Many of you who have investments probably know that bonds traditionally have been considered a good investment, especially for those who like a diversified portfolio. The percentage of stocks to bonds and other forms of investments, including silver and gold, real estate, or cryptocurrency, is usually dependent upon the age of the investor and his or her risk tolerance. Since bonds are typically thought of as being fairly stable, more so than the stock market, many financial advisors and investors look to bonds as a must. Not only are bonds historically stable, they also yield an interest payment.
In today’s market, therefore, it seems like bonds would be something each investor would already have or would want to include in his or her portfolio, especially in light of today’s volatile stock market. However, the rising interest rates are driving bond prices down and yields up. This is due to bond prices being inversely correlated to their yields (Interest rate). As yields go up, bond prices come down. As yields come down, bond prices go up. Historically, the Federal Reserve would not be raising interest rates heading into a bear market, which occurs when a market experiences a prolonged drop in investment prices, but instead would be lowering interest rates to spur demand and stave off a recession. Today, the Fed is rightly more concerned with fighting inflation than the consequences of a recession.
So, what DO you invest in in Today’s market?!
Let’s jump into the fundamental differences between stocks and bonds so you can make the best decision for your portfolio. One differentiation is that when you buy stock in a company, you are buying a part of the company. This gives you, in essence, part ownership of that company, and, therefore, you ride out the good times with that company when there is a profit along with the hard times when the company is performing poorly and not yielding a good profit or maybe even suffering a loss. Bonds, on the other hand, is you, as the investor, providing a loan to a company or government, the borrower, which uses your money to fund its day-to-day operations and expenses. The result of this is that the investor receives interest on the amount invested in that company through the bond along with the original amount invested in the company or the government which is the principal amount. Since bonds are loans to a company, investors are paid regardless if there is a bankruptcy situation. Stock investors, however, are not ensured anything because they are “owners” of the company who profit along with or suffer from the highs and lows respectively of the company.
Bonds, therefore, are seen as fairly risk free, especially those issued by the federal government. However, while bonds are a good way to balance out a person’s portfolio, those that are considered lower risk usually pay a lower interest. The older the investor and/or the lower risk tolerance an investor has, the higher percent of bonds to stocks and other types of investments a person may consider in a diversified portfolio.
With the instability of the market, it gives all of us time to pause and evaluate our portfolios. We are hearing rumblings of the Federal Reserve raising interest rates again before the end of the year. Analysts warn investors against honing in on how many times the Federal Reserve raised the rate but rather how many points. The Federal Reserve is indicating that they plan to increase the rates by another 1.25 percentage points with the possibility for another hike after that.
Nonetheless, bonds along with stocks are not doing well. According to a report by the Associated Press, Federal Reserve Chairman Jerome Powell warned in August that “the Fed’s moves will ‘bring some pain’ to households and businesses” and that their “commitment to bringing inflation back down to its 2% target was ‘unconditional.’” Powell noted that he wished there was a less painful way to get inflation under control but “‘There isn’t.”
What all of this amounts to is that we are in for some serious volatility in the market. But that should not cause us to pull out of the market. Being diversified is still the best thing for your portfolio. Historically we know the numbers over the long haul. Personally, I will not be making any changes in my portfolio. I am not reactionary or an alarmist. I will continue to live by my budget and to invest, keeping in mind that there are always fluctuations in the market. Stay the course. Think through the best situation for you based on your age, your needs, and your risk tolerance and ignore the noise. Education is key – always. When you want to take your budgeting and finances to the next level and commit to making real changes in your finances and the financial outcomes in your life, contact me about Budgetdog Academy. Educate yourself and change your path to real financial freedom and independence. Continue to follow me at Budgetdog for all of your financial needs.