September 30, 2021

In a brief titled “Rising rates don’t negate benefits of bonds,” Vanguard¹ addresses arguments that target why investors shouldn’t own bonds in a low interest or rising interest rate environment. They start with a point we’ve made ad nausea over the years: “…the role bonds play in a diversified investment portfolio – to be a shock absorber at times when equity prices head downward.”

Myth 1: “Bonds are a bad idea – abandon the 60/40 portfolio.” Ironically, “…the more that bond yields rise…the more important it is for long-term investors to maintain a strategic allocation to bonds, which could require rebalancing into bonds, not the other way around.” The notion that bonds are not needed in a portfolio because yields are currently low speaks directly to risk. If investors sell bonds and purchase equities, they’ve added risk to their portfolio. That may not be a problem if you’re a 25 or 30-year old with decades of time ahead of you. But for the rest of us…

Myth  2: Go to cash, avoid duration risk.” Duration risk pertains to the sensitivity between the price of a bond and the change in interest rates. For example, bonds with longer maturities tend to be more sensitive to interest rate increases, so their prices are more likely to fall when interest rates go up. Rather than fearing bonds when interest rates are projected to rise, bonds, or bond funds, with shorter durations are an effective option.

Myth 3: “When interest rates are rising – don’t just stand there – do something!” Unfortunately, the notion that doing nothing will hurt you is widespread, though not necessarily true. If interest rates are low and investors want downside protection in their portfolios, nothing has to be done if they already own short-term bond funds. Selling for the sake of selling doesn’t make the decision to sell a correct one. While difficult, sometimes doing nothing is actually the best thing an investor can do.

We all know that interest rates can’t stay this low forever, though the length of time they’ve been this low has been a surprise to most market prognosticators. The most important takeaway is knowing that bonds have a place in almost every investor’s portfolio. Good quality, short-duration bonds can not only help to cushion a portfolio against drops in the stock market, they also provide the liquidity that investors need for ongoing or emergency cash-flow needs. Owning bonds may not be sexy, but boring is beautiful when markets are most volatile. 

¹ Aliaga-Diaz, Roger. “Rising Rates Don't Negate Benefits of Bonds.” Vanguard, 30 Sept. 2021.

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