For those who follow The Motley Fool on Instagram, a popular post this week detailed four tips for investing during a bear market. A stock market fall of at least 20% in a short time is classified as a bear market. If you think about a bear, when it attacks it stands high and comes crashing lower on the prey. Slightly ominous, but that is why we call it a bear market!
On that basis, we can definitely say the FTSE 100 stock market is in a bear phase. The four tips mentioned in the Instagram post are of great help. The fourth tip was to “add highly rated bonds to your portfolio”. While we mostly focus on stocks here, supplementing stocks with bonds can be a great benefit at the moment. Here is why.
Negative correlation
Stocks and bonds typically are negatively correlated. This means that if the stock price goes up, the bond price should go down. This is mostly due to the way investors like you and me allocate our money – bonds are seen as very safe investments, with low volatility. The prices of investment-grade, high-quality bonds usually only move a few percent per year.
So during good times, if the FTSE 100 is gaining 10% a year on average, why would I own a bond that is giving me much less? This is the thinking that leads investors to sell bonds (prices fall) and buy stocks (prices rise). The opposite is true at the moment. Investors are selling stock and buying bonds. Buying a few bonds to supplement your FTSE 100 stocks can help you to offset some losses.
Income payouts
In a similar way to a dividend-paying stock, bonds also pay out income via a coupon. This follows a similar time frame to most stocks. A known percentage (your yield) of whatever amount you invested is paid out on an annual or semi-annual basis.Â
The reason I like to add bonds alongside my stocks at the moment though is that a bond coupon HAS to be paid, or else it defaults. On a stock, if you just own ordinary shares then you are not guaranteed a dividend. In recent news, ITV and Kingfisher both announced dividend cuts in order to cut costs. So while dividend-paying stocks are good when the market is performing well, in a bear market I would be adding bonds to ensure income.
Low volatility
While bonds may not be as exciting as some of the stand-out performers in the FTSE 100, they do have historically low volatility. I am currently seeing draw-downs of over 30% on some of my stocks. Yet on high-quality bonds, the volatility remains low in comparison, along with prices rising.
In order to help me have fewer sleepless nights, adding some bonds alongside stocks can bring down my overall volatility. This means the swings in my portfolio should be smoothed out in the long run.
You can choose whatever split of stocks to bonds you want. For me, I am looking at 70% stocks and 30% bonds as a realistic allocation. Stocks remain my primary investment tool, but adding some bonds is a wise move in my opinion.