Safe to Jump Back into Bonds?

With interest rates creeping higher and stocks having gone on quite a run, many investors are considering jumping back into bonds.

Is it safe to invest now?

Not if you’re talking about intermediate or long-term bonds. Rates are still too low and risks too high to invest in longer term bonds. If market interest rates were to go up 4 percentage points, the value of a 10-year duration bond would plummet by a whopping 40%.

But short-term bond funds do belong in your portfolio. When rates rise, they should hold their value. Their yields are modest, but they have less downside than longer term bonds — and safety is what you want in bonds.

Bonds in a portfolio reduce volatility, cover short-term cash needs and preserve dry powder to deploy opportunistically in a market downturn. If you’ll need to withdraw money from your portfolio within the next five years, cash or bonds are needed.

Even aggressive investors should own some bonds because they have a low or negative correlation with stocks. In every year since 1977 in which large U.S. stocks have had negative returns, the bond market has had positive returns of at least 3%.

How much fixed income do you need? It varies widely depending on individual circumstances, and you don’t want too little or too much. The proper mix of stocks and bonds for a specific investor is dependent on his or her risk tolerance. So long as nothing major changes in your life, this balance should be maintained regardless of market conditions.

I caution against overinvesting in bonds since doing so will likely cause you to lose the race against inflation.

Why going short-term is smart

Taking on more risk in a bond portfolio isn’t always a poor strategy, but it’s not a good one today. The prices of riskier fixed-income investments — like long-term, foreign and junk bonds — have been driven up by yield-hungry investors. But bond rates remain very low by historic standards.

Bonds are for protecting your wealth, not for risking it. Put your fixed-income allocation in low-yield, safe investments that won’t be too adversely affected by rising interest rates.

Such securities may include money market funds, short-term corporate and municipal bond funds, floating-rate loan funds and funds pursuing absolute-return strategies. Although these investments will earn less in the short term than a riskier bond portfolio, rising rates will not hurt their principal value as much.

When rates go up, you’ll have more money available to reinvest at higher interest rates.

When bond yields begin to approach their historical averages, then that will be the time to move some assets into longer-duration bonds. But even then, put most of your fixed-income allocation in short- and intermediate-term bonds.

Benjamin C. Sullivan, CFP, is a portfolio manager and financial planner with wealth manager Palisades Hudson Financial Group. He can be reached at ben@palisadeshudson.com and is based in the firm’s Scarsdale, NY, office.

Palisades Hudson is a fee-only financial planning firm and investment advisor with more than $1.2 billion under management. It offers investment management, estate planning, insurance consulting, retirement planning, cross-border planning, business valuation and appraisal, family-office and business management, tax preparation, and executive financial planning. Based in Scarsdale, NY, it has branch offices in Atlanta, GA, Fort Lauderdale, FL, and Portland, OR. Read the firm’s daily column on personal finance, economics and other topics at http://palisadeshudson.com/current-commentary. Twitter: @palisadeshudson.