The most celebrated and watched markets on the planet are the U.S. equity markets. Although underlying fundamentals and company financial statements can be difficult to analyze, the general public can easily discern price movements and understand the primary objective—buy low and sell high. For many investors, equities, are an essential component of portfolios to grow wealth. The S&P 500 Index experienced a 24.79% total return. Not bad! The hype, the ease, and the year’s results create a comfortable agenda to get behind.
The important takeaway is to… well, take away the wealth. What do I mean by this? How much money you make is not as essential as how much money you keep. Think about it. If an investor purchased the S&P 500 index on December 29, 2023, and sold it all on December 31, 2024, they “realized” the 24.79% return on their money. Still holding it? Nothing realized. Sold or bought outside those specific dates? Different paper return. The stock market has years with large gains and large losses indicating that market timing is critical in determining what can potentially be realized. An investor holding a bucket of stocks in the S&P over a long period, such as since the turn of the century (December 1999), has achieved an average paper total return of 7.7% per year. Again, until the stocks are sold, nothing has been realized. How does one “realize” these returns and keep this wealth? The answer is with individual bonds.
Let’s face it. Bonds are not as sexy as stocks. They really are quite boring. When buying a high-quality individual bond, we already know exactly how it will perform over its life. There is no anticipation, no ecstatic windfall, or, conversely, no sleepless nights. Changes in interest rates, wars in the Middle East, inflation, changing political environments, or even the Fed do not directly affect the performance of an individual bond held within a portfolio to maturity. Although a bond’s price may be affected by outside influences, barring a default, a held bond’s income, cash flow, and time when its face value is returned do not fluctuate. Individual bonds methodically perform on day one and every day thereafter to maturity in the exact same way. Boring… yet predictable in a good way. This boring performance allows an investor the opportunity to lock into the wealth created by the stock market or any other growth asset.
Many investors have enlarged growth allocations due to an upsurge in stock markets for two consecutive years. By rebalancing allocations or realizing some of this wealth and reallocating the proceeds to individual bonds, investors can lock the growth in without the consequences of future market fluctuations. The good news does not stop there. Although appropriate asset allocation is critical in any market, the fixed income market today provides the added benefit of higher interest rates. In other words, the growth taken out of the equity market can be locked into assets providing significant yields. Many intermediate-maturing individual bonds can deliver 5% or higher yields. Longer tax-exempt bonds may provide tax-equivalent yields north of 7%. Remember the earlier mentioned average annual total return of the S&P 500 index since the turn of the century is 7.7%. Locking into a more conservative individual bond in this market does not necessarily mean giving up much on long-term returns.
Begin the year by giving up some of the portfolio’s return risk while maintaining a healthy asset allocation. Locking in some of the last two years of equity windfall with boring bonds can eliminate some volatility and risk with a historically satisfying fixed income rate.
