In some corners of the investment world, word is bonds are toast.
Truth be told, they have been out of favor for some time. Now, with interest rates on the rise — fueled by resurgent levels of inflation not seen since the 1980s — investors’ fears are being realized.
The thinking appears to be…
- Interest rates, which have been near or even at zero, are on the rise.
- And, of course, when interest rates rise, bond prices fall. If you need to sell, you’ll face a capital loss.
- The exceptionally low rates over recent years has meant lower and lower levels of interest income for investors from their bonds.
- As interest rates reached levels near zero, or even below (negative interest rates), there was virtually no income to be had at all.
- This has meant hard times for savers and income investors.
- Inflation, which is bad for bonds, is now in full bloom.
- While better interest payments are coming from new bonds, any bonds you hold are destined to fall in value.
- Of course, barring default, if you hold your bonds until they mature you get your money back.
- But with inflation, that money now has less buying power. The dollar amount is the same, but the real value as dropped.
- The massive government spending and the burgeoning national debt of the last decade has begun to drive both interest rates and inflation higher.
- The idea that this newly resurgent inflation is transitory, is wishful thinking.
- Little or no income, plus the prospect of capital losses. Not very appealing.
- Bonds are doomed!
As it happens, I agree with all those points except the last. Yet I continue to hold bonds.
Here’s why…
Traditionally, bonds are held in a portfolio for the income they generate and, secondarily, as a counter balance to the volatility of stocks.
Around here, we look at it a bit differently:
- While juicy fat interest payments are nice, and are key for many who hold bonds, they are not the primary reason to hold bonds on The Simple Path to Wealth.
- We hold bonds primarily as ballast to smooth the volatile ride of stocks, and to provide “dry powder” when stocks drop and we rebalance our allocation.
Regardless of the interest rates on our bonds, they still serve that primary ballast function well.
But what about all those scary factors listed above? Well, those affect and apply mostly to individual bonds. But we don’t hold those.
We hold our bonds in VBTLX, and that makes all the difference.
Why does holding bonds in a broad-based bond index fund like this one make all the difference?
Glad you asked!
- VBTLX is Vanguard’s Total Bond Market Index Fund.
- This means it holds thousands of bonds.
- These bonds have many different maturities, so some are always coming due.
- In turn, that means VBTLX has a steady flow of cash with which to buy the new bonds as they are issued.
- As inflation drives up interest rates, VBTLX will be buying those higher interest paying bonds.
In short, individual bonds carry risks that are largely mitigated by owning them in a broad-based index fund like VBTLX. This is the major reason to avoid individual bonds and own your bonds in an index fund instead.
While bonds can certainly drop (or gain) in value, they are much less volatile than stocks, especially when held in a broad-based index fund. Just what you want when you go looking for ballast.
If all this has left you confused, don’t feel bad. Bonds are confusing. This post, Bonds, will help you sort it out.
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Addendum…
The day after this post went up, AF posted Owning Bonds in a Low Interest Environment. Had I known, I would have asked him for it as a guest post, dropped mine and gone back to my nap.
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For years now I have been a fan of Tuft & Needle and they, in turn, have been both an advertiser and now an affiliate partner supporting this blog.
Back around 2014 Daehee, their founder and CEO, reached out to me and offered to send me his new mattress. They were a new company with one product, what they now call their Original Mattress. From the very moment we opened the package and watched it magically inflate, we loved it.
When we bought Kibanda in 2017, there was no question what mattresses we’d have in both bedrooms. But this time we tried their new Mint version, and we got the new Walnut Frame they’d introduced. Here’s that story.
This year they brought out an even fancier version:
This past July they sent us one to try. Wanting to test it thoroughly before reporting back to you, we slept on it for almost four months until November 1st, when we returned to travel and our nomadic ways.
So what’s the verdict? Another win for T&N!
But that’s no surprise, given my experience with their products and, in some ways, it’s not the important question. That might be…
Which of their three mattresses is best: Original, Mint or Hybrid?
…and that’s a tougher call. While I’ve enjoyed each in turn, I haven’t tested them back-to-back. The current Hybrid is great, as was the Mint. But I also have very fond memories of the Original and would be happy sleeping on it today.
My best advice would be to read the specs, evaluate the price of each and decide what fits your needs best.
It is not like there is a bad choice here, and there is T&N’s very impressive 100-Night Sleep Trial and easy return policy just in case.
Sleep well!
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What I’ve been reading…
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