Bonds #5: Bonds' crash can be more of a whimper

This is the final in a series of articles that began with the proposed title, “Bonds: Bracing for the Crash.” In it you learned that 1) I don’t think there will actually be a crash, but that 2) it is likely that sometime in the not-so-distant future, as interest rates rise, bonds will fall. The longer the duration of the bond, the worse the fall will be.

That began our quest for a substitute for bonds. I was looking for something that generated a moderate amount of income with only small to moderate risk. First, as most people used intermediate-term investment-grade bonds in their portfolio, we examined if some other type of bond would be better. Each, unfortunately, had its own problems. Some had the same risk as the bonds they would replace; others looked more like stocks than bonds.

Then there were the non-bond alternatives, but they just substituted one risk for another, often without any defined income stream to lessen the blow.

The problem is that bonds are in a unique asset class with particular characteristics. As such, finding a fitting substitute is like trying to find a pet that is like a dog but isn’t a dog.

Bonds have had a heck of a run for three decades. You not only got a lower risk investment compared to stocks and a higher income source  compared to cash, but you also received a strong capital gain tail-wind as interest rates descended from double-digits in the early ‘80s to close to zero now. I hope you enjoyed it.

Fortunately, in the meantime, a plethora of other assets groups and subgroups became available. It’s easy to own foreign stock as well as foreign bonds. High-income bonds (let’s call them junk) are in an easier to digest form through mutual funds. Real estate and commodities, which used to be very difficult to invest in, are now a simple phone call or mouse click away. And then there are the newer more exotic investment types and strategies. These take some time to see whether they truly belong in your portfolio.

What I am saying is this: We don’t need to find a substitute for bonds in our stock-bond-cash portfolios. Instead we make room for others to join and compliment the mix we’ve been using.

Domestic stocks now include Domestic and Foreign and Emerging. Intermediate-term investment-grade domestic bonds have been joined by Floating Rate, Junk, Foreign, Emerging, and a host of other bond varieties. Real Estate and Commodities are now mainstays of any diversified portfolio. If you don’t want to bother with all of it, there are mutual funds that handle it all for you in a single investment.

With more pieces to the pie, any one of them faltering is no longer a calamity. When they all decide to take a break (think 2008), there will be several slices that will come back quickly enough to help shore up your portfolio.

Perfect it’s not. But it never was. So do your homework. There are answers out there for you.
 

This article was published under the title "Bonds crash won't be calamity" in the WichitaFalls Times Record Newson  August 11, 2013.