Seasoned investors know that when talk turns to bonds, peoples' eyes glaze over.
True, bonds can be the investment equivalent of that raw broccoli side dish. So what? says George Christison, investment planner and founder of IFM Planning Services.
"They're something I'm passionate about," he says.
The British Columbia-based adviser says bonds should be an integral part of any well-constructed portfolio. However, he does understand why people tend to gaze at their shoes whenever bonds are mentioned as part of the investment mix.
"Most investors neglect to look at bonds for various reasons. They, and sometimes their advisers, don't understand them as an investment vehicle and how to use them in a portfolio," he says.
Another reason is that "investors have been told for three and a half decades not to buy bonds because inflation and interest rates are going to rise and they'll lose money."
But Mr. Christison believes there is another reason for investors shunning bonds: "Advisers, fund companies and financial institutions make less revenue from bonds, bond funds and bond exchange traded funds (ETFs) than they do from similar investments in the stock market. So there's less incentive to promote them."
Despite their unglamorous image, bonds bring balance to a portfolio that most investors are unable to achieve on their own, Mr. Christison says.
"Most investors think that by owning bonds they will be handicapping their portfolios' investment performance. But the contrary is actually true," he says.
"If the volatility in the value of the portfolio can be reduced, it will also reduce the investors' bad behaviour, and they'll see greater investment performance."
He points to a report published annually by the asset management firm Russell Investments that compares the performance and volatility of investing in a single asset type, for example all stocks, with that of a portfolio that mixes several asset types.
"Investing in a single asset class is risky when you consider [that] no one asset class outperforms on a regular basis," the report says.
A portfolio that put 100 per cent into stocks between 1974 and last year would have had an average annual return of 11.46 per cent, but it would have been highly volatile. A portfolio with 60 per cent bonds and 40 per cent stocks would have earned nearly 2 per cent less each year but would have been 50 per cent less volatile.
An investor will usually be better off with a lower return but less volatility because even sophisticated investors get carried away when they see market fluctuations, he says: "Less volatility leads to less bad behaviour by investors. In my mind, if investors want to protect themselves from their own bad behaviour, adding bonds would help."
Not all bonds are alike. "Focus on credit quality first," says Mr. Christison, who recommends investment grade or higher bonds only. "Remember, your bonds are supposed to be your safe, conservative, defensive investments."
He avoids bonds denominated in foreign currencies because, since he's using bonds as defensive investments, "I am not trying to speculate or profit from currency swings."
Dan Bortolotti, an adviser at PWL Capital Inc. in Toronto, agrees: "Taking currency risk on the bond side is usually a bad idea. Because currencies are generally more volatile than bond prices, you'd be increasing your risk without raising your expected return. That's a bad idea," he says.
At the same time, "global bonds might indeed be an option for sophisticated investors," Mr. Bortolotti says.
"Most people will do just fine with Canadian bonds only, but a global fixed-income fund can offer added diversification, since interest rates in other countries do not move in lockstep with rates in Canada," he explains.
"If you've got a relatively small allocation to bonds in your portfolio, the case [for global bonds] is not strong. But if you're a conservative investor with 50 per cent or more in bonds, then diversifying beyond Canada becomes more compelling."
Mr. Bortolotti recommends not trying to buy bonds in individual sectors. "I just don't think it's possible to reliably identify which sectors will outperform the broad market," he says.
Mr. Christison recommends buying different types of bond investments for taxable accounts, compared with bonds to put into non-taxable ones such as registered retirement savings plans, registered educational savings plans and tax-free savings accounts. For non-taxable accounts, look to compounding bonds, but stay away from these for taxable accounts because "tax reporting can be a nightmare," he says.
"Investors should look for bond ETFs that fit with their investment theme – short maturities if you think inflation and interest rates will rise, or longer-dated maturities if you think inflation will remain low or go negative," Mr. Christison adds.
"I would look for two qualities in a fund – low costs and low portfolio turnover ratios."
Remember, bonds are supposed to be boring, but good for you.