why hold bonds at all?

With expectations of higher interest rates, the risks to many fixed income investments have risen. This has been widely publicized, and we have discussed these risks in the past. Bond bears point out that yields are near forty-year lows and if interest rates rise, the value of bonds and bond funds will fall. And some well known investors such as Warren Buffett have advocated selling bonds and just holding a mix of cash and equities. Nonetheless, we think bonds should still play an important role in an overall portfolio. Here are some reasons.

• Diversification and reduced volatility: One of the primary reasons to have an allocation to fixed income is for the diversification it provides in an overall portfolio. Historically, bonds have tended to move up in price when stocks and other riskier sectors of the market decline. When stocks and bond returns are not correlated, investors benefit by reducing the swings in their portfolios, resulting in lower volatility. When we looked at times when the S&P 500 experienced significant declines (we used declines of 14% or more for our study) since the 1970s, we see that bond returns have generally been positive.

Large negative stock returns have been offset by positive bond returns