In response to the severe stock market correction of 2008, investors have begun to look at bond portfolios because of their low correlation to stock returns. The term "flight to safety" was commonly used in the media to describe the preference of investors to sell their equity holdings and purchase high quality (investment grade) bonds. The "flight to safety" was particularly present in the 4th quarter of 2008. While the move to high quality bonds may seem like a good response to 2008, there are benefits to continuing to invest a portion of a portfolio in equities.
A good representation of the performance of high quality bonds would be to look at the Barclays Capital Government/Credit Bond Index (Barcap Government/Credit). In 2008 the Barcap Government/Credit returned 5.70%. Compare this with the total return for 2008 of the S&P 500 index of -37.00%. However, as of May 31, 2009 the Barcap Government/Credit returned -0.30% while the total return S&P 500 returned 2.96%. These returns certainly show a troubling conundrum for investors.
While moving between bonds and equities at specifically the right time to capture the better performing asset class would
be the ideal strategy, there are few investors who can continuously pick the right time to make these moves. Instead, investors should consider a total return strategy. The total return strategy looks for a consistent mix of both bonds and equities. Including bonds in an equity portfolio helps lower the correlation of returns. Correlation describes how component assets move in accordance with each other. A low correlation means bonds don't entirely move in the same direction as equities, which translates into a lower volatility (risk) of the portfolio.
Looking back to 2008, any combination of the Barcap Government/Credit index with the S&P 500 Total Return index would have resulted in better results than only holding the S&P 500 Total Return index. Additionally, any combination of the S&P 500 Total Return index with the Barcap Government/Credit index would have resulted in better results than only holding the Barcap Government/Credit index. The decision doesn't come down to whether or not to hold bonds or equities; rather, the question becomes what mix of bonds and equities should an investor hold?
The answer to which proportion of bonds to equities to hold in a portfolio ultimately comes down to the individual investor's risk tolerance. An aggressive investor may be comfortable with holding 90% equities and 10% bonds, while a conservative investor may be comfortable holding 20% equities and 80% bonds. A financial professional can assist individual investors with understanding risk tolerance and translating it to an acceptable allocation of bonds and equities.
Your Personal Banker at Canandaigua National Bank & Trust is knowledgeable in helping discuss a total return strategy with attention to risk tolerance in formulating appropriate asset allocations. Please contact your local personal banker today to discuss your individual total return asset allocation strategy.
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