The Role of Bonds in a Balanced Portfolio
Both stocks and bonds play an important role in your investment portfolio. Stocks largely provide long-term growth. Bonds produce steady income and enhance portfolio stability.
Currently rising interest rates and expectations for economic recovery are impacting bond prices. Bond mutual funds and ETFs don’t have specific maturity dates and chances are, your funds’ total returns have gone down.
It’s important to understand that maintaining your balanced approach can benefit your portfolio by managing overall risk and enhancing long-term growth potential.
The role of bonds
In general, stocks and bonds move in opposite directions and there are periods when one market will outperform the other. This will often cause investors to question the value of the underperforming asset class.
When the stock market is hot and interest rates are low, bonds are unpopular. When the stock market tanks, people flee to safety and bonds become more popular.
The reason to continuously maintain bonds in your portfolio regardless of current performance is to:
1. Provide steady, reliable cash flow. Income from bonds has long provided investors with a stable income stream year after year.
If you had invested $10,000 in Canadian bonds 10 years ago, you would have earned an average of 4.2% per year in income. (RBC).
2. Enhance portfolio stability. The stability of bonds can help offset the volatility of stocks in a diversified portfolio.
Since 1998, there have been six calendar years with negative returns for Canadian stocks. In those years, Canadian bonds delivered an average return of 7.6%, helping many investors offset the volatility of stocks. (RBC).
3. Diversify your portfolio. There are a wide variety of bond asset classes. The addition of U.S., global and emerging market bonds can give geographic and currency diversification.
High yield and convertible bonds can enhance returns and boost income during periods of rising interest rates.
The bottom line
While a recent period of volatility in bonds has some investors questioning their value, the key reasons to hold bonds in your portfolio – steady, reliable cash flow, portfolio stability, and diversification – have not changed.
When you see a market loss on your brokerage statement, it helps to remember what your actual dollar investment was. The cost base (book value) includes past interest and capital gains paid to your mutual funds or ETFs, so the short-term loss you see in market value is not entirely precise. Plus, your funds will receive higher interest payments on the new bonds purchased.
As an investor, you’ll want to balance your bond holding with your needs and risk tolerance. Having an appropriate asset allocation and sticking to your long-term investment plan remain key to your investing success.