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Why Don’t You Have Bonds In Your Portfolio?

Confession time: I’ve never held bonds in my portfolio. I didn’t own bonds when my portfolio was filled with Canadian dividend stocks, and there’s no bonds in it today. Instead I’ve opted for a two-ETF all-equity portfolio. I don’t have anything against bonds, in fact if you were to ask me to build you a diversified investment portfolio I’d definitely recommend a balanced solution that includes bonds.

Balanced portfolios are widely recommended, and for good reason. A typical investment portfolio consisting of 60 percent stocks and 40 percent bonds has served investors well for many decades.

Take the three-ETF model portfolio recommended on the Canadian Couch Potato website, for example. Over a 20-year period ending December 31, 2016, the balanced portfolio option made up of 40 percent bonds, 20 percent Canadian equities, and 40 percent international equities, returned 6.56 percent a year. That compares favourably with the aggressive portfolio consisting of 90 percent equities and just 10 percent bonds, which returned 6.63 percent a year.

Bonds smooth out investment returns and make it easier for investors to stomach the stock market when it decides to go into rollercoaster mode. Over the same 20-year period described above, the balanced portfolio’s lowest 12-month return (during the great financial crisis) was -19.28 percent. The aggressive portfolio, on the other hand, dropped 30.57 percent during the same period. That’s a lot of volatility to stomach for a measly 0.07 percent annual gain.

Bonds can also help you rebalance your portfolio. When the stock market is slumping, simply sell some of your bond holdings to buy stocks while they’re on sale. Conversely, when stocks are overheated you can trim back some of your holdings and add to your bond portion to bring your portfolio back into balance.

So for those reasons a balanced portfolio will likely continue to serve investors well and post solid if unspectacular returns over the long term.

All that said, I still plan to hold all stocks and no bonds in my portfolio – and here’s why:

Why No Bonds In Your Portfolio?

Why no bonds in your portfolio?

Before deciding on the makeup of my investment portfolio I took a broad look at my finances and found a lot of bond-like components. Remember, a bond is something that delivers a steady, predictable income stream.

First of all, I receive a steady monthly paycheque from my public-sector employer. I run a successful side-business that also generates monthly income, some of which is of the passive variety. My job comes with a defined benefit pension plan, which guarantees another steady income stream in retirement and reduces the need for draw from my investments post-employment. That pension, combined with CPP and OAS, should cover my basic needs in retirement and act as the fixed income portion of my retirement income.

Then there’s my age to consider. At 38, I’m no spring chicken but I’m still decades away from full-stop retirement. While it’s likely we’ll see another stock market crash of 20 percent or more in the next two decades, there’s still plenty of time for the markets to recover (and they always do).

An all-equity portfolio, while certainly riskier in the short-term, is a near lock to outperform other asset classes over the very long term. In Jeremy Siegel’s classic, Stocks for the Long Run, the author looks at 200 years of historical data and determined that stocks have returned an average of 6.5 percent to 7 percent per year after inflation. Bonds, meanwhile, returned less than 2 percent a year after inflation.

Couple that with the fact that bonds have been in a bull market since 1980 as plunging interest rates sent bond prices soaring. We’re unlikely to see that type of environment over the next 20 to 30 years as interest rates start to tick back up and (dare I say) normalize. Seigel expects lower returns from both stocks and bonds in the future:

“Stock returns are likely to be somewhat lower in the future. I now look for about 5% to 5.5% as the long-run equity return after inflation. On bonds, after inflation returns are very likely zero or perhaps even negative.”

Finally, I know myself as an investor and I truly believe with my four-minute portfolio I have the tools and the temperament to handle a major market crash without panicking.

Final thoughts

Why no bonds in my portfolio? Because I’m a relatively young investor with a steady public sector job, a successful side-business, and a defined benefit pension plan waiting for me in retirement. I believe in stocks for the long run, meaning stocks will outperform other asset classes, like bonds, over the very long term (as long as I can handle the short term volatility). This equity premium should be more pronounced in the future as bonds are coming off an incredible 30-year run.

But that’s me (and my unique situation). Not everyone can handle an all-equity portfolio and therefore most investors should hold bonds in some type of balanced portfolio.

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15 Comments

  1. D. D. Badger on October 2, 2017 at 7:21 am

    Not to mention the after-tax benefits of dividends vs interest income.

    • Echo on October 4, 2017 at 8:18 pm

      @D.D. Yes, this article assumes investing in a tax-sheltered account, but you’re right that in a non-registered (taxable) account bonds are taxed at your full marginal rate.

  2. Guy in Calgary on October 2, 2017 at 10:39 am

    Downside protection is important too though. Which would you rather:

    If I invest $100 and lose 30%, my $100 is now $70. If the market recovers and I make 30% the next year, I now have $91.

    If I invest $100 and lose 20%, my $100 is now $80. If I recover my 20% I now have $96.

    Basic example but just to illustrate a point.

    • Echo on October 4, 2017 at 8:20 pm

      @Guy in Calgary – That’s a great point and why it makes sense for most investors to hold some bonds to help smooth out that ride in the short term. Over the very long term the all-equity portfolio would of course recover and surpass the balanced portfolio (in theory).

  3. Garth on October 2, 2017 at 5:38 pm

    This sounds like the right decision for you. However, even Warren Buffet is sitting on a huge amount of cash because he just can’t find enough good buys at today’s valuations. Doesn’t this tempt you into keeping some dry powder and trying a little market timing as well?

