The bond portion of your portfolio should be designed to be safe, safe, safe.
I was thinking more about my post two days ago on differing styles of bond management. Building the bond portion of a portfolio is simple, but it is easy to misunderstand.
So I picked up and old favorite of mine, Security Analysis, 1934 Edition. I’ve written before about some of the fantastic insight you can get from reading investment literature from 1932-1934, and this time it didn’t disappoint.
I struggle sometimes to explain to families how and why they should invest in one bond fund rather than the other. Benjamin Graham explained it perfectly in the title to the first subsection of Chapter 7.
“Bonds Should be Bought on a Depression Basis.” he wrote.
What a great line. His eight words says what can take me 10 minutes to try to explain. In other words, buy bonds that you expect to pay up, even during a depression.
This really captures the essence of it. Advisors and clients often get way too caught up in correlations, currency risk, and all sorts of other tangential points of bond funds. In the past, I even heard a colleague tell a client that some non-listed real estate investments were a good higher-yielding substitute for bonds, which is utterly crazy talk.
Once you clear all these technicalities out of the way, here is the way to think about it buying bonds. If the economy goes crazy, if a depression hits, it all the s–t hits the fan, you want the bond portion of your portfolio to be able to hold up.
Don’t worry about star ratings, peer ratings, correlations (which change all the time anyways). Worry about how it will hold up at the darkest economic hour. The worst thing that could happen to a portfolio would be for the bond portion to be crumbling at the same time that the stocks are way down. This is especially important for inheritors who are planning on investing for well over 100 years. At some point during any century things are going to get really, really bad. Be prepared for it. I sometimes speculate that families actually get into more trouble with poorly considered bonds than with the stock portion of their portfolio.