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Bond Advice for Today’s Market: Think Big Picture

There is an old joke that some statisticians tell, that “a person with their head in an oven and their feet in the freezer is comfortable — on average.” Statisticians are not known for their sense of humor (clearly), but the joke is an effective warning about some of the shortcomings of relying on averages.

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Statistically, a simple average camouflages extremes within its sample data. And, while the statistician’s joke is somewhat extreme, it is no less extreme than the actual returns in the long-run average annual returns for stocks and bonds that set many investors’ return expectations.

What’s an ‘average’ annual return anyway?

If quizzed, it is likely that many investors would estimate the average annualized returns for U.S. stocks and bonds to be about 10% and 5%, respectively. Those averages are composed of decades of returns and describe history perfectly. However, although they describe the average annualized returns, they are a far cry from the typical or “average” experience.  In fact, in only two years from 1926 through 2020 did both the stock and bond market deliver returns within 2% (+/-) of their historical averages (see Figure 1).

Figure 1: Annual stock and bond returns, 1926-2020

Source: Liberty Wealth Advisors, using data from Morningstar Direct

In 2021, U.S. stocks  gained 25.7%, while U.S. bonds lost 1.5%.* While it is fair to say that it was a great year for stocks, is it fair to say that it was a bad year for bonds because they didn’t return their 5.7%* average?  Probably not. The only thing rarer than a year with “average” returns might be a year that investors appreciate their bond allocations amid a bull market for stocks.

For those of you thinking about abandoning bonds, here are some ideas that may help:

A bad day for stocks is often much worse than a bad year for bonds.

While investors prefer gains to losses, they also prefer small losses to big losses. While far from being predictive, Figure 1 demonstrates that negative returns in bonds have tended to be both infrequent and modest. In fact, the bond market’s worst annual return was a loss of 5.1% in 1994. However, the stocks of the S&P 500 index have posted daily losses that bad or worse 25 times since 1926.

Sometimes, the further the distance, the clearer the picture.

Often, it’s hard for investors to see the benefits that high-quality bonds can add to their portfolios, especially when the returns they are posting are modest — or even modestly negative. And today, concerns for higher interest rates due to higher-than-expected inflation are making it even more challenging for investors to ignore some pundits’ suggestions that holding bonds is a bad idea.

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I was given a magnifying glass when I was young, and I started looking at everything through it. Eventually, I looked at the Sunday comics and realized that for all I saw, I wasn’t seeing everything. The cartoons were nothing but a variety of colored dots! Magazine photos, too. It made me wonder how much else I was missing because I wasn’t looking closely enough. Now, I realize that when I was close enough to see the dots, I missed the bigger picture – literally.

Similarly, the dots in Figure 1 paint a picture that’s easy to overlook when you’re too narrowly focused: The principal benefit of investment-grade bonds isn’t their frequency of positive returns but the infrequency of large, negative returns. And, yes, if the returns in Figure 1 were inflation-adjusted, the frequency of negative returns for both bonds and stocks would increase. However, that would not change what Figure 1 tells us: High-quality bonds in a portfolio can help moderate the volatility of stocks.

The bottom line: Keep your eye on the big picture.

A well-diversified portfolio can benefit from bonds: More likely than not, a bad year for bonds will be much better than a bad day for stocks. While that certainly won’t insure your portfolio against losses, it can certainly help moderate the losses when the markets turn intemperate.

Having a well-diversified portfolio that includes an allocation to high-quality bonds can help keep a bad day in the stock market from turning into a bad year for your portfolio.

* Stock performance as measured by the CRSP U.S. Total Market Index. Bond performance as measured by the Bloomberg U.S. Aggregate Float Adjusted Index. Bond average is a geometric mean return for the Ibbotson® SBBI® U.S. Intermediate-term (5-Year) Government Bonds (Total return).

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Was the Pandemic Really a Good Thing for Some (Financially Speaking)?

It’s hard to think that there is a bright spot when you look at the death and destruction that the pandemic brought to so many.  But if we step back, let’s see if there has been a silver lining for some.

