Not Spock or Rip Van Winkle? Think Bonds!

Did the words "Fascinating, Captain" come to mind during the massive financial collapse in 2008 that sent stock values plummeting over 50%? Are you prepared to duck into bed for a 20 year nap? Granted, over the long term, exciting equities have far outperformed bond and debt instruments, but we're talking years – sometimes tens of years here. The truth is, few investors have either the ice-water in their veins or extraordinary risk tolerance to want to wait out the recoveries from the kinds of extreme market ups and downs we've seen these last couple of years. Anyone who started investing in 2000 knows that – their portfolios are probably still down, way down, if all they invested in were stocks.

That's where asset allocation – diversification – comes in. I'm not talking about investing in 25 different growth mutual funds, or 50 different companies in the S&P 500. I'm talking about asset classes. And the one asset class that finance professors and professional investors universally recognize as the must-have-to-own outside of stocks, are bonds, particularly US treasuries. When stocks go down, these tend to go up, providing needed cushioning to the portfolios of all but the superhuman. In fact, these bonds, either purchased directly from the US government, through mutual funds or ETF's (exchange traded funds), are the only asset class that really moved up when the markets crashed in 2008 and early 2009.

Take a look at the graph above…. Since the beginning of 2010, you can see how long term treasuries have moved in the opposite direction of the S&P Equity index. While the S&P is down 5% this year, treasuries are performing well.

While gold is usually thought of as the place of safety in difficult times, what we're seeing is a flight to the safety of the good ol' USA. Forget the Yen, forget the Euro, forget real estate -- the AAA-rated US treasury bond, during all this duress, has been the ultimate relief during these difficult times.  Even with the interest paid on a new ten year treasury is just over a measly 3%, they can hold their own better during tough times for stocks, and they can gain in value, as the above chart shows.

 Some pros might tell you that treasuries themselves are too pricey – that with inflation down the road, these bonds are likely to drop in value, and that the high levels of  US debt will ultimately result in less confidence in Uncle Sam's currency. Could be – but guessing if and when is just that. Study after study has shown that keeping a percentage of treasury bonds in a portfolio over time helps smooth out the ups and downs while allowing investors to continue to earn handsome returns.

Bonds – even treasuries – have two types of risk investors should consider. Interest rate risk can be a problem during a period of rising interest rates. When interest rates rise, so do the interest rates offered to new bond purchasers, and during these periods, existing bondholders can see their paper values go down (of course, those same bonds go up in value when interest rates drop.)  Bonds are also subject to credit risk – meaning they lose paper value (or gain value) when there is a change in the perception of the creditworthiness of the bond issuer. Right now, despite high budget deficits, US treasuries are considered the safest vehicles out there. Anywhere.

We typically incorporate a variety of bond vehicles – including corporate and international bonds, and others – in our clients' portfolios. A good diversified bond fund or ETF could help an overly stock-weighed investor. But if I had to start with one asset, I'd start with Treasuries, either individually or as ETF's (tickers: TLT, EVD,or VGLT). Sure, keep an eye on them if interest rates tick up or if the economy (and inflation) starts roaring ahead.  If you're stuck in a variable annuity or 401k plan, try to fund a subaccount fund that's heavy with longer term treasuries.  And it's usually safer to make a series of purchases than just do one lump sum.

In any case, unless you've got pointy ears or a spine of steel, think about putting some adding some basics – treasury bonds -- to your portfolio. The added sleep will do some good. And you won't have to sleep for 20 years.

Peace.

Ron Stein, CFP

Good Harvest Financial Group

www.goodharv.com