We are human, and that means even the most mature and experienced investor, given the right set of circumstances, will panic-sell.
Very few of us had the mettle to sit out 2008 and 2009, and 1987, 2000 and a lot of other sell-offs were no different.
The driving forces behind most losses are never fundamentals or even black swan events. The primary reason we sell into falling markets is volatility.
With that in mind, let’s look at how to limit price volatility in bonds and control the urge to dump into a falling market – something every person reading this has done.
For bonds, it’s all about the length of time your money is exposed to inflation and market risk. This is called duration. We’ve talked about it before but not in a preventative sense.
Duration is the measure of how much a bond’s price will drop with a one-point increase in rates. One of the primary variables in duration is maturity. Quality is the other.
It’s essentially a volatility sensor.
The shorter the maturity of your bonds, the lower the duration. The lower the duration, the less a bond will drop in value.
As you reduce the volatility of your holdings, your confidence in your bonds’ ability to deliver as promised in all markets should increase as well.
I say “should” because I have been in this business for a long, long time, and I know not everyone will respond as I predict. Some just can’t help themselves.
But limiting the urge to sell into a down market will eliminate almost all losses associated with it.
The quality variable is simple and cast in stone.
The higher a bond is rated, the more confidence its owners will have in its ability to survive anything the market can throw at it.
And as I said before, as confidence in our holdings increases, our urge to dump to “cut our losses” drops.
No one ever did anything by cutting losses but establish them.
The duration of a bond is usually listed on the same page in a broker’s inventory as the bond description. It should be the first stop for those who know their risk tolerance and have learned to stay well within it.
Reduce your volatility, and keep more of what you have.