One of my readers asked me a question that I feel warrants a proper response here.
He asked me whether I’m afraid of a bond market crash, and the reader wondered whether bond markets can plunge like stock markets.
The answer to both of those questions is no.
Bonds have had a great run lately, as people have poured money into bonds to escape the uncertainty of the stock markets. Bond prices have risen, and yields (interest rates) are currently low…much as a result.
But bonds move so little.
For a reference, check out the chart below.
This is a chart of the S&P 500 (in green) compared to the U.S. short-term government bond index (in blue). Please note that these movements do not include interest rates on the bonds, nor do they include dividends for the stocks.
Notice that the S&P 500 gained 65% from 2003, then dropped 20% below the 2003 price, then surged more than 80% from that low. This was a volatile period for stocks.
Bonds? Yeah, they were volatile too. You’ve heard it in the news. Check out that blue line. Not including interest, U.S. short term bonds are up about 6%, overall, since 2003. Note their relative stability compared to the stock index. The bond indexed line (in blue) would normally be running almost perfectly flat. It shouldn’t normally rise or fall much at all. It should be relatively flat as it throws off interest, but that’s all. Its popularity has seen it rise, and this is what people are afraid of. Bonds prices could fall.
If bonds drop (let’s say) 6% people will freak, news headlines will run rampant, and it will be called the great bond crash. If that happens, so what? Bonds will be coming back down to earth. You might not make money on bonds for the next couple of years (assuming a 3% interest rate per year and a sudden 6% price decrease) but the bonds you bought after the bond market “crash” would then earn higher interest yields.
If bonds become really unpopular, they could fall 10%. Such a fall (in stocks) wouldn’t create too much concern in the stock market world. But for bonds, this would be huge news. If that were to occur, the interest yield on newly purchased bonds would increase.
This is how it works. Assume that a bond index is priced at $100 a unit, and it pays $3 per year in interest for a 3% rate of return.
If the bond price fell 10% to $90, the bond index would still pay $3 per year in interest, but $3 is roughly 3.4% of $90, so the interest yield would rise for new purchasers.
Let bonds fall. In fact, let them fall hard.
I’ll be ready to rebalance my portfolio, as I always do, greedily adding what the world becomes fearful of. And in the end, I’ll reap some nice profits.
Over the long term, you could do the same.
Rebalance, dollar cost average, stay the course, and ignore predictions.
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18 comments
Rhys says:
November 3, 2012 at 12:18 am (UTC 8 )
“Rebalance, dollar cost average, stay the course, and ignore predictions.”
Awesome, Andrew! This should be a bumper sticker.
Andrew Hallam says:
November 3, 2012 at 6:54 am (UTC 8 )
Cheers Rhys!
Scott Kwasnecha says:
November 3, 2012 at 1:26 am (UTC 8 )
http://www.thereformedbroker.com/2012/10/26/33-times-you-poor-dumb-bastards/
Thoughts on this Andrew?
Andrew Hallam says:
November 3, 2012 at 6:52 am (UTC 8 )
Hi Scott,
It doesn’t say anything that I haven’t said above. But I think I’ve been a bit more polite about it. If bonds fall 10%, people would freak. But it could happen. I say let it come. I will then sell some equities and rebalance. I hate to say that people are lemmings because that’s not fair to the lemmings.
Cheers!
Andrew
ACMZ says:
November 3, 2012 at 5:32 am (UTC 8 )
Ya! I can see it now, a bumper sticker that takes the entire back bumper. Cool! and then give a number 1-800-GET-RICH.
Andrew Hallam says:
November 3, 2012 at 6:53 am (UTC 8 )
Perhaps we can create another one about the silliness of paying credit card interest while we’re at it.
Barry says:
November 3, 2012 at 10:44 am (UTC 8 )
Like the quote
“If you think that nobody cares that you’re alive – try missing a couple of credit card payments”
Barry
Andrew Hallam says:
November 3, 2012 at 9:10 pm (UTC 8 )
Just the kind of therapy to push someone over the edge.
