How much risk do we have in our portfolios? This is a question a lot of investors have been asking themselves as a banking crisis began last week at SVB Bank in California but quickly spread to the east coast and beyond.
Reviewing risk levels is always a prudent practice in investing. But after a tough year for bond investors in 2022, as well as current market dynamics, I believe it is an even more important time to re-examine the use of bond investments in your portfolio.
Stocks vs. Bonds
Stocks are a key pillar of any investment portfolio. In the long-run they can provide the growth that many investors both desire as well as need for their future objectives. However, they are inherently risky and at times can very quickly lose significant value.
One of the strongest ways to balance this risk is the use of fixed-income or bond investments. These debt investments generally offer greater income than stocks as well as historically much less risk.
The key point is that the other historical benefit of bonds is they tend to perform well when stock prices move sharply lower. This is generally referred to as correlation, or how similar the moves in one investment are to another. This low correlation between stocks and bonds has provided great diversification benefits to investors and allows for a decision of how much bonds to hold directly relating to the decision on risk.
Didn’t bonds not work last year?
Last year was a tough year for investors. Besides cash reserves, most investments lost value as inflation soared and The Federal Reserve worked to quickly raise interest rates.
However, according to historians, bond investors were particularly hurt as 2022’s loss was their worst year on record. In general, I have found that bonds are much less understood than stock investments. This lack of understanding I believe leads to a lack of desire to hold them even in more “normal” markets. Given last year’s challenging year for bonds this has led to even more negativity towards them.
However, despite last year’s relatively poor performance form bonds compared to themselves, they still held up much better than stocks! As seen below, the intermediate term bond index lost approximately 13% in 2022. But it still held up much better than a stock portfolio alone, even in their worst year on record!
2022 Asset Class Returns
Intermediate Bond Index -13.10%
US Large Cap Stocks -18.1%
US Small Company Stocks -20.4%
US Technology Stocks -33.5%
Bond Performance during SVB Bank Collapse
Coming in to 2023 bond rates and valuations looked much more attractive. But because of last years challenging year, and the correlation benefit being less than previous down markets, many investors came into this year with an even more dower view on bonds.
However, over the past week as we have seen challenges unfold in the banking system, bonds began to perform more similarly to longer-term expectations.
Over the past week, US large company Stocks have lost approximately 5%. While at the same time bonds performed very well as investors sought their safe haven nature and poured into them. This has led bonds to be positive by 2.7% over this time.
Stock & Bond Returns (Week of SVB Failure)
Intermediate Bond Index +2.7
US Large Cap Stocks -5%
The chart above reviews different stock to bond portfolios performance over the past week. The far left is an extremely conservative portfolio with 100% in bonds and the far right is an extremely aggressive portfolio with 100% in stocks.
A few notes of consideration:
Caution is advised when moving from stocks to bonds as this is a way of locking in losses in stock investments.
Determining your comfort level with risk for each type of investment account you have is key.
Develop a plan for how to move towards your comfort level gradually over time.
You may have different risk levels in a retirement account compared to a non-retirement accounts.
Time horizon or age is a key factor in your ability for risk or how much to have in non-stock investments.
GuidePoint Financial Planning - A Reston Financial Advisor
Ryan Phillips, CFA, CFP® is the founder of GuidePoint Financial Planning. He is passionate about helping busy families plan, save, and invest for their financial future. Contact him today if you are interested in learning more about the benefits of working with a fee-only (no-commission) financial planner.
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All material above is for educational purposes only and is no way a recommendation to buy or sell investment securities. You should always review investment changes with qualified professionals. The data referenced is very short-term in nature and is used for educational means.
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