During the pounding stocks took in the last quarter of 2018, one part of the market was virtually untouched by the volatility that rocked our worlds.
Yes, as you might expect from the bond guy, that part of the market was my corporate bond portfolio.
We did have a little downside – an average of 3.5% through the end of November. But except for our energy-related bonds, our fluctuation percentage remained about the same throughout the December carnage too.
Energy bonds are tied directly to crude prices, and that market has been one crazy place for several years. That craziness even hit our portfolio, but for only about 5%.
Now, before you start worshipping me as the new “guru of the markets,” let me make this abundantly clear… There’s no magic here. The incredible stability my bond portfolio displayed, even in the worst December on record, should not have been a surprise to anyone who knows bonds.
I won’t lie to you and tell you I wasn’t on edge when the stupid selling hit in late December. I was.
But my almost 30 years of working in bonds have taught me that if you stick to a couple of cast-in-stone, time-proven techniques, you can sleep well and make money with certain bonds in all markets. And we just did.
We didn’t take any losses, and we continued to earn our minimum expected annual return – about 6.5% on average – throughout the entire rout.
Here’s how I do it…
First, unlike with stock diversification, I recommend you own as many small positions – one or two bonds per position – as you can manage. Holding 40 or 50 different bonds is not a problem for most.
We do this because, despite the low default rates most bonds have (0.1% to about 6% over the long term), you always want to spread your risk around as much as possible. Because bonds require almost no maintenance or handling, you can own and manage many more than you can in most stock portfolios.
Second, own only super-short maturities in all markets – an average maturity of five years, but no longer than seven or eight years. The shorter the maturity of a bond, the lower the price volatility.
Yes, that is a cast-in-stone relationship, and it worked beautifully in the fourth quarter of 2018.
And in case you haven’t figured it out yet, emotional reactions to market fluctuations are responsible for almost all losses the average guy incurs in stocks and bonds.
Third, plan to have at least one bond maturing per year over a seven-year time frame. This allows you to have fresh money available every year to reinvest as rates move up. And, in this market, higher rates are all but guaranteed.
And despite the money media’s mantra that higher rates mean losses in bonds, time has proven that if you buy into a rising rate market, you increase your return.
That’s it! As I said, this isn’t magic, but market stability is something that every person over the age of 50 has to have.
Bonds are a forgotten asset for most. But if you want to avoid another unmerciful beating like the past three months, you have to make them an increasing percentage of your portfolio as you age.
The bad news? Wall Street makes it almost impossible for the average guy to do what I just described. Why that is, and how to beat that system, is a topic for next time.