The past few years have been quite interesting. In many respects, what is traditionally known about bond markets has been thrown on its head in light of the low-interest rate and post-Covid-pandemic environment. This has led many pensioners and people nearing retirement to see the value of their investment fall in a volatile market while thinking that they were in a traditionally “lower-risked” investment allocation.
Therefore, in this article, we are going to recap what bonds are, how they fit into retirement savings and investing for a future retirement income and the current market conditions suggesting that bonds may be an option to reconsider.
What are Bonds?
According to Blackrock’s definition, a Bond can be defined as an instrument used by governments and companies to raise money by borrowing from investors. Bonds are typically issued to raise funds for specific projects. In return, the bond issuer promises to pay back the investment with interest over a certain period.
So now that we have recapped what a Bond is (apologies to those that knew that already), how best do they fit in with the investment allocation and planning for your retirement goals?
Bonds are used by many investment managers to diversify the risk in a multi-asset portfolio away from equity-based investments. Bonds and stocks traditionally can be viewed as having an inverse relationship. This means that when the stock market is down, the bond market becomes more appealing. This has not been the case year to date with bonds performing poorly alongside stocks which have bucked the traditional inverse relationship between the two.
This has led many investors and pensioners to feel that their portfolios should have been able to weather the negative performing year that we have had but in many instances, Bonds have been performing in line with equities. This has been very disconcerting for investors who felt that they were invested in low-risked portfolios. The lows that have been experienced can be linked to the spike in yields on the back of future interest rate expectations. With the interest rate increasing at rates that have not been seen in 30 to 40 years.
So what makes bonds an attractive investment?
In short, investors are going to be chasing higher yields as a result of the raised interest rates that we have been experiencing. This, over the short term, can be seen to be an attractive option in comparison to long-term bond investments as there is concern over long-term Government debt in light of the recessionary worries that have been identified. These conditions have dictated that rates have increased to the levels that we have seen but the talk is that the rates may decline during the 2nd half of 2023. The era of low-interest rates and plentiful cash in the economy is well and truly over. This means that, once the decline in the interest rate has begun with levels consistently below the 5% mark, the market norms may return and bonds can be viewed as the traditionally risk-averse asset that it is but also as possibly a buy in the short-term.
What is apparent in the financial advice industry is the need to risk profile our clients to challenge them on how they view risk in the context of their own investing experience. This enables expectations to be set but more importantly, it opens up the conversation on the market performance and the need to review your investments in line with your long-term investment and retirement goals.
Written by: Greg Armstrong (Wealth Manager)
Date: 06 December 2022