Bond prices have generally risen and yields have fallen over the past 30 years, so returns in the future are projected to be less generous. But this doesn’t fundamentally change the valuable role bonds play in a diversified portfolio.
Mr. Kinniry pointed to Vanguard research that shows that bonds of high credit quality (as rated by independent credit-rating agencies) can be effective diversifiers during periods of stock market turbulence.
The accompanying chart shows how various investments did during the worst 33 months of U.S. stock market performance over the past 28 years.
Notes: Figure shows median returns for the worst 10% of months (33 in all) for U.S. stock performance from January 1988 to January 2016. U.S. stocks represented by the Dow Jones U.S. Total Stock Market Index, emerging-market stocks by the MSCI Emerging Markets Index, REITs by the FTSE NAREIT Equity REITs Index, dividend stocks by the Dow Jones U.S. Select Dividend™ Total Return Index, commodities by the Bloomberg Commodity Index, high-yield bonds by the Barclays U.S. Corporate High Yield Index, emerging-market bonds by the Barclays Emerging Markets USD Sovereign Bond Index, hedge funds by the HFRX Global Hedge Fund Index, U.S. bonds by the Barclays U.S. Aggregate Bond Index, corporate bonds by the Barclays U.S. Corporate Investment Grade Index, Treasury bonds by the Barclays U.S. Treasury Index, municipal bonds by the Barclays Municipal Bond Index, and non-U.S. bonds by the Barclays Global Aggregate Index ex USD (hedged).
Sources: Vanguard calculations, using data from FactSet; Morningstar, Inc.; and Barclays.
This ability to act as a buffer when stocks are volatile, as they have been in recent months, can help prevent investors from overreacting to stock downdrafts. But two factors, Mr. Kinniry believes, may be working against highly rated bonds issued by federal, state, or local governments; government agencies; or healthy corporations: investors’ search for higher yields, and expectations that interest rates will rise soon, leading bond prices to fall. (Higher yields, when reinvested, eventually compensate for bond fund price declines.)
For now, rates remain quite low. Nonetheless, regardless of how rates move in the future, Mr. Kinniry thinks bonds should remain part of any investor’s long-term portfolio.
“The message to me is as clear as it ever was,” he said. “High-quality bonds remain effective diversifiers, especially during sharp equity market declines.” He added with a smile: “Like Rodney Dangerfield, bonds deserve more respect.”
All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future results.
Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.