Bonds Always Play a Key Role in an Investment Portfolio
If you’ve been investing for any amount of time, you probably know that a diversified portfolio is vital to your chances of success.
However, that advice, in and of itself, really doesn’t do too much. Instead, you need to fully understand what it takes to diversify sufficiently your investments. One very smart way to do this is with bonds.
These aren’t some trendy option, but a resource that has always been central to creating a diversified portfolio.
Power of The Inverse Correlation
The main benefit of including bonds into an investment portfolio is a negative correlation with equities.A correlation is an investment metric that measures the movements of two investment assets on a scale +1 to -1.
When stocks move up, then the price of bonds move down. However, when stocks tank the bond prices soar, as investors looking for the safety.
Actually, the well-diversified investment portfolio includes assets that have a negative correlation with each other. Such correlation helps to offset losses of one asset class by a gain of another one.
According to the Vanguard, the correlation between the US stocks( S&P 500) and long-term government bonds (10-year U.S.Treasury) has fallen to its lowest level in the last 145 years. It has dropped to -0.6.
“Successful portfolio construction is not just about the return. It’s also about diversification.And at the moment, the data indicate that no asset boasts more potent diversification power—and more potential to protect a portfolio in a stock market downturn—than U.S. Treasury bonds”, said Joe Davis, the Vanguard Global Chief Economist.
I’m not trying to make the point that bonds only recently became important to a successful portfolio.
In fact, that’s just one more reason to invest in bonds – they have always been an important ingredient in the recipe for investment success.
On top of that, they’ve always been seen as one of the most stable, reliable and consistent investments you can find.
Bonds Are Better than Cash Right Now
As most investors are well aware, interest rates are currently at a historical low. Nonetheless, they’re still at a positive level here in the United States compared to the negative rates being seen throughout Europe and Japan.
One upshot of this is that five-year treasury bonds will pay out 1.93%. On top of that, corporate bonds will pay out 2.5% to 5%. That makes these bonds a better investment than actual cash.
Of course, if you have strong liquidity needs, cash makes a lot of sense. Otherwise, it’s sitting with a near-zero—if not negative—rate which should make it pretty simple to see why bonds look so attractive to so many right now.
Rising Rates Will Bring on More Buying Opportunities
The Federal Reserve has recently announced that it would be hiking interest rates two-three times in 2017. We’ll just have to wait and see.
However, it’s important that you try to prepare for when these rates do go up. One big factor to take into consideration is that these rising rates will create more opportunities to buy. Take advantage of this and you could greatly improve your portfolio during these times.
For those of you who have more generous horizons, higher rates just mean that the future yield you receive from investing in bonds will be that much greater. This is another great reason to get excited about seeing these rates go up.
That’s actually why rising rates are always a good thing for those who put their money into bonds. As long as you’re an investor who can keep your long-term goals in mind, this type of environment works to your advantage.