I apologize in advance if this question is too elementary for this group but, what is the value investing stance on holding 10% of your portfolio as bonds when there’s consensus that rates will rise? Like most investors, I can’t wrap my head around it and would likely hold cash on reserve instead of bonds. But there are still bond advocates out there. Could someone explain this reasoning to me?
Dan Naumov: The reasoning is simple. You dont know when and what asset class will move and by how much. If you are scared of stocks diving by over 40%, having some money in an asset that is likely to return zero makes perfect sense.Note that despite yield close to zero, bond prices (particularly short and long treasuries) often move inversely to stocks crashing.
Adrian Felismino: you will hold cash because intrinsic value of bonds is lower when variable rate is rising. example you bought 10000 at par with 5% interest rate. next month, same companies/issue again a bond 10000 at par at higher interest rate example 10%. the diff between 10% and 5% is a opornunity cost. there are factors to consider, it can be quanlitives and quatitives of underlying bonds.
Dave DeSanto: Thanks everyone. These perspectives are helpful.
Adrian Felismino: typically they want hold cash to have buying powers when specific bonds/stocks offer potential returns based on its fundamentals or they preferred technical analysis.
Simon Ch: Short term bond is ok. Cash and short term bonds are like call options without expiration.
Ang Yee Gary: If u hold the bond to maturity, u get the principal back. Aim for.short term bond if interest rate r expected to go up.
John Volf: Interest rates must rise, therefore the returns on other asset classes must rise also. Unless earnings from assets rise through rising profits, asset prices should fall proportionally.
Aquiles Losada: The reason for holding the cash is because you do not know when a good oportunity will appear. If you follow the value investing way its mean that you will be open mind to stocks that just dropped the price recently to buy them.
Dave Childers: Bonds – As others have have mentioned, the market value of short term bonds is much less susceptible to interest rate risk than long term bonds.Also, if you intend to hold your bonds to maturity, interest rate risk is less of a concern since you’re not going to be worried about selling the bond on the market. Your cost here is not loss of principal from decreasing market value, but opportunity cost if rates do in fact rise.
John Volf: But if interest rates rise, bond yields need to follow, hence capital loss imho
Dave Childers: If you intend to trade it on the capital markets, sure. But if you are holding it to maturity, you have a legally binding contract with the issuer of the bond for specified coupon payments and/or payment of principal at the end. Sure, if interest rates rise the present value of these amounts inherently decreases due to opportunity cost of capital, but the absolute undiscounted cash flows will remain the same.
John Volf: Assuming also there is no default
Dave Childers: John Volf true, but if you’re seriously worried about default, then you’re probably holding some lower grade bonds in favor of higher yields.Only good grade corporate and government bonds for me 😉
John Volf: Yep. Im in cash
Chinmay S Sangoram: Better if you hold in cash than in bonds.. Rising interest rate means tumbling bond yields, and so, prices.. So if u invest X amount today, its market value – between today till maturity – will decline.. If you intend to hold bonds till maturity, then you may go ahead and invest.. But if you intend to trade in bonds, it isn’t the right time..