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Will bonds protect you in the coming crash?

Much angst and gnashing of teeth is going on about the fact that bond prices have nowhere to go and hence the traditional protection of a mixed bond/equity portfolio will not avail you this time round. bond1

But what many fail to realise is that the return on bonds over time is almost 90% from coupon and only 10% from price. This applies in both bull and bear bond markets.

The charts and figures below are calculated by assuming a constant maturity 10 year US Government bond whose “price” rises and declines in strict mathematical accordance with the discounted effect of annual interest rate changes over the ten years to maturity.

As can be seen, unless the rise in interest rates is particularly swift and vicious, bond3bonds can continue to maintain positive performance in rising rate environments.

Rates rose from 1949 to 1981. Did this mean you could not make a return on bond investment during this period? Of course not.

Look at the table of S&P declining years since 1928: 24 of them. In all but 3 of those years, our constant maturity 10 Years US Government Bond recorded a gain. In those years it did not, note the dramatic and swift rate rises which meant price decline swamped coupon increase:

1931 rate increase 22%bond2

1941 rate increase 23%

1969 rate increase 27%

Note that in the 89 years covered by this data, the theoretical constant maturity bond would have lost you money in only 16 of those years.

So what can go wrong? Well for a start bond funds are not constant maturity schemes although they do their best to keep the maturity stable at the stated level. And of course there are a myriad of other factors which could screw things up: loss of faith in the US government being the biggest factor, caused by political disaster, natural disaster, bankruptcy, whatever.

bond4The future may resemble the past but will not repeat it exactly. But the US is not Greece (yet).  It seems a reasonable bet therefore that in the coming crash, bond holdings will provide some cushioning for stock losses.

But who am I to say?

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