Bonds don’t get as much love as stocks because they are considered boring. It’s hard to get rich quick off a bond. But it is possible to see a quick windfall if you pick the right high-flying stock.
Despite the lack of sexiness in bonds, if you’re serious about achieving financial independence or are already financially independent, bonds are an integral part of your portfolio.
As my wealth has grown over the years, so has my appreciation for bonds. Bonds have not only provided me tax-efficient income and peace of mind in my post-work life, bonds have also provided me a solid return since I graduated from college in 1999.
Stocks Versus Bonds Performance From 1999 – 2019
Take a look at the 20-year total return of the Vanguard Long-Term Bond Index Fund (VBLTX) versus the S&P 500 Index ETF (SPY).
As you can see from the chart, sometime around 2001, VBLTX started to outperform the S&P 500 and it never stopped outperforming!
The total return for VBLTX from 1999 – 2019 was 272% versus only 210% for SPY. While VBLTX’s outperformance is surprising, what’s even more surprising is the magnitude of the outperformance.
Bonds is the classic tortoise in the tortoise versus the hare parable. But in this case, the tortoise has been leading since almost the very beginning.
Of course, using a different bond investment may yield different results.
If you don’t like using VBLTX as a proxy for the bond market, we can use the Vanguard Total Bond Market Index Fund Investor Shares (VBMFX in blue) and compare it to the Vanguard Total Stock Market Index Fund Investor Shares (VTSMX in blue).
Bonds outperformed the stock market from 2001 to about 2013, or for 13 years. Since 2013, stocks have outperformed bonds. In other words, bonds outperformed stocks at about a 2:1 ratio during this 20-year time period.
The way I look at the chart above is that stocks are way above their 20-year trend relative to bonds. Therefore, I’m underweight stocks. You’ve got to figure out how much you’re comfortable losing for the potential reward.
Peace Of Mind In Retirement Rocks
Once you’ve amassed enough money to not have to work a day job, one of your key objectives is to move your money into the background so you can live your best life without having to worry about money.
As a stay at home dad now, I no longer have the time or energy to do extensive research on my investments and watch the stock market for hours like I used to.
Instead, what little spare time I have left is spent either writing, playing sports, coaching or napping. Sometimes my wife and I will go out for a nice meal or order an in-home masseuse.
At this stage in my life, the certainty of getting a 4% – 6% return is a far more desirable outcome than the potential for getting a 15% return or suffering a 15% loss. It is up to all of you to calibrate how much stress you are willing to feel for your potential return.
Below highlights the worst year for bonds was a 2.9% decline in 1994. The worst year for stocks was a 38% decline in 2008.
A negative 2.9% loss as the worst year means that bonds performed better than negative 2.9% in 2008, the worst financial crisis year in modern history. After adding back the interest payment, VBLX was only down about 1.5% in 2008. I’ll take it!
If you are already truly satisfied with your financial achievements, then you should also be finding bonds attractive. If you aren’t willing to have a sizable bond portfolio (20% or more of your net worth), it’s probably because you are still not as content as you think.
What About The Future Of Interest Rates?
Ever since I started working in finance in 1999 and ever since I started writing online about stocks and bonds in 2009, there’s been a plethora of warnings about interest rates going up. And if interest rates go up, bond prices get hit.
I will reiterate my strong belief that interest rates in America will stay low for the rest of our working lifetimes.
There is no reversing technology that allows information to flow instantaneously to make better macroeconomic decisions.
It will take beyond our lifetimes for the US dollar to lose its stranglehold as the world’s most sovereign currency.
Foreign entities that try to aggressively unwind US Treasuries will suffer self-inflicted wounds to the rest of their US asset portfolio.
Thanks to globalization and immigration, we have successfully imported deflation to make our goods and services more affordable. Electronic goods and manual labor have never been cheaper.
The only real inflationary concern left for consumers is healthcare costs. Looking at how unfit our nation has become, something has to give.
Ripoff college tuition doesn’t concern me as much because spending a fortune on college is a choice. And further, people are wisening up that college is increasingly becoming a bad investment.
The Consumer Keeps On Winning
Perhaps there’s another reason besides strong performance since 1999 as to why some investors love bonds so much. The stronger bonds perform, the more the investor is reminded about lower rates.
Below is a one-year chart of the 10-year bond yield, which has collapsed, partially due to stalled trade talks between the US and China.
At <2.26% on the 10-year, we are now below the March 25, 2019, previous low point of 2.41% where I encouraged folks to consider refinancing their mortgage.
I mentioned that I had failed at getting the then lowest mortgage rate possible of 2.875% for a 7/1 ARM with fees baked in. Instead, I had locked in a 3%, 10/1 ARM with fees baked in.
But never one to quit, I called my bank after the recent decline in interest rates and told them I wanted a rate renegotiation down to 2.875% like it had initially teased me to lock with them. If they didn’t match a competing bank, I would walk.
In the end, they acquiesced. With interest rates where they are, my bank will likely still be making the same spread it had when it was going to lend me money at 3%.
For those who missed the previous mortgage refinance window, now would be an excellent time to check online for the latest mortgage rates and call your existing mortgage lender.
Winning Three Times
Consumers should feel like they are at least winning twice. Once as a bond investor making a continued positive, steady return. And once as a borrower who gets to lower their mortgage payment and boost cash flow.
When you can combine making money with saving money, you have hit a personal finance jackpot.
But there’s a third win for bond investors who are also homeowners. That win is seeing your property grow in value as lower rates bring in more demand. After all, a home is like a bond, but with a valuable utility component.
The last thing you want to do is be a renter who does not invest in bonds or stocks or any investment that tends to appreciate over time. You will eventually experience a triple loss as asset prices will likely run away from you.
There’s just one big warning sign we should all be aware of. Lower bond yields are correlated with slowing economic growth. The bond market is telling the Fed to stop hiking and potentially start cutting.
The key is for the economy to have a soft landing and for policy makers to avoid self-inflicted wounds. But even if we do have a multi-year recession and the worst trade war in history, the optimist in me says that bonds will continue to do well as investors flee to safety.