If you were to read Section III.A in the Essays of Warren Buffett, then you’re going to hear all about Buffett’s opinion on the high yield bond market and bonds in general, but let me summarize for you – he doesn’t like them.
Buffett’s personal opinion, and it’s one that I 100% agree with, is that just because a bond has very low volatility or a beta of 0 doesn’t mean that it isn’t risky. In fact, it can mean that it’s even more risky!
People will typically purchase bonds when they’re looking for something more conservative in their portfolio. Maybe they’re getting close to retirement and want to start to decrease the risk in their portfolio. Or, maybe they’re trying to time the market (which is likely the worst thing that you can do, especially if you’re new to investing).
Timing the market seems to always be a “fan favorite” for new investors because they think that they can outsmart everyone else. I mean, I know that was my thought when I first started investing but I was wrong, and you will be too.
Don’t be upset, however, because you can still make money doing this…it just won’t be anything close to what you could’ve made if you didn’t try to time it. But alas, I digress.
Back to bonds – people will purchase them as they view them as a sort of “guaranteed income” and it’s hard to disagree with that, but the issue is that each year that income is digging a deeper and deeper hole for them.
Buffett talks about how the value of the dollar has absolutely tanked from 1965 – until he updated his book in 2011, and that it now takes $7 to buy something that was $1 back then. Yes, you’re probably just sitting there thinking,
“I know, Andy – that’s called inflation.”
And you’re right.
But if a bond is earning you 2-4% like a lot of bonds will, you’re going to be consistently underperforming the market and even losing money!
For an investor in bonds to simply maintain the same purchasing power in 2011 that they had in 1965, they would’ve had to earn an average of 4.3% on their investment during that time, and that’s before any sort of taxes being paid.
Now, while Buffett is very vocal about being against bonds, he does acknowledge the importance in having some sort of short-term investment that is very liquid if they would ever need to draw on the cash, either for financial issues or to pursue an investment opportunity.
For these circumstances, he says that Berkshire is completely invested in U.S. Treasury Bills around $10 – $20 billion at any point in time.
Personally, I have no issues with people investing in bonds if they understand the return that they’re going to get and understand the risks that come along with doing so. If investing in bonds is a long-term strategy, I think it could be setting the investor up for failure in the long-term.
Personally, I invest in bonds. There – I admitted it.
But – I only invest in them in my HSA and for a very small percentage of it. I have a large majority of my HSA funds invested in the stock market, about 20% in cash for me to use and then another 20% or so in bonds.
The reason that I do this is because if things ever timed up just right for a major medical expense and the market wasn’t doing well, I would hate to have to sell many under-valued stocks simply to pay for my medical bills, but that’s the situation that I would be in.
So, I try to keep enough cash and bonds in my HSA purely if I ever absolutely need them. At the end of the day, an HSA is essentially a tax-advantaged medical version of an Emergency Fund, so it’s extremely important in my eyes to have a decent chunk of those funds in liquid accounts.
Worst case would be to have a serious medical issue and not be able to pay for your bills, or as I mentioned, sell your stocks in the middle of a market crash when you ideally would like to be buying more!
Now, if you were to look at my IRA, 401K or my Brokerage Account, do you know how much would be invested in bonds?
Yup – absolutely nothing. And that’s because I am investing for the long-term, so the short-term noise (such as trade wars) has absolutely no impact on my investing strategy, and it shouldn’t impact yours either.
“But Andy, I am going to retire within 5 years – shouldn’t I be mainly in bonds?”
Well, no. If you’re going to retire in 5 years, let’s pretend that you’re 60. How long might you expect to live until? 80? 90? 100?!?!
Regardless of your answer, you need to plan for many more years of growth than the five years that you’re talking about. You could have another 40+ years of life and if you were to invest only in bonds, your money would likely consistently underperform the inflation rates and become worth less and less over the course of your life.
Even if you’re planning on having another 20 years left in your life, you need to have a large amount of your money invested in the market. Maybe you choose to find a “safer” option and simply invest in ETFs rather than individual stocks and while I don’t 100% agree with that plan, I can admit that it might be a happy medium to moving entirely to bonds.
So, are bonds the absolute worst thing that you could invest in? No, absolutely not. To be honest, holding cash is likely the worst thing because at least with bonds you’re getting some sort of return. Cash is simply going to stay at the same value while inflation will continue to increase, making you purchasing power decrease rapidly day by day.
But I think that Shelby Cullom Davis said it best: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”