After the last few years, some clients are asking whether bonds are worth holding at all – and I understand why.
In 2022, as the Reserve Bank raised interest rates quickly to bring inflation under control, Australian bonds had their worst year since 1989, falling at the same time as shares.
Our Investment Committee has looked at this question closely, drawing on research from Context Capital, and I wanted to share how we think about bonds here at Stephan Independent Advisory.
What bonds are for
The way we see it, bonds aren’t there to win – they’re there so you can hold your shares through a bad year.
Shares are where long-term growth tends to come from, but that growth only helps if you stay invested long enough to receive it. The hardest part of investing is often getting through the difficult years, when the headlines are loud and it’s tempting to sell at the wrong time. Having part of a portfolio that holds its value, and pays an income while you wait, makes that much easier.
That income has also improved. Context Capital notes that holding the whole Australian bond market now pays around 5% a year, up from about 1% in 2020.
Two kinds of bad year
It helps to remember that not every bad year for shares is the same.
In a weakening economy, businesses cut back and the Reserve Bank lowers interest rates. When rates fall, existing bonds paying higher rates become more valuable, so bond prices rise. In 2008, Australian shares fell 38% while bonds returned around 14.5%.
When inflation is the problem, the Reserve Bank raises rates instead. Bond prices fall, and shares usually fall with them. That’s what happened in 2022, when Australian bonds lost 9.7%.
Put simply, bonds protect you from a weak economy, but they don’t protect you from rising prices.
Context Capital’s research shows that since 2022, shares and bonds have moved in the same direction more often than in the two decades before. The cushion is weaker than it used to be, but it isn’t gone. Even when both have fallen, bond losses have generally been much smaller than share losses.
Why this matters for our clients
When company earnings growth slows, or in an increasingly volatile and interconnected world, bonds can bring stability and balance to a portfolio.
For the families we work with, much of their wealth is often tied up in the business, so the wealth they hold outside it has an important job to do. When conditions get tougher, sales can slow and customers take longer to pay, which is exactly the kind of year in which bonds have tended to do their job. Holding assets that don’t rise and fall with the business can give a family options, without needing to sell shares at a low point or draw more heavily on the business.
Bonds can also help if you need access to reserves in the shorter term, if your appetite for risk has changed as you’ve moved closer to handing over the reins, or if you’d simply sleep better knowing you hold different asset classes that don’t always behave the same way in a downturn. It’s one reason we encourage our clients to build a Plan B that doesn’t rely on the business alone.
How we think about it
Our Investment Committee doesn’t try to predict what markets will do next. Nobody knows which kind of bad year comes next, a weak economy or rising prices. So we may hold bonds alongside shares, cash and other assets that don’t all move together.
For our clients, the starting point is what the money needs to do. If you’re drawing an income in retirement, or have a large commitment coming up in the next few years, it matters a great deal that those funds aren’t relying on shares during a downturn. That’s the heart of sequencing risk. Setting aside more stable assets for near-term needs gives the growth part of a portfolio the time it needs.
What about term deposits? They have a place, particularly for money you’ll need soon. But when rates fall, your next term deposit pays less, whereas existing bonds tend to rise in value. And as we’ve written before, inflation can erode term deposit returns over time.
Keeping perspective
Everyone’s reasons for investing are different. For some people that’s a comfortable retirement. For others it’s keeping a business in the family, supporting the next generation or giving back to their community. Bonds won’t make those goals happen on their own, but they can help keep them on track when markets are at their least predictable.
If you’d like to talk about the role bonds play in your own portfolio, James and I are always happy to help. New to Stephan Independent Advisory? Book a 15-minute clarity call.
The information contained in this article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial planner as to whether this information is appropriate to your needs, financial situation and investment objectives. Whilst every care has been taken in the preparation of this article, Stephan Independent Advisory, its directors, authors, consultants, editors and any persons involved in the preparation and distribution of this article, expressly disclaim all and any form of liability to any person in respect of this article and any consequences.
