One way investors have traditionally protected themselves during periods of market volatility is to balance their portfolios by investing in fixed-income securities like bonds. While bond prices go up and down, they don’t rise and fall as dramatically as stock prices—leading many investors to view them as a “safer” option in times of economic uncertainty.
WHILE THIS STRATEGY HAS PROVEN EFFECTIVE IN THE PAST, IT’S A MUCH RISKIER PATH TO TAKE AT OUR CURRENT MOMENT FOR ONE CRITICAL REASON: RECORD-LOW INTEREST RATES
The low-interest-rate environment has led bond prices to rise and yields to go down. In fact, last year bond yields dipped under $1 for the first time ever. A smaller yield cushion, along with increasing credit and the potential for rising interest rates have made bonds a risky proposition. They simply may not provide the same protection and balance for your portfolio they did in years past.
GREATER INTEREST RATE RISK + FALLING YIELDS = LESS POTENTIAL REWARD
Right now, the risk of investing in bonds may be greater than the financial reward they can provide. Some bond investors could see losses if interest rates were to jump up by even just a little bit. Corporate bonds—which typically have a higher yield—also come with considerable risk right now because they are more likely to default or be downgraded during times of recession.
MOVING FORWARD, RETURNS ALSO LOOK TO BE LOWER THAN WHAT BONDS PREVIOUSLY DELIVERED
The average bond return has hovered around 6% in the past three decades. But history shows us that bond returns are closely connected to starting bond yields. Given the current low-yield rate, analysts are predicting lower returns on bonds over the next 10 years (around 1-3%). While the market can always fluctuate, nothing right now suggests strong bond returns ahead.
IF STOCKS AND BONDS ARE BOTH RISKY INVESTMENTS RIGHT NOW, WHAT’S THE RIGHT MOVE FOR YOUR MONEY?
Depending on your age and wealth, you may want to consider pivoting your financial strategy to one that will both position you for growth and protect you from potential downside in our current environment. For many investors that might involve looking beyond traditional strategies (like moving your investment dollars to bonds to mitigate risks) to consider the full range of options available to you.
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