Do Bonds Still Provide Diversification?

The bond market has been quiet for the past six months, with Treasury yields holding in narrow ranges near historic lows. Given these low yields, there is a lively debate going on about whether bonds can continue to provide diversification in a portfolio. Many fear that if markets become volatile and stocks decline again, bond yields don’t have much room to fall—and therefore, won’t provide the balance to a portfolio that they have in the past. This view is often wrapped up with the idea that the traditional balanced portfolio of 60% stocks and 40% bonds is “dead.” These fears were stoked by the turmoil in the markets in March, when bonds and stocks sold off at the same time for a few days, before the Federal Reserve stepped in to calm the markets.

In our view, those fears appear overblown. The 60/40 portfolio was never right for everyone. The right mix of assets depends on an individual’s capacity and tolerance for risk and specific goals. The 60/40 portfolio was more of a starting point. Moreover, correlations between asset classes diverge from time to time, so it’s a myth that they are stable in the first place. Investors should expect some variations in the short run. More importantly, we still expect low-risk or risk-free bonds, like Treasuries, to provide diversification from stocks during times of market downturns, even though a 60/40 portfolio may not be the best choice for most investors.

The correlation between stocks and Treasuries varies over time

Rolling 3-year correlation between U.S. stocks and U.S. Treasuries has varied from -0.6 to +0.6

Source: Charles Schwab Investment Advisory, Inc. Historical data from Morningstar Direct, as of 3/31/2020. Indexes representing the investment types are: U.S. stocks = S&P 500 Total Return Index (1990 onward); U.S. Treasuries = Bloomberg Barclays 3-7 Year Treasury Index (1992 onward) and FTSE U.S. Treasury Benchmark 5-year USD (1990-1991). Past performance is no indication of future results.