Every good investor knows that you should have balance in your investment portfolio. That means there should be a good mixture of equities, bonds and even cash in your portfolio. Over the last ten years, though, the pace of growth in equities have far outstripped the growth of interest provided by fixed income assets.
In fact looking back at the last ten years, the S&P index has skyrocketed from the lows of 2008 of around 800 points to 2800 points. That’s a jump of 3.5 times in value. During the last decade all the naysayers said the stock market was going to crash, it never happened.
Meanwhile smart diversified investors that bought into the index would have reaped those awards over time. Even a balanced portfolio that had roughly 25% of its funds in an S&P index fund would have seen significant gains.
Similarly anyone that held the Canadian TSX index fund from 2008 would have enjoyed a doubling of their investments over the last decade as well. With all these gains over the last ten years, what has happened to our fixed income portfolio?
Interest Rates Stuck At Lows
Anyone that has been sticking their money in high interest savings accounts over the last decade would have seen a loss of spending value. That’s because interest rates have remained so low for the last decade and inflation has far surpassed the value that interest has paid.
Similarly anyone that has been holding bond funds for the last decade would have seen minimal gains as interest rates have remained low. With minimal capital gains, bonds have only returned around 2-3% annually in interest. This has paled in comparison to stocks which have soared over the same period.
Over the last decade fixed income investments have been dead weight. Barely keeping up with inflation. So does that mean we shouldn’t be holding fixed income assets in our portfolio? Not exactly.
Keeping The Balance
Despite the woes of fixed income investments over the last ten years, bonds and cash still form a basis to help us smooth our returns over the course of the decade. Let’s take a look at how monthly returns have looked for the S&P over the last ten years:
It comes as no surprise to learn that the stock market don’t always go up. Despite the S&P 500 being up 3.5x over the last decade, months exists where large corrections occur. Corrections like -10.99%, -8.57%, -8.22% and -7.18% in a single month are not uncommon. During these month, holding some fixed income assets would certainly make our nights much easier to sleep. Just imagine holding a portfolio of $10,000 and to waking up a month later down $1,000. That’s not something many of us can stomach. This is where holding bonds and cash help soothe the ache.
Despite the notion that gains can be much greater by using a 100% equity portfolio, many individual investors are not prepared to lose a large portion of their investments to a stock market correction. If you’re reading this blog, there’s a large chance you aren’t mentally prepared to lose 50% of your equity.
That’s why this blog preaches balance. Don’t be a hero and try to swing for the fences. Building wealth takes time, savings and perseverance. Most novice investors should keep at least 40% of their portfolio in safe investments such as bonds, preferred shares or high interest savings accounts. The other 60% should be fully diversified into equities spread out across the world. Remember that investing only in Canadian equities isn’t a smart thing.
What’s On The Horizon?
The past decade has provided impeccable returns. These returns may never be repeated every again, but we can’t predict that. What we do know in the short term is that interest rates will continue to rise, putting upward pressure on mortgage and lending rates.
This will have the effect of slowing down the economy that seems to be firing on all cylinders. Growth will no doubt stall at one point once interest rates normalize to the norms of 6-8%.
This means we need to stay defensive, but not out of the markets. Continue to re-balance your investment portfolios as equities continue to rise. Don’t be greedy and chase gains by adding more stocks in your investment portfolios when you should be adding bonds.
If you’re still confused or have never invested before, stay tuned. I’ll run through some beginner options in a future post.