Why Bonds Make For Risky Investing

One of the most common misconceptions surrounding volatility and asset classes is that bonds are less volatile and, therefore less likely to earn investors “bad” returns. While was certainly true in the 2008 and 2009 investment years, bonds are just as likely (or even more likely) to earn negative returns as stocks. In fact, in the ten years from 1999 to 2009, Global Bonds as measured by the Merrill Lynch Global Government Bond index returned 5 years of negative returns versus the MSCI EAFE (international equities index) which also returned 5 negative years.

Of course, the benefit to bonds is that those losses were less in terms of total percentage. However, in terms of total overall performance, bonds were among the worst performers in 5 of those ten years (by comparison, global equities were the worst performance in just 1 of those ten years).

Ultimately, the reason why bonds will perform so poorly has to do with the fact that markets tend to be on the rise over the long-term. This happens to coincide with rising interest rates, which means that as rates increase, the market value of government bonds are in a falling trend.

Remember, bonds will pay a certain amount of income. This means that if that income, which is set during the bond offering and does not change, can be replaced with higher income (which happens when rates increase), then the value of that bond on the open market will drop so as to entice buyers in the open market to purchase the “cheaper” bond with the lower income rather than buying that same income at the current higher rates.

There could be a point in time when bonds will represent great long-term opportunities and that is normally in extended periods of dropping interest rates, such as what was witnessed since the mid-1980’s. In most of these cases, however, the bonds in question were either corporate bonds or even mortgages (which are similar to bonds).

But with so much expectation these days that rates are expected to rise (and rise aggressively at that), taking a long-term position in bonds with the hopes that there will be better gains and less volatility than an equity portfolio with steady dividend payments is an unreasonable expectation. For this reason, investors who are looking at fine tuning their income class investments will need to take a much-closer look at those bonds and make sure that the decision will not hurt them in the long term.

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