Should You Maintain an Allocation to Bonds When Current Rates Are Low?

by Craig Israelsen

Should You Maintain An Allocation To Bonds When Current Rates Are Low? Splash image

The performance of bonds is related to movement in interest rates. Those two phenomena are related—that much we know. How tightly they are related is a pertinent question at this point in time.

This article reviews how interest rate movement and bond returns have been related to each other since 1948. In addition, bond performance is considered in the context of an overall, multi-asset portfolio and not simply as a stand-alone asset. Finally, the performance of various portfolios in the “distribution phase” is examined, the phase when money is being systematically withdrawn from a portfolio. Bonds are typic

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Craig Israelsen is an associate professor at Brigham Young University in Provo, Utah. He is a principal at Target Date Analytics LLC ( and the designer of the 7TwelvePortfolio ( .


caesark from Missouri posted 11 months ago:

The early baby boomers who invested aggressively during the 80s and 90s and then survived Y2K began to focus like a laser beam on a safe, sound and "cushy" retirement at the start of the century. Then, the "wheels came off the chariot" as the two worst bear markets in their adult life began to play before their eyes. Portfolios that remained heavily concentrated in equities were absolutely devastated. Retirement goals were delayed and/or devalued. As a boomer who has studied asset allocation over the past 14 years, I have developed a sense of peaceful tranquility with respect to a very diversified portfolio similar in nature to that constructed by the author of this article. The bottom line is - as one well known CNBC market madman has occasionally shouted - "a diversified portfolio is the only free lunch in the world of investing"

Harry Rich from Ohio posted 11 months ago:

Speaking as a pre-baby boomer who was mostly in equities in both bear markets it didn't go that badly. Of course my investments were a supplement rather than a substitute for lifetime income, or I would have been more diversified.

However, we are heading into unprecedented territory. The more people in the world join the middle class and the more efficiently we meet their needs, the less reason there is to expect the sort of economic growth which has existed for all of my lifetime, and the less reason there is to believe the next bear stock market will climb all the way back up.

So, now, the real question is not whether, but how best to hedge my bets. I even have some Treasury zeroes in the mix.

Chris from Vermont posted 11 months ago:

I am always skeptical of reports such as this. The devil is in the details: which mutual funds or ETFs were used? Were they chosen retrospectively to maximize the gains of this "7-twelve" portfolio (with its for-profit web site)? How did management fees and transaction costs detract from this performance?

Overall, I wish the AAII editors had asked these questions prior to publication.

Chris Johenning from Ohio posted 11 months ago:

To me, an annnuity has place in the diversified portfolio - Why do you not include this asset class? Chris J

Thomas Potter from New Jersey posted 11 months ago:

Nice charts but what is not empahsized is that no where in recent history has the fed discount rate been so near to "zero". If the fed discount rate climbs back to its average over the next ten years, bonds will be in a sustained bear market, and possibly very deep. I dont buy the arguement in this aritcle.

CMV from Vermont posted 11 months ago:

This article seems contrary to the spirit of AAII. When I tried to fact check this article, the author's web site does not specify any of the sources of the claimed performance of the seven-12 portfolio. However, for a few hundred dollars, they will sell you the names of mutual funds or ETFs which will are consistent with their diversification targets. Shame on AAII for publishing this clearly promotional article!

MEV from Indiana posted 11 months ago:

However, since the author tells us that his 7-12 portfolio consists of equal weightings of some standard asset sub-classes, it wouldn't be hard to replicate this with index ETF/funds.

His 7-12 portfolio breaks down to a 33% bond/cash, 42% equity (of which 20% are emerging markets) & 25% "alternatives" portfolio. Small caps consist of 33% of the domestic equities

During the time period tested, the over-weighting of the sub-asset classes that have particularly over-performed during this time period accounts for the 7-12 over-performance.

The "retro-spectoscope" is always amazingly accurate. Its the future thats a bit murky.

Jay from California posted 11 months ago:

I agree with the comments above - generically speaking, a diversified portfolio makes sense. In this particular environment where bonds have had an unbelievable run due to the artificial stimulus provided by the Fed keeping rates at around zero, I can't see how it makes sense to own bond funds right now. They return nothing in yield and have nothing but downside. There may be an argument for owning individual bonds, but bond funds? I don't think so.

Lee from Washington posted 11 months ago:

The author used the intermediate-term US government bond returns from 1948 to 1975 and the Barclay's Capital Aggregate Bond Index returns from 1976 to 2012. My sources indicate that less than 50% of the Aggregate Bond Index is US government bonds, about 30% are securitized instruments and about 20% are corporate bonds. Am I missing something?
The article states that the Federal Reserve's discount rate was 1.34% in 1948 and 0.75% at the end of 2012. These are nominal rates not real rates adjusted for inflation. Should the rates be adjusted for inflation before constructing the graph?
Even if the rates are not adjusted for inflation, the current discount rate is almost half of the rate in 1948.
I share the concerns of several of the other post authors:
1. Unable to fact check this article
2. The current low interest rate environment has no historical precedent
3. The AAII Journal is supposed to be free of advertising

Jack from California posted 10 months ago:

An unmentioned but well recognized benefit of an allocation to cash and/or fixed income in a diversified portfolio, whether interest rates are rising or falling, is to reduce volatility, i.e. risk.
I use short-term fixed income holdings for this purpose, don't attempt to time allocations, and would prefer to risk small sustained losses than periods of high downside volatility.

Dave Gilmer from Washington posted 10 months ago:

Even though diversification is generally a good thing, this article seems a little one sided in its flavor towards bonds. In the final analysis the author chooses to use one of the best 14 year periods for bonds and the worst period for stocks. Why not balance the article by showing both sides of the coin - interest rates rising in a good stock market. Alternately, why not show a longer time period result, such as 40-50 years.

In the end we have to remember the long term effect of adding bonds to a portfolio - it reduces the long term return of the portfolio as any analysis clearly shows. So only diversify with bonds to the extent needed for your time horizon, or alternately use other strategies that offer the same income, but with a better return potential.

Finally, I still find it hard to invest in an asset class that even the author agrees has no place to go but down from here.

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