By Kyle Tetting
Questions may be my favorite part of client meetings.
While I read, watch and listen to financial experts opine on what should be happening in the markets and the economy, much of what they say is in an echo chamber. I’m not suggesting the ideas aren’t helpful or that they don’t provide useful insights, but often they aren’t relevant to what many people are actually wondering about their money.
When we get good questions, we share them across the firm and often include them as the foundation for a discussion on the Money Talk Podcast. So I appreciate a great question we received recently from a podcast listener, a question that resonates with many of the conversations I’ve had with balanced investors. We addressed the question on the April 19 podcast, but I want to dive in a little deeper here.
I’m paraphrasing, but the listener was speaking to the heart of the place for fixed income in our portfolios. In short, he wanted to know what role bonds should play if, for more than a decade, they’ve offered very little in the way of return. It was an especially relevant question for this listener as he explained he has been taking required minimum distributions recently. If not for the strong returns of stocks in his portfolio, he said, he would have been forced to sell bonds at lower prices than what he had paid for them.
As a firm, we’ve spoken for decades about bonds being the piece that provides an inevitable source of withdrawal. It’s an asset class that generally zigs when the stock market zags, and so it should be a reliable source of withdrawals when the rest of a balanced portfolio isn’t behaving.
It seems logical then that for investors taking money out of their portfolios, bonds would have been an easy place to pull from. However, the last decade plus has been accompanied by immense returns from stocks. As a result, we’ve spent the past few years often trimming gains from the stock portion, given how robust returns had been.
Meanwhile, despite behaving differently than stocks, bonds aren’t without risk. After years of zero interest rate policies and a premium being paid for any extra interest at all, the transition away from that environment proved painful.
Bond investors endured losses in 2022 as a direct result of the preceding low rates. In particular, those investors saw the prices of their existing bonds decline as they began to look less attractive relative to newer bonds issued at higher rates.
The situation ahead looks markedly different.
Interest rates, while having the potential to move higher still, appear unlikely to see the same rapid pace of increase of the last two years. Further, rates have moved off the zero lower bound to offer attractive alternatives for investors. No longer are we forced to look strictly at stocks for the potential for positive real returns: Money markets, CDs and other safer alternatives all offer attractive rates.
Add in the potential for interest rates that may move lower at some point in the future, and the same head winds to bond prices two years ago could become tailwinds. In other words, investors would be willing to pay a premium for bonds issued in today’s higher interest rate environment should rates fall.
So, whether interest rates fall and bond investors benefit from their now more in-demand holdings or they stay higher for longer and offer attractive yields, the outlook for bond investors has improved.
None of this is to say that investing in bonds is a panacea. Bonds have unique risks, like the potential default of an issuer, in addition to the risk that a fixed interest rate may struggle to keep pace with inflation at times. But as part of a balanced portfolio, bonds offer an alternative to simply riding the waves of the stock market.
If you have a question you’d like discussed on the Money Talk Podcast, share it with your advisor team.
When considering where we go from here, the role of bonds hasn’t changed much for me. What has changed is the outlook.
Where recent history saw us trimming stock gains to provide for required minimum distributions, our near future may well see us falling back on those same underappreciated bonds the next time the stock market hits a rough patch. It’s the very reason why we trimmed the stocks in the past: We sell the thing we feel is giving us the most favorable pricing.
In the past decade plus, stocks compensated for the uncertainty in bonds. And while I remain optimistic the road ahead is bountiful, bonds appear increasingly likely to provide for the uncertainty in stocks in the years ahead.
Thanks for asking.
Kyle Tetting is president of Landaas & Company, LLC.
Learn more
Investor upsides as interest rates rise, a Money Talk Video with Kendall Bauer and Kyle Tetting
Bonds also face investment risks, A Money Talk Video with Tom Pappenfus
Get the total picture of your investments, a Money Talk Video with Paige Radke
Be patient holding bonds as rates rise, a 2018 Money Talk Video with Steve Giles
(initially posted April 25, 2024)