The Problem with Bonds


At some point in the last several years, most of our clients have heard us say that the bond market will produce lower-than-average returns going forward. The historic return on traditional, high quality bonds in the U.S. has averaged around 5-6% for the last 80+ years. However, we expect returns to be much lower than that over the near term (the next 3 to 5 years or so). Why? The answer is really quite simple. Because interest rates have fallen to such low levels, it is nearly mathmatically impossible to get historic returns.

But the risk is actually even higher than that. Because when interest rates rise, prices of existing bonds typically fall, long-term bonds have the potential to lose significant value in a rising interest rate environment. To protect against this, we have, on the whole, kept our bond durations low, and avoided traditional, core bond portfolios.

If interested in learning more about this topic, check out this great primer on how bonds and interest rates work, from the Khan Academy: