Why Bonds? #1 – Stocks are risky. Bonds can be safe investments (video)

– Posted in: Asset Allocation

Asset allocation is your most important decision. How much to own in stocks? How much in bonds? Determine the ratio that is appropriate for you, and then maintain it. Bonds are your safe investments. This is the first of four short videos that address why CDs, Bonds, and Bond Funds are critical to building an all-weather portfolio—even during low interest rates.

Video Transcript: Why Bonds? Bonds are your safe investments.

What if the stock market tanks—right before you need the money! That’s coming up.

Hi everybody. Welcome to the video series about bonds. I’m Rick Van Ness. We’re a non-profit site to help you be a smart investor and use common sense to build an all-weather portfolio to finance your dreams.

So, Why Bother With Bonds? The first reason why owning some bonds is always important is because stocks are very risky. If we pay any attention to the news, then we know they are volatile. A good rule of thumb is that they could lose 50% of their value in any year. That year could be this year, or the first year after you retire—so they are risky in the short-term and the long-term as well.

Over the past two centuries, stocks have returned 7% per year above inflation—or a real return twice that of bonds. (1)(2)

But doesn’t this chart just beg our very question: Why Bother With Bonds? One important time is: when you can be hurt by short-term volatility. The ratio of stocks to bonds is the most important lever you have to control your overall investment risk.

Bonds can be safe investments, if chosen correctly.

Bonds are risky too. Later we’ll see that bond values move opposite interest rates and sometimes don’t keep up with inflation. But keep this in perspective! They are an order of magnitude less volatile than stocks and we’ll learn how these risks can be managed.

Now it’s time for some fun. It’s simple. I’ll give you two facts. You choose the fact that is true.
Here’s the first one: The longer you own stocks, the safer they become.
The second one is: The longer you own bonds, the safer they become.
It’s your turn now. Click on the one that is true.

If we use volatility to measure safety, then this one is false. Stocks remain volatile every day of every year, including the day before you sell them 40 years from now. But this is an easy mistake to make because we often hear that “stocks held for decades rarely lose money”. That’s true too, but not losing the amount you originally invested becomes less important than not losing the value it grows to become—and that you come to rely on.

This is correct. These two choices get at a major difference. While buying stocks are buying ownership in companies—something you can keep forever; buying a bond is really just loaning your money for a specific period of time. The longer you own the bond, the closer you get to the maturity date, at which time you’ll get back the full value that you invested. The highest quality bonds are very safe with no surprises. (3)

Later on we’ll look at CDs, bond funds, and other ways to own bonds that have some differences to be aware of.
But next, we’ll look at how bonds can provide welcome ballast to stabilize your portfolio in a bad year
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Thanks for watching.

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Footnotes And Video Production Credits for Why Bonds? Bonds are safe investments.

(1) This chart was created by Professor Jeremy Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania. Used with permission.
(2) John C. Bogle takes the nominal returns in this chart and converts them to real returns in Common Sense on Mutual Funds, 1999, page 8.
(3) This fictitious conversation to illustrate the difference between stocks and bonds was inspired by a posting by Boglehead Nisiprius.

This video may be freely shared under the terms of this Creative Commons License BY-NC-SA 3.0.

Video copyright 2009-2014 Rick Van Ness. Some rights reserved.

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