Bonds are just one of the asset classes that go into making up your investment portfolio and each class comes with its own level of risk.
While shares vary in risk – generally between medium and higher risk – they also offer the possibility of high returns. Bonds are the go-to low-risk option, offering a regular income with reasonable, if unspectacular, returns.
Conventional investment wisdom states that 60% of your portfolio should be made up of higher-risk equities, with 40% in lower-risk assets, such as government bonds. But is this still the case?
Warren Buffett, the billionaire CEO of Berkshire Hathaway, used his annual letter to shareholders this year to state that bonds are no longer “the place to be”.
What does this mean for the “60/40 rule”? And for your investments?
Bonds are loans to governments or companies in return for a regular income
When you invest in bonds you are effectively lending money for a set period, after which your loan must be repaid. You receive a regular income from your loan, in the form of interest.
Loans made to the British government are known as “gilts”. Because the UK government is unlikely to go bankrupt – and thereby default on your loan – gilts are considered low-risk. As with other types of bonds, gilts offer a fixed rate of interest over a specific term. The amount of interest you receive depends on the time until maturity.
Government bonds issued from other countries work on a similar principle but might involve a greater level of risk.
You might opt to loan money to a company by investing in corporate bonds. These are higher-risk and therefore will generally offer greater levels of interest.
“Fixed-income investors […] face a bleak future”
Despite being seen as low risk, there are dangers attached to investing heavily in bonds. Last year, in our article Why cash is no longer king: The risk of not taking enough risk we looked at the impact of low interest rates and inflation on your cash savings.
The same factors could have a bearing on the value of your bonds.
The impact of inflation
One of the reasons why fixed-income investing could face a bleak future, as Buffett predicts, is rising inflation. In 2020, the coronavirus pandemic ravaged world markets. Now, as governments look to shore up their economies, inflation could start to rise again.
In January, UK inflation stood at 0.7%, just a 0.1% rise on the previous month but up from 0.3% in November 2020.
A rising inflation rate effectively devalues the fixed rate of interest you receive on your bonds.
Interest rate risk
Bonds are inextricably linked to interest rates. When you buy a bond, it is at a fixed rate of return, set until your investment matures. If interest rates rise while you hold a bond, the fixed rate begins to look less attractive and bond prices fall.
With rates currently at a historic low, a future rise is inevitable. The inverse relationship of bond prices and interest rates will harm the value of the bonds you hold.
Holding a diversified portfolio is still important
A successful investment strategy manages risk versus reward.
This means giving you the best chance of achieving your long-term investment goals while, at the same time, exposing you to the lowest possible level of risk.
The 60/40 investment “rule” helps to ensure your portfolio is diversified. By spreading your investment across asset classes, we spread your exposure to risk.
It is hoped that a fall in one asset class will be offset by a rise in another. This holds whether it relates to high-risk equities in a new start-up, for example, or a traditionally low-risk gilt.
But asset class isn’t the only way that HDA diversifies your portfolio. Diversifying across different industries and sectors, as well as geographically, helps to spread your risk even further.
Focusing on your goals while keeping risks as low as possible means that we can cut out the exterior noise of investment fads and trends, achieving long-term growth rather than chasing large and high-risk returns.
Your portfolio will include a mixture of assets, in various industries across the globe. While it is important to understand that even a low-risk investment is not without its dangers, your portfolio will always be aligned to your risk profile and driven by your aspirations.
Get in touch
At HDA we have a wealth of experience and expertise and understand the way the stock market works. We can help you build a portfolio that is individual to you and aligned with your goals.
If you’d like to discuss the balance of your portfolio or are interested in investing for the first time, please get in touch. Email enquiries@hda-ifa.co.uk or call 01242 514563.
Please note
The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
