If you have been invested in traditional bonds for any amount of time since 2010 you probably have noticed they are no longer very good at protecting your portfolio, nor providing reliable income.
(By the way, traditional bonds can include corporate and municipal individual bonds, bond funds, and bond indexes offered by advisors and retirement plan sponsors all over the world).
Since the 1970s we have all been told that traditional bonds were a way to protect our portfolio and provide reliable income. This was a big part of the Modern Portfolio Theory and was a concept that was seemingly immortalized by the 40-year bond-bull-market that followed.
But in today’s market, traditional bonds no longer perform like they used to.
2021-2022 highlighted this perfectly.
If you owned traditional bonds in 2021 you may have noticed you weren’t earning much of a yield. But you were probably still owning traditional bonds because you expected them to provide some sort of protection against losses in your portfolio.
But in 2022 the Fed started raising rates and bond prices fell almost 20%, which was nearly as bad as the 25% the S&P 500 lost.
And since then the S&P has fully recovered (including dividends) while traditional bonds still have not bounced back over a year later!
You may be planning on holding on to your bonds, awaiting the Fed to lower rates again. But rates are not going back down to post-pandemic levels so bond prices will not come back up to post-pandemic prices.
Plus, the next time there is a major systemic sell-off in the market you should expect to see a sell-off in traditional bonds as well. Just like 2020. Just like 2008.
Now you may be wondering if there is any way to diversify out of traditional bonds.
There are a plethora of ways to diversify out of bonds.
One of my favorites is Structured Notes (which are really just custom bonds- ideally issued by a large US bank like BOA, Citi, JPMorgan, etc.).
Why should you ask your advisor about structured notes?
- Better protection (many structured notes protect you 100% from losses!).
- More upside (many structured notes offer a multiplier on an underlying index -a recent note a client bought has a multiplier of 115% of the S&P 500
- More tax-efficient- structured notes can be setup to obtain capital gains treatment on 100% of the profits whereas with traditional bonds the interest is taxed at ordinary income rates (or you can buy muni bonds and earn less interest by an amount roughly equivalent to the taxes you would pay anyway).
That may seem a little confusing so here’s a short video explainer:
P.S. Want further proof that traditional bonds are junk?
Did you know that financial advisors don’t usually buy traditional bonds in anywhere near the same proportion as they recommend to their clients? Now why would that be? Don’t worry, I am going to write more on that some other time.