Learn about the benefits of bonds


Interest rates are low now but if the Fed raises rates, what will be the role of bonds in your portfolio? Todd Bechtel of Vanguard Personal Advisor Services explains the bright side of increasing interest rates.

Notes:

All investing is subject to risk, including possible loss of money you invest. Diversification does not ensure a profit or protect against a loss.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2017 The Vanguard Group, Inc. All rights reserved.

TRANSCRIPT

Amy Chain: Okay, very good. David has noted that bonds, now we talked earlier about bonds so let’s go back to that. David has noted that bonds are generally considered a stabilizing component of a diversified portfolio: “What is your view on the proper role of bonds today, given that interest rates are low, and the almost-certain increases will impact principle values negatively?” Why don’t we pause first, Todd, and talk to us about the role that bonds can play in a portfolio, and then we can talk about what’s going on in the environment.

Todd Bechtel: Right and that question’s from David?

Amy Chain: This question’s from David.

Todd Bechtel: David. Great question. And your observations, you hit in your observations the two main, in my opinion, the two main benefits of bond investment which is diversification and then within bonds what are you getting out of its interest. And so bonds play an integral part, and I think that was part of the question in portfolios to the extent that you don’t want equities. I mean let’s be very clear. If you have a long-term time horizon and you believe in the U.S. economy or the world economy, then why would you have bonds? Well, it’s because you can’t stand the downside risk, and it’s not appropriate for your portfolio, so then you fill that gap with bonds. And so that’s the diversification aspect. Interest-rate wise, that’s what we want. And we’ve seen interest rates not spike per se but go up recently. And yes, there’s a negative price component to that and I believe most of the audience probably knows as rates go up, existing bond values, or the values of existing bonds that have a lower coupon or a lower yield are going to be worth less, because why would you buy them, they’re just not as appealing, so you have to discount the value of the bond in order to entice someone to buy, and that’s a mathematical equation. So interest is important. Diversification is important. And they go hand in hand. And so in this environment, there is pain when interest rates rise, there’s a price to pay initially on the share price. But that’s okay. And that in fact I would argue that’s good because you’re increasing the diversification benefits of the portfolio. The example would be is if you have a negative 10% market equity loss, would you rather have a 4%-yielding bond strategy or a 3? I’ll take the 4 because it’s going to offset better the loss on the downside on the equity. So interest rates are, have gone up, they may continue to go up. The Fed is projecting that they may continue to do certain things on the yield curve, and maybe Fran would want to speak to about the yield curve and how it actually works. But it’s good. We want to see interest rates go up. It adds diversification.

Important information

All investing is subject to risk, including possible loss of money you invest. Diversification does not ensure a profit or protect against a loss.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor, or by Vanguard National Trust Company, a federally chartered, limited-purpose trust company.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

© 2017 The Vanguard Group, Inc. All rights reserved.