A well-balanced portfolio is an important part of investing. Allocating different investment types to your pool of assets can help spread and minimise risk in the event of market downturns so that, should you experience any losses, only a portion of your portfolio will take the hit as opposed to its entirety.
In this blog, we’ll discuss what bonds are, how they can contribute to a well-balanced portfolio and a guide on how to split and allocate your investments correctly for a healthy investment pool.
What are bonds?
Bonds are a lending system that allows companies to raise money from investors for a particular project. In return, investors receive a legally binding bond certificate that secures their investment and returns. Investment bonds tend to be a mid to long-term commitment and profits are normally paid at the pre-agreed rate, either at the end of the bond term or at maturity.
Why bonds should be part of your investment portfolio
One of the key benefits of bonds is diversification. When looking at diversifying your portfolio, each new investment should generally have a low or negative correlation to your existing assets. This can reduce the risk of substantial overall loss, so if one market declines, most of your portfolio is protected. You can use the below chart for guidance on how different investment types can impact each other:
Let’s compare bonds against stocks, for example. The correlation between them is 0.02, meaning that they are the least likely to impact one another during market changes. In contrast, bonds and cash or multiple bonds have a moderate to high correlation, so if these markets decline, a larger portion of your portfolio will suffer. So, if you have existing investments like currencies or international equity, bonds could be suitable, helping you diversify whilst lowering risk.
When should I invest in bonds?
Considering the current economic climate, many investors are looking for stability as the UK faces a recession following a year of soaring interest rates and record-high interest rates – this is where bonds can help. Bonds are not immune to economic decline, but historical data shows that it’s rare for the bond market to fall for more than two consecutive years even if interest rates are on the rise, so whilst they can have their ups and downs like any other market, past performance shows that bonds can be relatively stable.
If you’re considering investing in bonds and the time is right for your financial plans, you can find many investment-grade bonds that offer regular, fixed-rate returns, so you can pre-agree on your terms and payment options to match your needs and find a reliable income stream.
How much of your investment portfolio should be dedicated to bonds
There are no clear-cut asset allocation rules and there are several ways to find a suitable balance that works for you, but as you get older, you’re likely to want to reduce the level of risk associated with your investments.
For stocks, a common rule of thumb that some investors abide by is 100 minus your age. For example, if you’re 60 years old, 40% of your portfolio should be in stocks and the rest should consist of investment-grade bonds and other safe havens. However, this is just a guideline, and as markets progress and life expectancy rises, the rules can change, so you may find that it makes more sense for that to be 110 or 120 minus your age to make your plans more achievable.
Another method to consider is Warren Buffet’s 90/10 investing strategy. Somewhat controversial at the time, Buffet created this new investment plan in 2013 for his wife’s retirement, saying that after his death, her inheritance should be split 90% towards stock index funds and 10% towards short-term government bonds. Generally, investors are advised to gradually move away from stocks as they get older to protect their assets from market downturns, so for many investors, Buffet’s method was a little radical. Comparing that to the ‘100 minus your age’ rule, by 70, most of your investments should be in bonds rather than stocks, but as life expectancy has been rising over the years, it’s no longer uncommon for investors to be more aggressive with their asset allocation. In fact, when the 90/10 investment strategy was put to the test, the results were surprisingly positive, with a relatively low failure rate. Here’s how the strategy performed against other splits:
For the test, a hypothetical $1,000 investment was split into 90% stocks and 10% short-term bonds. Based on historical market performance, the rate at which the 90/10 strategy ran out of money over a 30-year period was only 2.3%, the third lowest result on the table. Although other strategies have shown to be more successful – a 60/40 split taking first place with an incredible 0% failure rate – it’s surprising to see how resilient the 90/10 method has been against some of the toughest financial periods since 1900. So, while Buffet’s approach hasn’t performed perfectly in this scenario, it certainly performed well, so you may find this to be a suitable portfolio split to consider.
If you’re looking at historical returns, the below table shows how different stock and bond mixes have performed:
Between 1926 and 2020, a 50/50 mix experienced the fewest loss years and the most gain years. However, it has seen the lowest average annual return of 8.2%, while a portfolio consisting of 100% stocks has had a higher average annual return of 10.1%, albeit with nearly 50% of worst and best years.
You could look at the average as the most successful mix, that being a 70/30 split, but the answer as to which is most suitable to you comes down to personal tolerance of risk and historical data and hypothetical tests can only serve as guidance. If you’re unsure where to start with balancing your portfolio and how bonds can fit into your existing assets, think about factors like your age, gender, when you’d like to retire, and how much money you’ll need to sustain yourself financially. This can help you understand your time horizon and how much risk you’re willing to take on.
Finding the right bonds
If bonds are currently missing from your portfolio and you’re looking to diversify, there are several bond types that could suit your investment needs. Depending on your goals, risk tolerance, and time horizon, you’ll find different bonds that could be beneficial to you, however, it’s important to be aware of the pros and cons of each and assess how bonds could impact your existing investments.
One of the main advantages of bonds is that they can provide stable profit options, so if you’re going to be dependent on bonds for regular income, you could consider secured fixed-rate bonds. At Propiteer Capital, our property bond offers flexible investment options to suit your needs and help you plan your finances. You can choose between monthly and annual returns of up to 12% with a minimum term of 12 months with the added benefit of peace of mind, knowing that your funds are secure and backed by high-quality UK property. Your investment is also spread across a diverse property development portfolio with a gross development of over £785m, meaning that your money goes towards a range of property types and geographical locations to help you diversify conveniently.
To find out more about us, our process, and what makes our bond unique, visit our website or contact our customer care team with any questions. You can also see some of our past and active successful property projects here to give you an idea of how investments are used.
Rates are accurate at the date of publishing. For our latest rates, please visit our homepage.
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