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Long-Term Bonds & The Duration Risk in Your Portfolio

by: Lawrence Hamtil     
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After a brief surge after last fall's election, long-term Treasury yields are again approaching all-time lows [the gap in the data is explained by a temporary halting of issuance in the mid 2000s]:

Given the precipitous drop in long-term yields, I thought it would be wise to revisit why I think investors would do well to reduce, if not avoid, exposure to long-term bonds in their portfolios.

First of all, as discussed previously, long-term bonds behave more like stocks than perhaps many investors realize.  Both stocks and long-term bonds share the characteristic of extended duration (meaning they are particularly sensitive to interest rate movements), so they can be extremely volatile when discount rates rise.  This can clearly be seen by tracking the drawdowns of stocks versus both long- and intermediate-term bonds over the last 20-plus years:

 

Given that there is an inverse relationship between an investment's yield and its duration, today's extremely low rates on long-term bonds should caution investors, particularly those with considerable domestic equity exposure.  The reason I say that is because long-term yields have fallen to such an extent that GMO recently calculated that 30-year Treasury bonds have essentially the same duration as the S&P 500 equity index:

In other words, with current yields as low as they are, investors who are already heavy in U.S. equities are assuming even more duration risk by also investing significantly in long-term Treasury bonds.  

Given current low yields and rich equity valuations, investors would be better off, in my opinion, by reining in the duration of their portfolios by holding more cash and short-term bonds to reduce their overall interest rate sensitivity.  At these rates, only in a severely deflationary environment would continuing to hold a large amount of long-term bonds really make sense.


NOTE:  For further reading about the volatility and diversification value of long-term bonds, see the previous post in this series, "Long-Term Bonds Behave More Like Stocks Than You Might Think"


 

Disclosure:  The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. 

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Fortune Financial Advisors, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Fortune Financial Advisors, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.


The information provided above is obtained from publicly available sources and it is believed to be reliable. However, no representation or warranty is made as to its accuracy or completeness.


Lawrence Hamtil is a fourteen-year veteran of the financial services industry, having served clients in all aspects of the business during his career, which started in 2002. In 2005, he joined Dennis Wallace of Fortune Financial Services, LLC, becoming, at the time, one of Multi-Financial Securities, Inc's youngest registered representatives. In 2008, Dennis and Lawrence made the decision to become fully independent by founding their own Registered Investment Advisory (RIA), Fortune Financial Advisors, LLC. He serves clients in the United States and Europe. His financial commentary has been referenced in Barron’s online edition.

You can connect with Lawrence on Twitter ( @lhamtil) or via email, lawrence.hamtil@fortuneadv.com. 

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