When my son was a toddler, my wife’s “go-to” cookbook was Deceptively Delicious by Jessica Seinfeld. The premise of the book is simple: Finicky children won’t mind eating their vegetables if you can sneak the broccoli into their brownie. Our own experience is that it works. The caveat is that you need to resist the urge to brag to your child after the fact.
Recently I’ve been thinking about this strategy in a somewhat different context. Investors everywhere are trying to stomach something even more unpalatable than boiled cauliflower, namely buying a 10-year Treasury at a 1.50% yield. While most investors realize that traditional bonds dampen portfolio volatility, it’s hard to commit to an asset class unlikely to produce any real return (see the chart below). To add insult to injury, as yields have dropped, duration has risen. Even a small rise in rates will inflict real pain on a part of the portfolio designed to provide stability.
Market Realist: Low bond yields affect your portfolio adversely
As the graph above shows, the ten-year Treasury (IEF)(TLH) yields are currently testing their all-time low at around 1.5%. Meanwhile, the 30-year Treasury (TLT) yields are trading at a paltry 2.2%. The factors driving yields low include poor economic growth, an easing of monetary policy, the demand from foreign investors, and low supply, among others.
Bonds are typically used to provide ballast to an equity-heavy portfolio, as the two assets tend to move in opposite directions—as we’ll explain in the next part. Also, bonds tend to be much less volatile than equities (IWM)(VTI). Therefore, adding bonds to your portfolio usually dampens portfolio volatility.
However, given the current ultra-low yields on bonds, you may need to tweak your portfolio a bit in order to reduce the duration or interest-rate sensitivity of bonds, which is currently quite high. A small rise in interest rates might cause a significant backup in yields.