| Topic - Who Needs Bonds? | Education Center |
LET'S FACE IT, bonds have never been as sexy as stocks. But they've never quite looked this dowdy, either. At a time when the business pages can't stop blaring about the latest Internet millionaire and the widow next door is getting quietly rich on her portfolio of blue chips, the attitude toward fixed-income securities can accurately be summed up in two words: chopped liver.
Who needs bonds, anyway? They're confusing. They're arcane. And while stocks have averaged 11% annual returns over time, bonds have slogged along at less than 6%. The situation was particularly acute in 1998, when bonds posted an 8.6% total return and stocks took a 26.7% rocket ride. It was the fourth straight year of 20%-plus gains for the S&P 500 index.
Well, don't be fooled. Stocks won't always give you such lustrous returns. And it's often the case that when stocks go down, bonds go up, making them an excellent tool for diversifying your portfolio. In the third quarter of 1998, the S&P 500 dropped by 11% due to fear of a global economic slowdown. But faced with the same news, the bond market produced a 6% gain. A portfolio split 70%/30% between stocks and bonds, would have been a boon for diversified investors. A portfolio of 100% stocks dropped almost twice as much as a portfolio with a mix of stocks and bonds.
The lesson is clear: Unless you're 40 or younger and have lots of time to make up for short-term losses in the stock market, you'd be silly not to diversify your portfolio with at least some exposure to bonds. It's true that figuring out how a bond really works is only slightly less confounding than quantum physics. But this section will help by giving you the basic background you'll need to invest in the fixed-income market wisely.