as diversification within your stock portfolio.
We all know that interest rates, inflation expectations, and credit conditions are continuously changing. As a result, it’s important to monitor and manage your bond portfolio. Professional fixed-income managers will focus on balancing income opportunities while keeping an eye on interest-rate risk, reinvestment risk, and credit risk. Building a bond ladder can help reduce the impact of changing interest rates and provide a more consistent stream of cash flow.
Ultimately, a well-constructed portfolio typically uses both stocks and bonds because each asset class serves a unique purpose. Stocks help build wealth over time, while bonds help protect and preserve it. Together they can create a balanced foundation designed to support your portfolio through a variety of market environments. We never know when that next “event” will happen.
Dottie Bourlier, CFP®, TPCP®, MBA is a financial planner at Focus Partners Wealth in Indian Harbour Beach. Contact her at 321-428-4555 or dottie.bourlier@focuspartners.com.