Why Bonds Are Essential for Your ETF Strategy

One key element of building a successful portfolio is understanding the role that bonds play. But what makes bonds so valuable in an ETF portfolio? Let’s break it down in simple terms.

‍

🔍 How Bonds Provide Income

Bonds are essentially loans you give to governments or companies. In return, they pay you interest, which is often a steady source of income. For example, a U.S. Treasury bond typically pays interest every six months. This predictable income stream can be an excellent way to balance the more volatile returns from stocks.

‍

📈 Stability in Uncertain Times

Bonds provide essential stability in an investment portfolio, particularly during periods of stock market volatility. When equities experience sharp declines, bonds tend to hold their value better due to their fixed-income nature. Multiple studies support the notion that bonds consistently exhibit lower volatility than stocks, acting as a buffer against market fluctuations​. This stabilizing effect is why many investors shift toward bonds in uncertain times, leveraging their ability to mitigate risk and preserve capital.

‍

💼 Diversification: A Key Advantage

Including bonds in your portfolio also helps with diversification. Stocks and bonds often (but not always) move in opposite directions, meaning when one goes down, the other might go up or remain stable. This creates a smoother ride for your overall portfolio. A classic 60/40 portfolio, which is 60% stocks and 40% bonds, is a well-known model for achieving this balance.

For instance, the iShares Core U.S. Aggregate Bond ETF (AGG) is a popular choice for investors looking to add bond exposure. This ETF provides broad access to U.S. bonds, helping to diversify risk while generating income.

Quantlake tracks two Classic portfolios that consist of SPY (SPDR S&P 500 ETF) and AGG (iShares U.S. Aggregate Bond ETF): the US 60/40 and US 80/20. Both portfolios rebalance quarterly to maintain their target risk profiles. Let’s compare their performance since September 2003:

US 60/40: 8.1% CAGR, Sharpe Ratio of 0.6, max drawdown of 34%.

US 80/20: 9.7% CAGR, Sharpe Ratio of 0.5, max drawdown of 45%

‍

A higher bond allocation in the US 60/40 portfolio lowers the CAGR but reduces risk, as indicated by the lower maximum drawdown and higher Sharpe ratio. The ideal bond allocation depends on your investment goals and risk tolerance.

‍

💼 Takeaway

Research supports the importance of bonds in a balanced portfolio. This means that by including bonds, you can achieve a better balance between risk and reward.

At Quantlake, we are dedicated to giving you the tools and insights you need to make informed investment choices. Understanding how bonds provide income, stability, and diversification is key to long-term investing success.

Quantlake offers a wide range of simple and enhanced portfolios to help you in your investment journey.

‍

Happy Long-Term Investing from the Quantlake Team.