By Tim Courtney, Chief Investment Officer
In the first installment of this series, we will examine the current income environment and discuss the role bonds should play in portfolios today.
Historically, investors have turned to bonds to both manage risk and generate a steady source of income. You may be familiar with the traditional “balanced” or “60/40” portfolio – which is still common today – where 60% of portfolio assets are invested in equities and the other 40% in bonds.1
You may have also come across the old rule of thumb suggesting the percentage of stocks in your portfolio equal 100 minus your age, meaning a 65-year-old should have 35% in equities and 65% in less-volatile investments such as bonds.2
There are valid reasons for utilizing these portfolios, but current yields on bonds are making it harder to generate future returns with traditional allocations. Consider the 10-year Treasury, for example. Ten, fifteen, and twenty years ago it was yielding 3.4%, 4.4%. and 5.3% respectively.3 Today it is just above 1%, only about half of the expected rate of inflation over the next decade.4
The Fed has communicated their intent to keep rates low for a number of years, and the US government has every incentive to keep rates low to facilitate the payment of interest on our debt. We expect interest rates to rise modestly from 2020’s extremely low levels but to remain well-under those levels of decades past.
As for the future expected return on bonds, the current yield is a good estimate. The 10-year Treasury yield a decade ago was 3.4%.3 The Barclays Aggregate Bond Index return over the last decade was close, at 3.7%.5 We expect future bond returns to be near 2% annually.
At Exencial, we still believe bonds play a role in portfolios to lessen volatility, manage risk and store liquidity. Bonds can also be used opportunistically when waiting for an attractive entry opportunity into equities. However, the over-utilization of bonds and cash will pull future expected returns lower and make it more difficult to meet the return goals of many investors.
In the next part of this series, we will discuss options investors might consider to generate income and returns while traditional bond yields are so low. Stay tuned.
Sources:
1. Investopedia (8/12/20) – Why a 60/40 portfolio is no longer good enough
2. Investopedia (2/9/20) – Stock allocation rules
3. Treasury.gov (1/14/20) – Daily Treasury yield curve rates
4. Forbes (12/24/20) – The key fixed income challenge for 2021
5. Morningstar (01/14/20) –Total return for the BB Barclays US Aggregate Bond Index
The Bloomberg Barclays Aggregate Bond Index, is an index used by bond traders, mutual funds, and ETFs as a benchmark to measure their relative performance. The index includes government securities, mortgage-backed securities (MBS), asset-backed securities (ABS), and corporate securities to simulate the universe of bonds in the market.
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