Why own bonds in your portfolio?

Earlier this year, we did an episode explaining bonds. But we often hear that folks understand what bonds are; the question is why do I want them in my portfolio, especially if stocks have historically produced higher long term returns?

The answer starts with understanding that stocks and bonds have different jobs. A successful portfolio is not built by choosing one perfect investment. It combines investments that support different goals. Stocks generally provide long term growth. Bonds can provide stability, income, and flexibility.

Stocks have delivered stronger returns over many decades, but those returns come with greater risk. Markets have experienced severe declines, including the technology crash, the 2008 financial crisis, and the rapid decline in early 2020. It is easy to claim comfort with risk when markets are rising. That confidence can change quickly during a major downturn. Bonds can help reduce portfolio volatility and make it easier to remain committed to a long term plan.

The current interest rate environment also strengthens the case for bonds. For many years after the financial crisis, bond yields were extremely low. Bonds offered limited income, even though they still helped control risk. Higher interest rates now allow many high quality bonds to produce more meaningful cash flow. This can be especially valuable for retirees who depend on their portfolios to fund living expenses.

Bonds also help address the danger of selling stocks during a market decline. A retiree with an all stock portfolio may be forced to sell investments at depressed prices to cover withdrawals. Those sales lock in losses and leave fewer shares available to benefit from a later recovery. A portfolio that includes bonds and cash may give the investor another source for distributions while stocks recover.

This issue is known as sequence of returns risk. Two retirees can earn the same average return over 25 years and still experience very different results. The investor who suffers major losses early in retirement may run into trouble because withdrawals occur while the portfolio is declining. Bonds can provide income and liquidity during those periods. For example, a retiree with 40 percent in bonds and a 4 percent annual withdrawal rate may have roughly ten years of potential distributions available from the bond allocation, even before considering growth or rebalancing.

The unusual market environment of 2022 does not mean diversification stopped working. Stocks and bonds both declined as the Federal Reserve raised interest rates aggressively to control inflation. Diversification is not designed to protect investors during every short period. It is designed to improve the range of possible outcomes over time.

The central lesson is that successful investing is not about earning the highest return every year. It is about creating the greatest probability of reaching financial goals while taking only the risk that is necessary. Bonds are not competitors to stocks. They are complementary tools that can provide income, stability, and flexibility when markets become difficult.

You can always email Alex and Ed at info@birchrunfinancial.com or give them a call at 484-395-2190.

Or visit them on the web at https://www.birchrunfinancial.com/

Alex and Ed's Book: Mastering The Money Mind: https://www.amazon.com/Mastering-Money-Mind-Thinking-Personal/dp/1544530536

Any opinions are those of Ed Lambert Alex Cabot, financial advisors, RJFS, and Jon Gay, and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The examples throughout this material are for illustrative purposes only. Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional. Diversification and asset allocation do not ensure a profit or protect against a loss. Past performance is not indicative of future returns. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. The prices of small company stocks may be subject to more volatility than those of large company stocks. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. Holding bonds to term allows redemption at par value. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.

Risk Considerations:
There are special risks associated with investing with bonds such as interest rate risk, market risk, call risk, prepayment risk, credit risk, reinvestment risk, and unique tax consequences. To learn more about these risks and the suitability of these bonds for you, please contact our office.
Bonds are subject to risk factors including:
Default Risk - the risk that the issuer of the bond might default on its obligation
Rating Downgrade - the risk that a rating agency lowers a debt issuer's bond rating
Reinvestment Risk - the risk that a bond might mature when interest rates fall, forcing the investor to accept lower rates of interest (this includes the risk of early redemption when a company calls its bonds before maturity)
Interest Rate Risk - this is the risk that bond prices tend to fall as interest rates rise.
Liquidity Risk - the risk that a creditor may not be able to liquidate the bond before maturity.

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