Selecting investments for your portfolio is a critical part of planning for your financial future. So where do you start? Stocks? Bonds? Real Estate? The truth is that it is different for everyone, however there is a core principle that applies to all investors. Diversification. You may have heard us talk about diversification previously, but you may not have heard us talk about Long-Term Bonds and the role that they can play in your portfolio. Long-Term Bonds have a unique feature that is very attractive when constructing an investment portfolio, negative correlation to stocks. Assets with negative correlation tend to move in opposite directions. This may seem counter-intuitive, but it is the core principle that influences all investment portfolios.
What is a Long-Term Bonds?
A Long-Term Bond is a fixed income security that has a maturity greater than ten years from today. Bonds have two key risks that need to be considered before investing, Credit Risk (will the borrower be able to pay back the loan) and Interest-Rate Risk (the opportunity cost of better/worse investment opportunities during the life of the loan). In this discussion I will be specifically referencing U.S. Treasury Bond, which are free from credit risk. These Long-Term Bonds are deemed ‘risk-free’ because they are guaranteed by the U.S. government. This feature instills confidence that investors will be paid back when the bond matures. However, due to the long-term nature of these bonds there is significant interest-rate risk.
A Hedge Against Stocks
The largest contributor to risk in most investment portfolios is stocks. While the last ten years have felt great to own stocks, it is important to remember that they do not always go up in a straight line. Stocks tend to underperform other asset classes in the later stages of an economic expansion. Given the current state of the economy and volatility in the stock market, it is relevant now more than ever to consider adding asset classes, such as Long-Term Bonds, that outperform in this type of an environment. The chart below illustrates this by plotting the performance of Long-Term Bonds versus the performance of U.S. Stocks during each phase of the economic cycle.
Are Long-Term Bonds Right For You?
Long-Term Bonds may not be an appropriate investment for everybody. One important consideration is the size of your allocation to stocks. Simply put, the more stock exposure you have in the portfolio, the more attractive an allocation to Long-Term Bonds becomes. If you do not have any stock exposure, it is likely that an allocation to Long-Term Bonds is unnecessary. Another important consideration is the current duration (a measure of interest-rate risk) that is currently in your fixed-income portfolio. Since Long-Term Bonds have a significant amount of duration, it is important to carefully consider how much duration you are willing and able to accept.
Long-Term Bonds can be a great hedge to a stock portfolio, but they may not be right for every portfolio. If you want to know how they fit into your portfolio, contact your Wealth Advisor.
Important disclosure information
The index returns shown above reflect the total return for various investment indices and include the impact of the reinvestment of dividends. A comparison to indices may not be a meaningful comparison. Comparisons to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the performance of a client’s portfolio. The investments in a client’s portfolio may differ substantially from the securities that comprise each index and are not intended to track the returns of any index. One cannot invest directly in an index, nor is any index representative of any client’s portfolio. Actual client accounts will hold different securities than the ones included in each index. The index returns are gross of applicable account transaction, custodial, and investment management fees. The actual investment results would be reduced by such fees and any other expenses incurred as an investor. For definitions of the indexes used are below.
Index: S&P 500 Index
The S&P 500 is an index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Each constituent in an index is weighted by its market-capitalization, as determined by multiplying its price by the number of shares outstanding after float adjustment. The price return of an index is a measure of the cap-weighted price movement of each constituent within the index.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.
This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.