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Bond Talk: Why Invest When Yields Are So Low? Thumbnail

Bond Talk: Why Invest When Yields Are So Low?

It's once again time for Bond Talk, where we answer your questions about what's happening in Bond World.

Question 1: When's the new flick coming out?

No Time to Die, the 25th Bond film and 5th and last starring Daniel Craig, will be released in theatres on April 21, 2020.  Fun fact: James Bond's adversary Safin is played by Rami Malek, who portrayed Queen lead singer Freddy Mercury in the biopic Bohemian Rhapsody.

Question 2: Why own bonds when yields are so low?  

Let’s start by taking a look at where interest rates are.  

If you have money in a cash account, your yield is basically zero. The Federal Reserve has forecasted that the federal funds rate will stay near zero at least through 2023, meaning almost no return on cash for a long time.  

Let’s move on to the safest part of the bond market, U.S. Treasuries. Today, you can lend money to the U.S. Government for the next 10 years and get 0.90% in annual interest. How about bonds issued by corporations, such as Microsoft or CVS Health? Not much more, maybe 1.5%.

So we are in a low yield environment and probably will be for some time. But looking in the rear view mirror, bond investors have done quite well. Over the last year, the most popular bond market index has returned over 7%1. That’s because interest rates were higher a year ago—as rates fell, the prices of bonds rose, leading to strong returns.

But here we are today. With yields so low, does it still make sense to own bonds as part of a balanced portfolio—one that holds stocks as well?

Yes.  Bonds have two important roles for long-term investors. First, they provide a stream of income. Ok, today, not so much as in the past. But still, more than cash.

Second, they provide a cushion, a diversification benefit, during those inevitable periods when stocks go down. Think back to the stock market’s 35% drop earlier in 2020, as news about Covid became widespread. Bonds did well, helping investors ride out the downturn. Bad news brings out a “flight to quality” as investors want to own safer bond investments, pushing up their price.

What if interest rates rise from here? Won’t the value of bonds go down, hurting performance?

For starters, it’s not a sure thing that interest rates will rise. We always like to point out that future expectations of economic growth and inflation are already “baked” into current bond prices.

Bond market strategists have been calling for higher interest rates for years, and for years they have been wrong. Maybe they’ll be right this time. It’s very difficult to predict the direction of interest rates—and further, the magnitude of the change. Rates may rise as the economy strengthens, but it may take some time. And typically, when rates do rise, you make up the drop in the value of your bonds relatively quickly as you reinvest your interest payments at higher rates.

There is a cost for holding cash and waiting for rates to rise. You are foregoing the higher yields that bonds offer, in hopes of getting the timing right and moving to bonds later.

For investors with a long time horizon, the better strategy is to stick with a disciplined asset mix that includes high-quality bonds with short and intermediate maturities. Over the next few years, we may look to stocks for the bulk of investment returns, but bonds will play an important role as well.

Question 3: Who sings the new Bond theme song?

American singer / songwriter Billie Eilish released the theme song, No Time to Die, in February 2020.

David Rappaport, CFP®

David is the Co-Founder of Rappaport Reiches Capital Management.  He acts as personal CFO to entrepreneurs and corporate executives, providing organization and clarity in their finances.  Please connect with David below.  He loves to talk about investing, financial planning, and Aspiritech, a non-profit hiring individuals on the autism spectrum.

1. Bloomberg Barclays US Aggregate Bond Index, 12/1/19 to 11/30/20. Source: Bloomberg. Bloomberg Barclays data provided by Bloomberg Finance L.P. Past performance is not a guarantee of future results. You cannot invest directly in an index.
The author does not intend to provide investment, legal or tax advice as these materials are for general educational purposes only.  Please consult your legal, tax or investment professional for advice on your particular situation. This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. It is not intended to be a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction. Investing involves risk including the possible loss of principal. Past performance does not guarantee future results. Please refer to RRCM’s Form ADV Part 2 for additional disclosures regarding RRCM and its practices.