We can’t forget the backdrop of the pandemic.  We were petrified as we went into 2020, as people got sick and businesses started to shutter. We had no defenses from the disease or from losing our loved ones and livelihoods. Unemployment surged to levels not since the Depression. But help was on the way. The government poured trillions of dollars into the economy; people received real money via two rounds of stimulus payments; the government also paused mortgage and student debt payments for millions of people; the Fed kept liquidity flowing into our economy; inflation and interest rates were negligible. 

What Were the Results?

According to the Census Bureau, stimulus payments lifted 11.7 million people out of poverty. In other words, almost 12 million more people would have been considered impoverished if Congress had not acted to alleviate the situation.

The stimulus checks were delivered to people both above and below the poverty line.  We know that not everyone benefited equally, and many people are still in a tenuous position. But if you were working and Zooming from home in your PJs, you didn’t need to buy work clothes or spend money commuting to the office.  You weren’t traveling or going out to eat.  So, for those who were lucky enough to keep their jobs and were not trying to just survive, the stimulus checks were a bonus.  Working from home allowed many to reduce their expenses. Their mortgages and student loans were on pause, and they diligently increased their savings.  These people amassed $2.7 trillion in extra savings.

Savings Were Up

The personal savings rate, which is a measure of how much money people have left over after their expenses and taxes, soared to almost 33% in April 2020, according to the Bureau of Economic Analysis. For the two years before the pandemic, it had averaged just under 8%.

According to a report from NerdWallet and Goldman Sachs, families in the top 20% of income put more than a third of their extra savings into investment accounts or down payments on homes, and lower-income families mostly kept their extra savings in banks or used it to pay down debt. What’s interesting, as noted in the report, is that, “The majority of Americans (78%) report that the pandemic has spurred them to take some sort of financial action.”

Debt Was Down

Americans also paid down some of their credit card debt during the pandemic.  Over $100 billion in credit card debt has been paid off by consumers due to the influx of stimulus money.  People also had fewer places to spend money, but still they could have been clicking away online, and didn’t.  Before you jump for joy, the average cardholder still has more than $5,000 of credit card debt.

That’s Changing: People Are Spending Again

I wish I could see the trends of spending less, saving more and paying down credit cards continue … but no.  We noted a great holiday shopping boom, even the midst of rising prices due to supply chain issues and inflation. Holiday spending increased by 11% for online sales and over 8% for in-store sales.

Millennials and Gen Zers Are So-Over-Covid

Optimism about improved finances in 2022 is highest among Generation Z, those born from 1997 to 2012, and diminishes with each successive older generation, based on Bankrate’s survey findings.

Gen Zers and millennials who said they felt optimistic about 2022’s finances most often attributed it to making more money at work, while baby boomers who felt positive cited having less debt.

Some of this optimism is based upon the fact that the younger generations are expected to enjoy higher wage increases in 2022.  Pundits say that the expected 4% wage increase is due to the current soaring  7.48% inflation rate, as food, housing and gas prices are spiking. I think it also has to do with the fear of losing good employees.  Last year the job market lost over 38 million workers during the Great Resignation, to seek fame and fortune elsewhere. The raise many will receive may not be a reflection of a job well done, but more of a plea not to leave.

What Can You Do to Remain Financially Healthy in 2022?

  1. Create a real budget that you will stick to. List all of your expenses based upon your real spending habits, not the pie-in-the-sky ones you want. Then re-create the budget you want. Make sure that paying off debt is one of your line-items for your new budget.
  2. Set up an emergency fund. You should make sure that you have three to six months of money put aside.  It is not only to buy those tires you may need, but it is also for money to carry you over in case of a lost job.
  3. Cut down spending.  You know that this makes sense, but it is hard to do.  As a rule of thumb, if you can’t pay the full balance on your credit card each month, don’t charge anymore.  If you are carrying balances, pay more than the minimum each month. The average rate on credit cards today is 16%, and those rates will rise as general rates rise this year.
  4. Review your credit card statements each month. Cancel all of the memberships and things you no longer want or use.
  5. Spend less on food and entertainment. It’s expensive to go out.  Your friends will want to save money, as well.  Decide to get together for potluck dinners. Enjoy each other, and enjoy not getting the credit card bill at the end of the month.

The pandemic can be seen as a really tough wake-up call. It stills looms over our nation’s health. Financial health is part of your overall health. It’s not about how much you earn, it’s about how much you save and spend to create a stress-free life for you and your loved ones.

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