If you’re holding all – or almost all – stocks in your portfolio, the last six weeks have been a very expensive lesson.
And right about now, you’re probably feeling like you’ve had your head handed to you on a daily basis.[ad#Google Adsense 336×280-IA]That’s because you have!
The topic this week is reducing risk and volatility in your portfolio while increasing your return with what most consider a risk asset: high-yield bonds.
If you combine high-yield bonds with a portfolio of quality stocks, or better yet, a dividend stock portfolio, you actually increase risk-adjusted return.
Sounds crazy, right?
The bad boys of the bond world reducing risk?
Let’s first debug the beliefs most have about high-yield bonds.
Over an 80-year period, 1928 to 2008, Moody’s reported the average default rate for these so-called “risky” bonds was only about 6%. That means 94% of high-yield bonds paid all their interest due and returned $1,000 in principal per bond exactly as promised.
In the current market, the high-yield default rate is around 2%: 98% of junk bonds are paying exactly as promised.
So much for high risk from high yield.
And the average returns of the S&P 500 and the Barclays’ high-yield index between 1998 and 2015 were almost identical: 7.5% for stocks versus 7.3% for high-yield bonds.
But in one way, bonds have a big leg up on stocks thanks to what’s referred to as known terminal value. Bonds have a maturity date, and this known information reduces the drawdown of an investment. Drawdown is measured from a high to a low, or a peak to a trough in a sell-off.
Drawdown was reduced from 11.8% for stocks to only 6.3% for high-yield bonds for the same period from 1998 to 2015, the one I mentioned above.
So what that means is less volatility; bonds have almost half as much volatility as stocks.
And right now is the best opportunity since 2008 to buy both investment-grade and high-yield bonds.
Double-digit annual returns are common, and total returns of 50% to well over 100% are there for the taking.
Yes, bonds are new to most of us. And, I know, the idea of actually reducing your overall risk with high yields seems inconsistent with their reputation.
But the reduced drawdown effect, their real, long-term risk, and their current returns mean you have to at least consider them. It is one of the best ways to reduce volatility, increase your income and increase your overall returns.
Take a look at high yields.
Source: Wealthy Retirement