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Benefits of bonds?

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  • Avatar NationalPark 
    Participant
    Status: Physician
    Posts: 18
    Joined: 06/22/2019

    Hoping for a basic rundown of the benefits of bonds. My basic understanding is that they are lower risk/lower reward compared to stocks, sound right?

    Looking at the Vanguard total bond index price for the last 20 years, it seems like price has always been about $10. With some big market swings in those years, seems like hard to make any money, and would have been better off drawing 2% in a no risk savings account.

     

    What am I missing?

    #231835 Reply
    Avatar Peds 
    Moderator
    Status: Physician
    Posts: 4452
    Joined: 01/08/2016
    What am I missing?

    Click to expand…

    dividends….price means nothing.

     

    bonds are not for making money (except the lost decade). they serve as diversification, ballast, help with psyche, etc…

    #231839 Reply
    Avatar ajm184 
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    Status: Other Professional
    Posts: 637
    Joined: 07/14/2017

    There are all kinds of things that qualify within the ‘Bond’ basket, though for US government and highly-rated ‘normal’ corporate bonds, and municipal bonds, the answer to your first question is ‘Yes’.

    Your second point is incorrect from a couple of perspectives;

    a. Yes the price of the bond fund you are using as an example may not have changed much over the last ten years in aggregate.  A normal bond (or stock for that matter), return is composed of two parts; a. price which you mention and b. coupon/dividend.  For normal bonds, the coupon/dividend is significant return component versus price (which are more dependent upon risks that are outside the holders control, such as interest rates, economic conditions, liquidity, credit risk).

    b. Though you can get 2% now in a high yield saving account, that interest rate was not achievable risk free or without going really long tenor with bonds, for the better part of the last ten years.

    c. Bonds are used as part of an overall portfolio to dampen equity volatility because individuals may not have the risk tolerance/time horizon for all equity volatility and have a portion of their portfolio in bonds to dampen/reduce overall volatility.  Bonds can also be used as lower risk option return when you have a known shorter time horizon with certain saving in which some /albeit safer return/use of funds such as saving for home/car.

    #231849 Reply
    Avatar Peds 
    Moderator
    Status: Physician
    Posts: 4452
    Joined: 01/08/2016
    seems like hard to make any money

    Click to expand…

    also also cause cherry picking is fun.

    in 2018 you would have made 5% more by picking total bond vs total us stock…..

    #231923 Reply
    Liked by Lordosis
    IntensiveCareBear IntensiveCareBear 
    Spectator
    Status: Physician
    Posts: 235
    Joined: 12/22/2018

    Yep, this is not the 1980s. If you’re not FI and/or about to croak, bonds barely keep with inflation and can be bypassed when doing AA or market strategy. Your 2% savings account analogy is actually not bad… but your savings account principal can’t crash 30% for no good  reason like bonds can in a bear or a war or quant easing or etc. Any bond that does significantly better than ~3% right now will usually be almost as volatile as the market (not always a bad thing). Bonds, in the current rate market – and in general terms, are for people who are already FI (or who didn’t reach FI but are old and done earning… and now, they need to preserve what they have and generate a bit of income). Bonds, dividend stocks, and maybe annuities are (sadly) the way a lot of people choose to generate cash in retirement… and cashing out shares and SSecurity, of course.

    If you think it through, barring short periods here and there (peds 2018 example above or other sideways/down stock years), bonds can never give you the RoR of stocks. The companies all borrow money at or around bond rates. If WalMart, Amazon, or any other company you can name can’t grow and profit at a rate better than interest/inflation rates, they wouldn’t exist. Sam Walton’s heirs and Bezos and etc etc would all just buy bonds and avoid the hassle of running the companies. They could also sell the company, make a ton of cash, and borrow it out at bond rates if they wished. They don’t do any of that… since they can make much much much better RoR in their business. They might even sell their own corporate bonds if that beats interest rates for drumming up cash for their expansions or other needs.

    …if 10yr T yield hits 5% or more, the bonds are more interesting for the average investor. That would offer a decent return with a bit less volatility than indexes (but bonds still crash in bears… quite well, actually, check long term graphs). That viable bond cash divi rate hasn’t been the case for quite awhile, though, and it doesn’t happen overnight. The growth minded investors who use bonds will blabber some excuse to have a basket of underperforming bonds in their portfolio sometimes (“diversity” or “tax advantage” or “risk tolerance”), but it’s just not a good reason IMO. US10YT and similar can have a role for very risk-averse buy and hold investors (All Weather portfolio, etc) or for posthumous funds like trust funds or inherited annuity for heirs who have no interest or savvy in the market, but the bond idea is still pretty illogical for a young doc and for the vast majority of folks until maaaaybe at or very near retirement…. again, that is unless bond rates go up significantly. For most people who are still tracking towards FI, bonds are simply a “check back later.”

    "Hmm, that sounds risky." - motto of the middle class

    #231984 Reply

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