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    Home»Investments»If stocks always produce better results, why own bonds at all?
    Investments

    If stocks always produce better results, why own bonds at all?

    October 21, 20245 Mins Read


    Every study shows that stocks outperform all other types of investments over the long term – and by a large margin.

    In his book, Stocks for the Long Run, Wharton Professor Jeremy Siegel writes: “Over long periods of time, the returns on equities not only surpassed those of all other financial assets but were far safer and more predictable than bond returns when inflation was taken into account.”

    An accompanying table looked at the annualized returns of several types of investments over the period from 1802 to 2012. Stocks posted an average annual return of 6.6 per cent. Bonds were a distant second, at 3.6 per cent.

    Given those numbers, the obvious question is: Why hold bonds at all? Why not simply create a 100 per cent equities portfolio and ride with it? Noah Solomon, President and CIO of Toronto-based Outcome Metric Asset Management LP, tackled those questions in his company’s September newsletter.

    “The buy-and-hold, 100 per cent stock portfolio is a double-edged sword,” he says. “If (1) you can stick with it through stomach-churning bear market losses, and (2) have a long-term horizon during which the need to liquidate assets will not arise, then strapping yourself into the roller-coaster of an all-stock portfolio may indeed be the optimal solution. Conversely, it would be difficult to identify a worse alternative for those who do not meet these criteria.”

    The danger for those who don’t fit the all-stocks profile is emotion. When the stock market plunges, as it has several times since we entered the 21st century, many people lose their bravado and bail out. Remember, Nasdaq lost 78 per cent of its value in the dot.com crash of 2000-2002. How many retail investors in tech stocks rode that out without a flinch?

    In his newsletter, Mr. Solomon looks at the relative performance of stocks and bonds during recent bear markets.

    As you can see, while stocks were taking a beating, bonds were producing profits in all cases but one (1990). And even that loss was only about one-tenth of the decline in stocks. On average, stocks fell 34.2 per cent during these market crises. Bonds gained 10.9 per cent.

    “Bonds have at times proven to be a magic elixir from a portfolio perspective,” Mr. Solomon writes. “The foundation of this magic is bonds’ potential to provide a reasonable return and provide effective diversification from stocks during bear markets, thereby limiting overall portfolio losses.”

    So, are we talking market timing here? I think tactical asset allocation is a better term. Your portfolio should be comprised of a mix of equities, bonds, and cash. Adjusting that mix from time to time in conjunction with changes in market conditions makes good sense.

    You can do this by rebalancing your own portfolio periodically or you could add a position in a tactical asset allocation (TAA) mutual fund or ETF to your holdings.

    Outcome has a Global Tactical Asset Allocation Fund, which is ahead 6.4 per cent year-to-date (to Sept. 30).

    If you prefer an ETF, check out the Purpose Tactical Asset Allocation Fund (RTA-T). It’s an actively managed fund of funds that can range from 100 per cent equities to 100 per cent bonds, depending on economic conditions. Right now, 90 per cent of the assets are in stocks with 8 per cent in bonds and 2 per cent in cash, but as recently as April the equity position was only 26 per cent.

    As of Sept. 30, the fund showed a one-year gain of 13.91 per cent. Since inception, the average annual compound rate of return is a little over 6 per cent, The MER is high, at 0.75 per cent,

    Vanguard Canada offers a less expensive suite of asset allocation funds, but these are strategic rather than tactical, meaning the portfolio never varies much from its core target mix. All are funds of funds.

    The Vanguard Balanced ETF Portfolio (VBAL-T) takes the most traditional approach. The current asset mix is 60.83 per cent stocks, 39.15 per cent bonds, and a small amount of cash. The fund never varies significantly from a 60/40 split.

    VBAL, which has $3 billion in assets under management, has been a strong performer recently, with a one-year gain of 21.77 per cent to Sept. 30. The average annual compound rate of return since inception (January 2018) is 6.37 per cent. The fund has a management expense ratio of 0.24 per cent.

    More aggressive investors may prefer the Vanguard Growth ETF Portfolio (VGRO-T), which aims for a mix of 80 per cent stocks, 20 per cent bonds. Obviously, that’s a riskier approach, but the returns have been impressive. The ETF gained 25.47 per cent in the year to Sept. 30 and shows an average annual compound rate of return since inception (also in early 2018) of just over 8 per cent. The MER is also 0.24 per cent.

    There is a wide range of tactical and strategic asset allocation funds from which to choose. Make sure you understand exactly what you’re buying.

    Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.

    Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.



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