Risk & Allocation
What a bond allocation is actually for
Bonds are held to change how a portfolio behaves in a bad year, not to maximise return.
Everything here earned its place by changing an outcome. Nothing about bonds in a portfolio is included to round the number up.
What matters most
- The role of bonds is dampening volatility and funding near-term needs.
- Duration determines sensitivity to interest rate changes.
- Bonds and equities do not always move in opposite directions.
The purpose is behaviour, not yield
A bond allocation reduces the size of drawdowns, which makes a portfolio holdable through a decline. That is a behavioural benefit with a real financial value, because the alternative is often selling equities at the worst moment. Judging bonds on their return alone misses what they were included to do.
Duration is the main risk lever
Duration measures sensitivity to interest rate changes; longer duration means larger price moves for a given rate change. The sharp bond losses of recent rate-rising periods were a duration event rather than a credit one. Matching duration roughly to your horizon reduces that exposure.
Credit quality is a separate axis
Government bonds from stable issuers carry low credit risk; corporate and high-yield bonds carry progressively more. High-yield bonds tend to behave more like equities in a crisis, which undermines the reason for holding bonds at all. For the defensive part of a portfolio, higher credit quality is usually the point.
The correlation is not a guarantee
Bonds and equities have often moved in opposite directions, and in some periods they have fallen together. Assuming a permanent negative correlation is an assumption rather than a property. This is an argument for holding some genuinely short-dated or cash-like assets for near-term needs.
Near-term money belongs here
Anything needed within a few years sits naturally in cash or short-dated bonds regardless of the rest of the allocation. That removes the need to sell equities on a schedule set by your spending rather than by the market. It is the simplest available protection against sequence risk.
Everything above, in order of what to do first
- The purpose is behaviour, not yield. A bond allocation reduces the size of drawdowns, which makes a portfolio holdable through a decline.
- Duration is the main risk lever. Duration measures sensitivity to interest rate changes; longer duration means larger price moves for a given rate change.
- Credit quality is a separate axis. Government bonds from stable issuers carry low credit risk; corporate and high-yield bonds carry progressively more.
- The correlation is not a guarantee. Bonds and equities have often moved in opposite directions, and in some periods they have fallen together.
- Near-term money belongs here. Anything needed within a few years sits naturally in cash or short-dated bonds regardless of the rest of the allocation.
The takeaway
Hold bonds for how the portfolio behaves in a bad year, and keep the duration honest.
The version you keep doing is the version that works.
Questions readers ask
Should a young investor hold any bonds?
With a long horizon and stable income, a small or zero allocation is defensible. The question is whether you would hold an all-equity portfolio through a severe fall.
Why did bonds fall at the same time as shares?
Rapidly rising interest rates reduce the price of existing bonds, particularly long-duration ones. That mechanism can coincide with equity falls.
