The outbreak of COVID-19 has ushered in a new situation. Risk sits at the forefront of every investor's thinking right now. For retirement savers, it can be uncomfortable to see volatility within such a short period and a promised lift in term deposit rates dashed. This is certainly a situation that no investor would want to be in.
However, long term, well diversified investors are in a different situation. Their portfolios are all about balance and they can focus on their lockdown baking, home schooling or daily walks. Now let's dive down and see what I actually mean by balance.
We may all say that we have diversified portfolio as we have invested in many companies so if one makes a loss another will make a gain. Understandable.
Now consider this situation.
As a fellow island nation, our cousins over the ditch have a long sailing tradition. In 1983 they amazed the world ending the USA 132 year run in the America’s Cup yacht race, the secret weapon was deep underwater. An 18-tonne winged keel gave the yacht Australia II the stability - and the crew the confidence - to win the 7th and final race.
Just like the famed winged keel, bonds may not attract much attention, but they are just as vital. While equities (shares) provides the growth, bonds provide stability. Without them it’s like driving a car without a seatbelt.
While there are claims in the media that bonds no longer succeed in playing that stabilising role, we only have to go back to the first quarter of 2020 during the initial shock of the COVID-19 pandemic to see what a difference bonds made when equity markets sank 30-40% in five weeks.
This doesn’t mean that it will work every time, bonds carry a risk.
While lower interest rates probably won’t push any economic recovery, there is an outcome that low-interest rates almost guarantee – increased offerings of “high yield" bonds.
High yield bonds are more volatile and carry a higher risk of default than investment-grade (low-risk) bonds. In times of economic stress, defaults may increase – making this high-yield sector more sensitive to economic shocks.
Despite the contradiction in bonds they can provide a more predictable income stream. For example, bonds may be more attractive to individuals during the pandemic as individuals will receive payments at known intervals over the bonds term. For example, if you are supposed to receive $1,000 on the 31st August it is guaranteed you will receive this fixed income on that day.
Alongside their reputation to damper volatility, they can be a source of liquidity, a protection against inflation and a source of returns. Hence, having bonds as part of your portfolios allows individuals to tailor their portfolios to their goals and risk appetites.
Financial advisors use information from today’s price, to build portfolios for clients ensuring that they help our clients meet their financial goals. They consider the importance of having bonds as part of client’s portfolios as it promises diversification, source of liquidity, and stability.
This aligns with the sayings of Suze Orman, “Every portfolio benefits from bonds; they provide a cushion when the stock market hits a rough patch”
So, worry less about what’s happening in the market and concentrate more on your well-being and Whānau.
Kia Kaha (Be strong) Kia Maia (Be steadfast) Kia Manawanui (Be willing)
· Nick Stewart is a Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.
· This article is prepared in association with Stewart Partners, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
