Do I really need bonds in my portfolio?
By Dr. Anna McKeone, Guest Editor
Even for early and mid-career investors, the most respected asset allocations recommend holding bonds. This recommendation is based on the idea that bonds don’t fluctuate as much as stocks, and it’s to the point that people consider them to be fairly “safe” money. Additionally, they can (but not always) be negatively correlated to stocks, meaning that if stocks are down, your bonds may be worth more over the same period.
But for some of us, obligations may not make sense. Here’s why I have exactly 0% bonds in my portfolio.
Trading Education for Time in Market
Like most of you in the medical field, by the time I started investing I already had gray hair. Due to the late start (and with few assets to lose), I was willing to bet on equities to take on more risk and get better long-term expected returns. Many of us have friends who had been contributing to their retirement accounts for a decade by the time we started making money as participants. The power of compounding is the real deal, and to make up for lost time, you either need to save more each year for retirement, take on more risk for better expected returns, or both. I chose to hold 90% equities and 10% real estate with no bond allocation, in part because of my late start and because I feel I need to be willing to take more risk to catch up on my decade of success. graduate school when I wasn’t in the market.
Long term investment horizon
I’m on my own bumpy road to financial independence, and my road is long. Having a long-term investment horizon allows me to invest in riskier assets, because over the long term they are expected to get me to my destination faster with better returns. The riskiest period for retirees is the few years before and after retirement, when the sequence of performance risks will have the greatest impact.
Most investors will want to significantly reduce their portfolio risk with something like a bond tent in the years around retirement to mitigate this risk. Since I’m still a long way from retirement, I can celebrate when stocks are down because to me they’re just on sale (I also celebrate when stocks are up and I’m making money with my money) .
Over the past few years, with excellent yields, this has been quite easy to digest. And then came 2022 with negative returns. Although it is painful to see my retirement account numbers go down instead of up, I know that unless I withdraw that money, the loss is only theoretical. Also, I would still prefer to lose 10% of my money this year, but that same money has been gaining 25% per year for the past few years. If I hadn’t had it in stock during that time, there would have been a lot less total in the account to date. Also, I won’t need this money for 20 years and I trust that when I need it, this money will come back and bring more.
But the main reason bonds are off limits for me right now is that money is fungible. If money is fungible and debt is money, that means the debt is also fungible. I still have low interest debt, including my student loans and my mortgage, which I am trying to pay off. Initially, when I was preparing my written investment statement, I planned to have a bond allocation. However, on closer analysis of my financial situation, investing for an unsecured 3% return when I had 3% debt didn’t make sense. The idea of investing in a bond with money that is basically borrowed from my house or from student loans struck me as wrong.
I realized that my low-interest debt basically worked like a negative bond. By paying off my low-interest debt instead of investing in bonds, I guarantee that return. Some would say, “Take advantage of all the low interest debt you can!” And those people I would refer to Dr. Jim Dahle’s excellent talk on debt at the Physician Wellness and Financial Literacy Conference (you can find this talk in the 2022 Continuing Financial Education course). Taking the percentage of your asset allocation that would normally go to bonds and using that money to pay off your low-interest debt will have the effect of increasing your net worth while taking steps toward a debt-free life.
have a pillow
To do this responsibly, I need easy access to money if something happens to me and the market goes down. This includes having an adequate emergency fund as well as access to credit cards and a home equity line of credit if things get really bad. My plan is that once my low interest debt is paid off, I will use that money, according to my target asset allocation, for bonds, as is generally recommended.
When will bonds be right for me?
I see obligations added when my debt is repaid. I’ll even pay for my house first, because I don’t like debt and I like the idea of not owing anyone anything. Once I run out of debt repayments, I’ll add an allocation to bonds, probably around 25%. Then, as I approach retirement, I plan to create a bond tent for the 4-5 years before and after retirement when the return risk sequence is highest. A bond tent effectively increases bond allocation in the pre-retirement years, and I would likely target up to 75% then. In the years following retirement, I plan to return to about 40% bond. If all goes according to plan and my retirement fund remains sufficient, I will start increasing the asset allocation to equities again. The more money I have in inheritance can then be directed to more donations.
As they say, personal finance is personal. Whatever you choose to do with your investments and debt, make sure you understand it, make it part of your written investment statement, and give you a good night’s sleep.
What percentage of your portfolio is in bonds? Do you think it makes sense to have absolutely zero bonds in your possession? Has the crater market of 2022 changed your opinion? Comments below!
[Editor’s Note: Dr. Anna McKeone is a practicing emergency physician and a lover of the outdoors and personal finance. You can find more of her work at The Bumpy Road to FI. This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]