Do I really need bonds in my portfolio?
from dr Anna McKeone, Guest Writer
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 that people consider them to be fairly “safe” money. Additionally, they can (but not always) be negatively correlated with stocks — meaning your bonds can be worth more over the same period if stocks are falling.
But for some of us, attachments might not make sense. Because of this, I have exactly 0% bonds in my portfolio.
Trade training for time in the market
Like most of you in the medical field, I already had some gray hairs when I first started investing. Because of the late start (and with little wealth to lose), I was willing to go all-in on stocks to take on more risk for better long-term 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 caregivers. The power of compounding is the real thing, and to make up for that lost time you must either save more annually for retirement, take more risks to get better expected returns, or both. I have chosen to hold 90% stocks and 10% real estate with no allocation to bonds, in part because of my late start and because I feel I must be willing to take more risk to catch up from my decade in college, when I wasn’t at the market.
Long investment horizon
I’m on my own bumpy road to financial independence, and the road is long. A long investment horizon allows me to invest in riskier assets because I expect them to get me there faster over the long term by delivering better returns. The riskiest time for retirees is the few years before and after retirement, when the sequence of risk of return is at its strongest.
Most investors will want to significantly de-risk their portfolio in the years leading up to retirement with something like a bond tent to mitigate that risk. Since I’m still a long way from retirement, I can party when the stocks are going down because to me they’re just selling out (I also party when the stocks are going up and I’m making money with my money).
In recent years of great returns, this has been pretty easy to digest. And then came 2022 with negative returns. While it’s painful to watch my retirement account numbers go down instead of up, I know that if I don’t pull the money out, the loss is only theoretical. Also, I’d still rather lose 10% of my money this year, but for the last few years I’ve made 25% a year on the same money. If I hadn’t had it in stock at the time, there would have been a lot less total on the account to date. Furthermore, I won’t need this money for 20 years and am confident that by the time I need it this money will have come back and made more.
fungibility of debt
But the main reason bonds are a no-no for me right now is because money is fungible. If money is fungible and debt is money, then that means debt is also fungible. I currently have low-interest debt, including my student loans and mortgage, that I am working to pay off. When I prepared my written investment statement, I initially planned a bond allocation. However, when I analyzed my financial situation more closely, it made no sense to invest for a 3% non-guaranteed return while I was 3% in debt. The idea of investing in a bond with money essentially borrowed from my home or student loans felt wrong.
I realized that my low-interest debt essentially functions as negative borrowing. By paying off my low-interest debt instead of investing in bonds, I guarantee that return. Some would say, “Leverage all the low-interest debt you can!” Reference Jim Dahle’s excellent talk on debt at the Physician Wellness and Financial Literacy Conference (you can find this talk in the Continuing Financial Education 2022 course). Taking the percentage of your asset allocation that would normally be allocated to bonds and using that money to pay down your low-interest debt will have the effect of increasing your net worth while taking steps toward a debt-free life.
Do you have a pillow?
To do this responsibly, I need easy access to money if something happens to me and the market is down. That includes having adequate emergency funds, as well as access to credit cards and a home equity line of credit in case things really go wrong. My plan is that once my low-interest debt is paid off, I’ll use that money to bond as usual, in line with my asset allocation target.
When are bonds right for me?
I see adding bonds when I’ve paid off my debt. I’ll even pay off my house first as I’m debt shy and love the idea of not owing anyone anything. Once I’m out of debt payments, I’ll add an allocation to bonds, probably somewhere around 25%. Then, as I approach retirement, I plan to create a retirement tent for the 4-5 years before and after retirement when the risk of return is highest. A bond tent effectively increases the allocation to bonds in the years leading up to retirement, and I’ll probably aim for as much as 75% at that point. In the years after retirement, I plan to go back to around 40% borrowing. If all goes as planned and my retirement savings remain adequate, I will start increasing asset allocation to equities again. The more legacy funds I have, the more I can donate.
As they say, personal finance is personal. Regardless of what you do with your investments and debt, make sure you understand it, that it’s part of your written investment statement, and that it will allow you to get a good night’s sleep.
What percentage of your portfolio is bonds? Do you think it makes sense to have absolutely zero bonds in your possession? Has the crater market of 2022 changed your mind? Comment 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.]