Toby says:
November 3, 2012 at 6:09 am (UTC 8 )
Thank you for another excellent piece of writing. I always look forward to checking your website for the latest update.
Short term bonds are a key part of my portfolio. They provide me with my plan for when the markets decrease in value. Having this plan allows me to sleep well at night. When the market has a mood swing overnight and drops like a lead brick dropped from tall building, I know I can sell some bonds and buy the indexes while they are cheap. This is not what the majority of investors will be doing. They will be selling. When the markets increase again, I will sleep happily knowing that I there at the grand sale and I had money to spend! Yes, bonds are a key part of my portfolio.
Thank you for the great website Andrew!
Andrew Hallam says:
November 3, 2012 at 6:52 am (UTC 8 )
Cheers Toby,
You’ll do well as an investor over your lifetime…very well!
My Own Advisor says:
November 3, 2012 at 8:27 pm (UTC 8 )
What can I say Andrew…..awesome post.
My wife and I continue to keep a bunch of bonds in the form of XBB. Over time though, because we are very fortunate to have 1 DB and 1 DC pension plan, we’ll reduce our exposure to bonds. The pension plans are what I consider a “big bond” and they will stabilize our portfolio.
I recognize we are very lucky to have these plans, which allows us to take a bit more equity risk for the long haul. I have a post planned to discuss this…I hope you check it out. I’ve love to hear your thoughts about it.
All the best my friend,
Mark
Andrew Hallam says:
November 3, 2012 at 9:05 pm (UTC 8 )
Thanks Mark,
With those DB pensions, you’ll have the game licked. I wish I had one! Your investments become a heck of a lot of icing.
Cheers!
Andrew
Alesso says:
November 3, 2012 at 8:59 pm (UTC 8 )
Hi Andrew,
It’s hard not follow you on your investment idea. We are thought not to think like you do but i belive you are right, that’s why i’m starting to invest in indexs!
Thanks for that eye oppening!!
Cheers
Stanley says:
November 8, 2012 at 10:50 am (UTC 8 )
Hi Andrew
I keep an eye on your website. Thanks for your insight. Your making the world a better place.
I wanted your insight on fidelity index funds. I am using the spartan fund FIBIX. I wanted to know what other funds should I add to the line. Thanks a lot for your guidance.
Regards
Stanley
Andrew Hallam says:
November 16, 2012 at 7:06 am (UTC 8 )
Hi Stanley,
Those are great funds. If you were roughly my age, you may want to try this:
45% of your money in the Fidelity Intermediate Bond Index
30% of your money in the Fidelity U.S. (S&P 500) Stock Index
25% of your money in the Fidelity International Stock Index
Cheers,
Andrew
Rob says:
November 16, 2012 at 6:21 am (UTC 8 )
Hey Andrew,
Always great advice. I’m curious your thoughts on Robert Wiedemer’s prediction of another ‘super crash’ coming with markets potentially dropping as much as 90%? IS this something you are looking forward to to snatch up cheap stocks? And how would you protect your money already invested from depreciating so drastically?
THANKS for all the advice!
Andrew Hallam says:
November 16, 2012 at 7:03 am (UTC 8 )
Hi Robert,
I would love to see something that irrational occur with the stock market. I wouldn’t try to “protect” anything. You have seen my portfolio. I would rebalance, which would put me in an attacking position, rather than a defending one. My suggestion is to ignore forecasts. They just get your hopes up–in this case, anyway!
Cheers,
Andrew
Robert says:
November 16, 2012 at 8:27 am (UTC 8 )
Thanks Andrew. I definitely try to just stick with your advice and ignore predictions. Best case scenario I guess would be if another crash did occur, hope to be a little heavy in the bond index and then go crazy buying up cheap stock index’s.
Thanks again, your posts and your book have completely fixed my spending and saving habits in only one years time!