    • Echo on October 4, 2017 at 8:23 pm

      @Garth – Ahh, yes. Buffett is an anomaly because his business generates so much cash (insurance float) that it’s impossible to stay fully invested. He also needs to make such big buys to even move the needle on his overall holdings (hence buying entire companies now, rather than just a small stake).

      To answer your question, no, I’m not tempted to try any market timing. Behaviourally, for me, it makes the most sense to just continue adding new money regularly (monthly for my kids’ RESPs, quarterly for my TFSA, less often for my RRSP) and not try and guess where the market is headed.

  4. LOBNA on October 4, 2017 at 7:58 am

    Hi, I need your advice, please. I’m 55 single self-employed Mom, being in Canada (Ottawa ) only 12 years ago. I have been always fascinated with the stock market but being bad with number kept me away. Just slowly starting to learn about all this ETF’s investment and would like to have a substantial/sustainable income for my retirement years. Information is overwhelming for me. Where do I start? Do I need a broker? which bank institution will assist me? Do I have to have a TFSA as well? and how much $$ I will need to start with? Or do I have to approach Questrade, than once I figure how I switch to self-directed ETF’s? I’m a slow learner but a smart one too 🙂 Please, I need honest and proper guidance in this, and I must start soon. Thank you in advance for your effort and time.

  5. Frugal Guy with Balance on October 4, 2017 at 11:33 am

    I am 65 have been retired for 5 years.

    I have a bond fund which is a defined benefit pension plan, CPP & OAS. No indexing on my defined benefit pension plan.
    Have blue chip stocks which pay dividends which I use to index my pension because dividends have increased nicely in the last number of years.

    I am fully invested with maxed out TFSA’s.

    Life is Good….

  6. Grant on October 5, 2017 at 7:40 am

    I think a good way to think about bonds is that you own them not for returns (you own stocks for that), but to decrease the volatility of your portfolio so you don’t panic sell stocks in a crash. So if you don’t need that smoothing effect of bonds (which most people do), you don’t need them, as anything you do to decrease volatility will decrease returns. The other good thing about bonds, (at least government bonds) is that they go up during market crashes, the “flight to safety”, giving you more money to buy stocks at depresssed prices when you rebalance your portfolio.

  7. Karl Steiner on October 11, 2017 at 5:37 pm

    I came to same conclusion about bonds after an exhaustive review of bonds vs. stocks.

    It’s a pretty unique time for bonds after a tremendous 30 year bull run. Many others that I summarized agree with Jeremy Siegel that bond real returns are likely to be around zero for the next decade or so. However, because I am just entering early retirement now, I do hold a bit of cash in a high interest savings account to create the same “ballast” effect as bonds in case of a market downturn early in my retirement withdrawal phase. It seems crazy, but I can get nearly as much return from cash as intermediate bonds right now. And cash won’t suffer the downward pressure that rising interest rates will have on bond returns. I will reassess bonds as part of my portfolio if/when interest rates rise by about 2% or more. But I don’t see much point in bonds for right now.

    • Grant on October 12, 2017 at 4:40 am

      Karl, bonds will generally give you a better return than cash, plus a bump up in value when equity markets crash, which cash will not give you. Even today the yield to maturity of ZAG, a total market bond fund is 2.43% after fees, more than you’ll get for cash. A 5 year GIC ladder will give you a still higher yield, due to the liquidity premium. Even the the price drop of bonds that occurs when interest rates rise is a temporary phenomenon, reversed if you hold the fund for it’a duration. For the long term investor, I think bonds will give you a better return than cash.

      • Karl Steiner on October 12, 2017 at 9:49 am

        Totally agree and thanks for the reply. My cash position is a few year position that will be reassessed as bond conditions change. My main point was that I agree with you about stocks vs. bonds. Scary as they are right now, stocks are still the place to be the vast majority of time.

        Right now, I still think bonds are a losing proposition for the next few years. For example, real return estimates for bonds for the next 10 to 20 years are dismal. Adding to Siegel’s estimate from your post: William Bernstein says a -1%, Bogel says 1% (if you take on extra bond risk), Ferri says 0.5% tops, etc. I have references for these and more on my blog.

        In contrast, I’m getting 1.25% nominal (-1% real) right now on my cash account. Personally, I’m fine with that short-term trade off for current conditions. Check back with me in 2 years and my opinion will probably be totally different.

  8. Jover on October 19, 2017 at 5:15 pm

    I’m in a similar position (34, government job, side hustle), but since stocks seem overvalued right now, I’m putting 2/3 of my contributions into a bond fund, to be deployed as dry powder when stocks inevitably correct. Then I’ll switch all contributions back to stocks until I think we’re getting “toppy” again. I choose to leverage both strategies, but I don’t feel like I’m trying to “time the market.”

  9. Grant on October 19, 2017 at 11:34 pm

    Excuse me, but you are doing exactly that – trying to time the market. There is a lot data that shows you are better off to simply hold a fixed asset allocation and rebalancing as necessary.

    • Jover on October 20, 2017 at 5:21 am

      I’m doing it with a limited portion of my investment dollars (9%) at the end of an historic 9-year bull run. Stats be damned.
      People who truly try to time the market look to sell stocks at the top and re-buy at the bottom.

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