Portfolio Research utilizes both cash and bond funds in our risk-controlled model portfolios. Whereas cash has returned nothing in nominal terms (and has lost value when adjusted for inflation), Treasury Bond Funds* have returned over 7% annualized over the past three years -- and longer-term bonds and high-yield bonds have done even better. Increasingly US Bonds have been a safe haven for global investors nervous about Europe.
But as we described in this article on diversifying the bond portion of your portfolio, rising interest rates can diminish the value of your bond funds. If we do see rising interest rates, money market funds and certificate of deposits will eventually return more than bonds. Many longer term forecasts (such as GMO’s 7-year expected return forecast), are predicting negative returns on US Bonds.
So for your “satellite” portfolio, (at least the portion set aside for emergency needs), you may be prudent to stick with putting cash in the bank -- just be aware that the value is likely to erode over time. For your core portfolio we recommend a mix of bonds, cash and other asset classes based on objective factors such as volatility, correlation, and expected returns.
For example, look at our second lowest risk model - Risk-Target 5 Strategy - which is designed to preserve wealth while providing some capital appreciation, and for which we expect fluctuations less than plus or minus 10% per year, 95% of the time. The fixed income allocations are split among asset classes to generate a return and preserve wealth in any of the possible inflationary, deflationary, growth or recession scenarios we might encounter in the year ahead:
US Bonds – 19.1%
International Bonds – 16.1%
TIPS – 15.2%
Cash – 21.9%
US Bonds funds would be low-cost broadly diversified funds or ETF such as iShares Barclays Aggregate Bond (AGG) or Vanguard Total Bond Fund (BND), while international bond funds include iShares S&P/Citi Intl. Treasury Bond Fund (IGOV), and SPDR Barclays Capital Short Term Intl. Bond (BWZ). The remaining 27% of the portfolio is allocated to Equities, REITs and Commodities.
* Barclays U.S. Aggregate Bond Index
l Barclays U.S. Aggregate bond index