Should we lose faith in bonds as valuable insurance to protect our portfolio?
Posted on March 29, 2024

I view the bonds we retirees hold as a form of insurance – downside protection. We need to sell from our portfolio each year for our spending. We don’t want to sell stocks when they’ve taken a deep dive. Selling stocks then for our spending just magnifies the decline. We want to give stocks time to recover and repair our portfolio. We want to sell something else that has performed much better. Most everyone agrees that the “something else” is bonds.

 

2022 could challenge our faith in bonds as valuable insurance: the real return for stocks cratered and bonds were worse – the worst in history.

 

This post shows that 2022 was the outlier. Stocks have declined in 30 of the last 98 years. Bonds have outperformed stocks in 27 of those 30 years and by an average of 15 percentage points. They haven’t been perfect, but one has to conclude that bonds give us excellent downside protection when stocks crater. Don’t change the mental image of bonds as insurance: we are wise to hold bonds that we can sell for our spending when stocks crater.

 

 

DETAIL:

 

== Stocks generally swamp bonds ==

 

When stocks are good, they are very good relative to bonds. Real stock returns have been positive in 68 of the last 98 years – about seven of ten years. In those years, stocks returned more than bonds in 62 of the 68 – better than nine of ten years – and outperformed by an average of 16 percentage points per year: stocks averaged +19% real return per year and bonds averaged +3% in the 68 years.

 

 

== Bonds swamp stocks when stocks decline ==

 

When stocks are bad, bonds are very good relative to stocks. Real stock returns have been below 0% in about three of ten years – 30 of the past 98 years. In those years, bonds returned more than stocks in nine of ten years – 27 of the 30 – and outperformed by an average of 15 percentage points: bonds averaged 1% real return and stocks averaged -14% real return in the 30 years.

 

 

The outlier for poor performance for bonds relative to stocks was 2022; the return for bonds was the worst in history; 9 percentage points worse than the second-worst year in history (1946).

 

== Bonds even better when stocks worst ==

 

Bonds have been even better relative to stocks when stocks were their worst. Bond returns have been better in 19 of the 20 worst years for stocks – years when the real return for stocks was roughly -9% or worse. Bonds outperformed by 20 percentage on average.

 

 

 

Conclusion. The very poor performance for bonds relative to stocks in 2022 could shake our mental image of stocks as valuable insurance that we use to protect our portfolio. When we look at the 30 years that stocks have declined over the past 98, the advantage for us retirees to hold bonds is clear, even including 2022. Bonds return much more than stocks – on average 15 percentage points more – when stocks crater. We are wise when we disproportionately sell or totally sell bonds and limit the damage to our portfolio when stocks crater. We buy time for stocks to recover and repair our portfolio.