A closer look at the critical role bonds can play even with today’s low-interest rates

With negative interest rates now prevailing in a handful of countries, and some corporations borrowing for close to zero percent, the income available from bonds continued to remain low in 2019. While it’s natural for investors to question the value of owning bonds in this environment, the reasons to hold bonds stretch beyond income. Bonds can offer significant portfolio and diversification benefits, and despite today’s low-interest rates, there’s no reason to think that will change.

Portfolio stability

Regardless of whether interest rates are rising or falling, or equity markets are up or down, bonds can provide investors with multiple layers of stability:

1. Steady cash flow – While the income from bonds today is modest, bonds continue to provide a stable income stream.
2. Capital preservation – Through volatile equity markets, bonds can act as a stabilizer in diversified portfolios.
3. Liquidity – For those holding individual bonds, the return of principal at maturity provides a natural source of liquidity.

A diversified source of income, and more portfolio stability

Beyond the Canadian bond market, a wide variety of bond strategies and asset classes are available to investors, all of which can provide unique diversification benefits:

1. Bond ladders provide excellent liquidity, a transparent cash-flow stream and can minimize interest rate risk. A bond ladder is a portfolio of bonds that mature at regular intervals. The maturing funds can be re-allocated to the ladder or used to rebalance your overall portfolio.
2. U.S. and global bonds can help lower portfolio volatility through geographic and currency diversification and offer a wide range of corporate opportunities that can help boost income.
3. High-yield bonds can boost income, have traditionally lowered overall bond portfolio volatility and have often provided portfolio stability during periods of rising government interest rates. However, high-yield bonds do come with a higher risk than most government or high-quality corporate bonds

Stability, steady income and diversification

The purpose of bonds is to provide investors with portfolio stability, diversified income, timely liquidity and capital preservation through challenging markets. These unique qualities have stood the test of time, and despite the modest income they offer today, bonds continue to be an essential source of portfolio diversification.

Capital preservation through a challenging period for equity markets

Looking back to 2008-09 and 2018, two periods in which Canadian equities were down significantly, an equity investor might have seen their portfolio down by a significant amount (In 2008, an equity investor might have seen their portfolio down by close to half as the market bottomed). On the other hand, a more balanced investor, holding a diversified equity and bond portfolio, would likely have been in a position to take advantage of lower equity prices, or able to participate in a very timely opportunity to rebalance their long-term asset allocation.

If you are concerned that your portfolio is not adequately prepared for the next economic downturn, contact me today at 905-895-4102 or by email at connor.ryan@rbc.com for a complimentary portfolio review.