For those that have been riding the stock wave higher the past six years, it may be easy to opine that there are no good reasons to own bonds. However when everyone becomes fond of a security or asset class, from a contrarian viewpoint, it oftentimes signals a topping out point. Ergo, it may be better to sell or minimally stop buying that asset when everyone else falls in love with it.
While I’m not suggesting that the sky is about to fall and you sell all your stocks, you should be aware that equity valuations are on the historically high side, and represent more general “reversion to the mean” risk than they have in many years. Now may be a good time for equity-heavy portfolios to turn back the risk knob and diversify into other assets.
To see a list of high yielding CDs go here.
So with no further ado, here are the top three reasons to own bonds:
- Achieve Portfolio Balance: Investors who are taking on too much concentrated risk generally do not realize it until a harsh market sell off occurs. When paper loss gets too great to handle, bad, panic-led decisions are typically made. Possessing assets, like bonds, with typically less fluctuation potential and negligible capital risk when held to maturity, makes getting through a market sell off easier. Newer investors who’ve never been through a nasty “’08-09 like” sell off before may be especially susceptible to the panic selling phenomenon.
- Develop A Dependable Income Stream: While bonds certainly do not provide screaming income value in this ultra-low interest rate environment, with some equities yielding more than what their intermediate-to-long-term paper pays out, bonds do pay more than the .25% savings or .01% checking accounts at your local bank. Having a laddered portfolio of solid, investment grade bonds with 15 year blended maturity could earn you 3.5-4.5%, depending on the credit quality. For those with a bit more tolerance for risk, junk bonds are available with upper single digit yields. Here are some of examples of currently available 15-year maturity bonds at Fidelity:
- Capital Preservation: While cash is generally looked upon as the ultimate capital preservation tool, short-term investment grade bonds would be a close second. Even in a recessionary environment, a bond portfolio full of A-rated bond issues with fortress-like balance sheets should provide investors with virtually all the confidence of an FDIC insured bank account. Below are some examples of what can be had in the 1-3 year range. Again, not eye-popping but more competitive than what can be found at the bank.
Yesteryear, the argument for bonds was stronger. Higher coupon rates and the prospect for capital appreciation made inclusion of bonds in a portfolio a virtual no brainer. Today, with a stock market that continues to breach new highs and interest rates that make fixed-income products less attractive to the masses, bonds are viewed with general disdain. Still, while it may make little sense for investors to dominate a portfolio with them, bonds do have a variable place in most investor portfolios, although it may take an uncomfortable stock sell off for many to realize it.
About the author: Adam Aloisi has over two decades of experience investing in equities, bonds, and real estate. He has worked as an analyst/journalist with SageOnline Inc., Multex.com, and Reuters and has been a contributor to SeekingAlpha for better than two years. He resides in Pennsylvania with his wife and two children. In his free time you may find him discussing politics, playing golf, browsing antique shops, or traveling.