Why Bonds? #2 – Treasury Bonds Make Risk Palatable (video)

– Posted in: Asset Allocation

Asset allocation is your most important investment decision: How much to own in stocks? How much in bonds?  Treasury bonds can make stock market risk more palatable, which is the topic of this second 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: Treasury Bonds Make Risk Palatable

Buy high and sell low… Coming up: how bonds help prevent that.

So, Why Bother With Bonds? We already saw that stocks are both attractive, but risky. A second reason to own some bonds is to make that stock market risk more palatable. An allocation to bonds (especially high quality bonds, like Treasury bonds) moderates the short-term volatility of stocks.

Here an investor put $10,000 into the stock market and had a wild ride. Here’s how it felt. (1)

Too many panicked after the market tumbled and sold at a loss. Remember: newspapers, magazines, and television shows all amplify the hysteria that cause some to sell their stocks. That’s bad and might have been prevented if that investor owned a bigger allotment of high-quality bonds.

Here’s what happened to an equal investment in Treasury bonds over this same period. It did fine, but probably most important is if it kept that investor from panic selling during a bad year. Bonds give the risk-averse long-term investor the courage and confidence to “stay the course” when the market periodically tumbles.

Now it’s time for some fun. Here are two statements. You choose the one that is true.

First we have: “Bonds are the underwear in your portfolio.”

Next is: “Bonds are the jewelry in your portfolio.” Click on the one that is true…
< — 10 SECOND COUNTDOWN – >

Nah, no one is going to brag about their bonds at a party, although they might brag about some stock they got lucky with, or show-off their jewelry.

Correct! The full quote by Dr. William Bernstein is “Bonds are the underwear in your portfolio—unexciting and not much thought about, but select the wrong pair and you’ll be surprised at just how uncomfortable you are.” Perfect! Because this episode is all about planning to take as much risk as you comfortably can, after considering your goals and circumstances, and then sticking with your plan no matter what happens in the stock market. Dr. Bernstein made this comment when addressing whether to buy bonds that will mature in the short-term or the long-term. But I also like it because it applies to choosing between high-quality bonds or yield-yield bonds. We’ll get to all that later.

But first, I have asserted that Bonds can be a very safe bet. Is that really true? That’s next.
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Footnotes And Video Production Credits for Treasury Bonds Make Risk Palatable

(1) Market data from Fidelity website.
(2) Dr. William Bernstein quote from http://www.efficientfrontier.com/ef/997/maturity.htm

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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