Bonds are typically thought of as the safer part of an investors’ portfolio — a form of protection when the stock market gets unruly.
Yet as inflation becomes a growing concern, that form of security is looking a little wobbly.
“One of the single greatest concerns to bondholders is inflation,” said certified financial planner Andy Mardock, founder and president of ViviFi Planning in Bend, Oregon, and a member of the National Association of Personal Financial Advisors.
The reason for that is simple, he said.
When you buy a bond, you’re lending a company or the government your money in exchange for a promised fixed rate of return, which is based, in part, on expectations of inflation. If those expectations are exceeded — in other words, if inflation picks up more than anticipated — that agreed upon return becomes less attractive.
“If you lend money for 2% interest per year but inflation turns out to be 3%, the end result is a loss of 1% in terms of what you can buy with your money,” Mardock said. “Add taxes on top, and the effective loss grows.”
Overall, more conservative portfolios tend to recover faster from downturns than more aggressive ones.
A portfolio with more than 70% stocks and the rest in bonds and cash took more than two years to recover from the financial crisis, compared with just seven months for a portfolio with more than 70% in bonds and cash and the rest in stocks, according to calculations provided by Charles Schwab.
Investors nearing a particular goal or retirees who need to live off their portfolio will want to pay extra attention to that history.
“Your bond allocation will keep your retirement cash flow stable, even during particularly difficult times in the stock market,” said Benjamin J. Brandt, a CFP and president of Capital City Wealth Management in Bismarck, North Dakota.
There also are some bonds that are specifically designed to protect investors against rising prices.
Those include Treasury inflation-protected securities, or TIPS, and Series I bonds, both of which increase with inflation.
There are a few key differences between the two, though, Mardock said. TIPS have a maturity date, while Series I bonds can be redeemed at any time, although the latter can’t be sold for a year after being purchased, and are subject to a three-month interest penalty for five years.
“Aside from redemption limitations, I consider Series I bonds to be more conservative than TIPS while still providing some helpful inflation protection,” Mardock said.
Both could become a more valuable part of people’s fixed income portfolios, Doll said.
“Because inflation has been so low over the past few years, many people have forgotten about them,” he said.
