I suppose that it is understandable to automatically think only in terms of stocks any time the words market and investing come into a conversation. Face it, bonds just aren't sexy. It is a whole lot more interesting to most people to marvel at what happened with LinkedIn's (NYSE:LNKD) IPO, for example, when at a Memorial Day BBQ, than it is to eavesdrop on a conversation about the shape of the yield curve.
Nevertheless, I feel that bonds have an important place in a retirement portfolio, especially as an investor gets close to retirement. The reason that I say this is because bonds do an excellent job of dampening the volatility of a portfolio.
It is all well and good to think to one's self that we're investing for the "long term", or a big sell-off is really a "buying opportunity", but I'm sure we all know folks that, back in 08/09, ended up panicking and throwing in the towel at the bottom of the crisis, and consequently being forced to drastically modify, and even delay planned retirements.
Of course, it is true that defensive dividend paying stocks in sectors like health care, utilities, and consumer staples aren't nearly as volatile as a high flying tech stock, biotech, or a junior gold or silver miner, but in a market-wide decline, even the defensive players can get dinged substantially.
By way of illustration, here are four charts, comparing 2 bond ETFs and 2 bond CEFs against the S&P 500. In all cases, the charts are for 5 years, in order to capture the 08/09 financial crisis.
First, is the chart of AGG, the Barclays Aggregate Bond ETF.
Next is LQD, the Investment Grade Corp Bond ETF.
Next is GIM, the Templeton Global Income Fund, a sovereign debt CEF.
Finally, a chart over the same time frame for TEI, the Templeton Emerging Markets Income CEF.
(charts provided by BigCharts.com)
A look at the above charts shows that the biggest drawdown suffered by AGG was 10%, and for LQD, it was just shy of 30%. Losses like this are much more survivable than the S&P's 48% (approx.).
While these charts don't show GIM and TEI in as favorable a light, it should be remembered that both of these funds are invested in foreign sovereign debt, with an emerging markets tilt, particularly TEI. As an example, Asian stocks had lost more than 60%, at the bottom, so GIM's 30% drawdown, and TEI's approx. 46% drawdown don't look nearly as bad.
One other thing that I noted in putting this together, is that both GIM and TEI do show the May, 2010 "flash crash", whereas AGG doesn't, and LQD just has the barest of dips...barely discernable on these charts.
By mixing and matching bond funds, I believe an investor can fashion a portfolio that caters to his/her particular risk tolerance, while still avoiding the sort of massive drawdowns that wreak havoc with retirement planning.
Disclosure: I am long GIM, TEI.