Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Are Bonds Still a Good Investment?

Apr 20, 2022


read this quote today from personal finance author Ramit Sethi that I thought was spot on, “the way people feel about money is highly uncorrelated with the amount in their bank account.” When it comes to retirement, people are primarily worried about one thing, running out of money. It doesn't matter if they have a lot or a little; the worry is the same. In behavioral studies, they refer to this as loss aversion, where the pain of a loss is almost twice as severe as the reward felt from a gain. So, what do we do when we get closer to retirement? We sell our stocks and we buy some bonds because we don’t want to lose money.
When interest rates are going down (purple line below), that works well. The 10-year treasury rate, pegged as the long-term interest rate benchmark, enjoyed a decline from 15.84% in 1981 to a low of 0.52% in 2020. As did inflation for the most part (orange line below), which declined from a 1980 high of 14.76% and then dropped to no more than 6% for the next 40 years. The chart below shows what I am talking about.
But what happens when interest rates go up? Well, that's a scenario that folks saving for retirement haven't faced for decades. Not to discount the experiences of the dot-com bust and the GFC, but this is a different type of macro headwind altogether. To put it directly, bonds go down. Sometimes very fast. Currently, a record 91% of bond ETFs have a negative 12-month return, as shown in the chart below.
Since the first of the year, the Vanguard Target Retirement 2025 Fund is down -8.11%, while AGG, the aggregate bond ETF that tracks the total U.S. investment-grade bond market, is down a similar amount. I point these out specifically because that's a lot of pain for what is typically represented as a “safe” investment.
Across the board, we are seeing losses in the bond market. The chart below shows treasuries, U.S. aggregate, credit, muni's, and high-yield bonds all taking losses in 2022.
As I wrote in this piece in late March, it's normal for interest rates to be below the inflation rate. Even though interest rates are climbing right now, hurting bond returns, they are still well below our inflation rate, indicating that there may be room for more pain in the bond market.

What Does This Mean to Me?

Bonds are where investors have enjoyed the benefits of diversification and positive return for more than 40 years. As we approach retirement, the pain of a loss increases, no matter the account size. Investors want to have a place to de-risk investments as they approach their spending (not making or saving) stage of life. Unfortunately, due to a myriad of factors including but certainly not limited to monetary and fiscal policy, the bond market has been a source of risk so far this year.
Two camps are developing right now in the professional investor world. Some believe that interest rates are going to go up for the foreseeable future, causing more pain in the bond market. Others believe that we are at peak inflation; rates may go higher for the next few months, then move lower at the end of the year, causing a bond rally. The premise is that the Fed will overreact to inflation too late, then reduce rates when markets react unfavorably to the increase. If that scenario plays out, you will want to own longer-duration bonds (a dangerous trade, in my opinion).
The reason I bring this up is that the investment community is split. Some think rates and inflation are “toppy,” while others believe we have a long road ahead. One thing is for sure, no one knows the future, and they certainly do not know your unique financial picture.
Here is a great investment story to end with, one Morgan Housel reminded me of. He wrote:
“Everyone knows the investing duo of Warren Buffett and Charlie Munger. But 40 years ago there was a third member, Rick Guerin. The three made investments together. Then Rick kind of disappeared while Warren and Charlie became the most famous investors of all time.
A few years ago hedge fund manager Mohnish Pabrai asked Buffett what happened. Rick, Buffett explained, was highly leveraged and got hit with margin calls in the 1970s bear market.
Buffett told Pabrai:
‘Charlie and I always knew that we would become incredibly wealthy. We were not in a hurry to get wealthy; we knew it would happen. Rick was just as smart as us, but he was in a hurry.'’
While retirement may be approaching, there are still many years of investment life ahead, and that longer-term time horizon can be of great value in the current environment. Is it time to get strategic with your bond allocation? I think that is an easy yes. But I don't think that making extreme moves that can drastically change your long-term outcome is a smart move either.




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