Allworth co-founder Scott Hanson shares a few essential reminders about a key component of a diversified portfolio.
Do you remember Schoolhouse Rock?
Schoolhouse Rock ran uninterrupted from 1973 until 1985, and then was revived for three-years starting in 1993.
It was an educational public service series of short, animated films, created for children that broadcasted into our family rooms in-between Saturday morning cartoons.
The creation of Schoolhouse Rock was the brainchild of David McCall, an advertising executive, who noticed that his young son, despite being able to memorize the lyrics of virtually every song written by the Rolling Stones, was struggling to learn his multiplication tables. 1
As I sat down this morning to write to you about bonds, I briefly misremembered and thought that the famous Schoolhouse Rock episode, “I’m Just a Bill” - a short cartoon about how a bill becomes a law - was actually titled, “I’m Just a Bond,” but an Internet search quickly proved that it was just wishful thinking.
That’s not to say bonds aren’t important enough to have their own edition of Schoolhouse Rock. It’s merely to acknowledge that the topic of bonds, while a vital instrument for investors, didn’t hold much relevance for pre-teens of the 1970s.
“I’m just a bond.” Imagine that. What follows are 5 important things you should know about them.
What is a bond?
A bond is an investment you buy to earn interest. But unlike purchasing a stock, you aren’t technically buying a slice of a company. You are instead buying a debt security issued by a corporation or government.
Bonds typically have a lifespan, or maturity date, and offer pre-determined interest rates. The entity promises to repay the money you’ve loaned (principal) them back while paying you interest along the way, much like an IOU.
Basically, think of buying a stock as “ownership” and buying a bond as “loanership.”
Why should a bond probably be a part of your portfolio?
It’s fairly likely that you have bonds, maybe even a lot of bonds, in your portfolio. But above I say “probably” because every person’s situation is unique, and because over the last few years (especially in 2022) bonds have struggled compared to how they’ve performed in the past.
That is why you should not consider this as formal investment advice, and why you should instead speak with your advisor if you have any questions about how bonds could fit in your allocation.
But historically, bonds have been an important part of a diversified portfolio because, until the recent high interest rate and white-hot inflationary period, in the most-broad sense, bonds and stocks have tended to move in opposite directions.
This means that, in investment terms, bonds have typically had what is referred to as a “low correlation” to stocks, and so having them in your portfolio has generally reduced risk. (When one zigs the other zags.)
Of course, especially in 2022, the correlation between bonds and stocks increased, with both having difficult years.
Which is larger, the stock market or the bond market?
Most people are genuinely surprised to hear that the bond market is slightly larger in aggregate value than that of the stock market.
According to the Securities Industry and Financial Markets Association (SIFMA), as of 2021, the global market cap for equities was $124.4 trillion compared to the $126.9 trillion value of the global bond market.
Is there a key difference between government and corporate bonds?
Bonds issued by the government are considered safer than bonds issued by a private entity or corporation because the former are backed by … well, the government. So, the possibility of default is obviously much lower than a corporation’s.
To summarize bonds:
- Be they corporate or government, they are entities that are borrowing money from you
- They mature over time
- They pay interest
- From “issue” price to “trading” price, just to name two, bonds have different values
- Like all investments, they carry risk
- They have credit ratings that determine their quality and creditworthiness
If you’re not already a client of Allworth, and you’ve been thinking it might be time to have an investment and retirement readiness check-up with an advisor, or at least get a second opinion … you should.
We offer complimentary, no-pressure appointments, where you will get your financial situation evaluated by an experienced, fiduciary advisor.