A debate has raged in recent years about the wisdom or otherwise of investing in government bonds. I’ve advocated their inclusion in portfolios for a very long time, and I still do. But I have to say I’m less enthusiastic than I was, for reasons I’ll explain.
But first, how did government bonds perform in the recent tariff crisis? After all, it’s when markets are volatile and stock values fall that bonds, such as Treasurys in the US and gilts in the UK, come into their own.
As I write this, we’re still in the midst of the storm, and the situation is changing by the hour. But, so far, government bonds have proved a mixed blessing, to say the least. Here’s what happened.
President Trump made his announcement when New York trading closed on Wednesday, 2nd April. Global markets fell sharply on Thursday and Friday, as did yields on government bonds. Yields and prices move in opposite directions, so as stock values declined, bond values rose, cushioning the blow for diversified investors.
That, in other words, is precisely what most commentators would expect to happen; as stocks zig, bonds tend to zag, and vice versa.
It didn’t all go to plan
But Monday, 7th April, brought an unexpected twist. Suddenly, even as stocks continued to fall, hedge funds and other institutions began to sell bonds, pushing yields back up and values down. (1)
The tariff crisis is, of course, a highly unusual situation, and commentators generally agreed that Monday’s sell-off reflected less a retreat from bonds and more a broader drive toward cash and liquidity.
“I think investors are moving to cash and cash-adjacent assets to weather this market volatility,” one analyst told the FT. “The simplest explanation (for the move in yields) is investors selling what they can and hunkering down. Selling equities now will lock in losses so the lowest-hanging fruit is to raise cash by selling Treasuries.”
Even still, the bond sell-off is a reminder that stocks and government bonds are not as negatively correlated as is often assumed. Sometimes — as in the 1970s stagflation era or the aftermath of the ill-fated Liz Truss mini-budget of September 2022, for example — stocks and bonds have fallen together.
In recent days, we’ve seen one thing happen on one trading day, and the opposite happen the next.
Four reasons for my change of view
So, is it wise to include an element of government bonds in your portfolio or not? And if it is, how much is too much?
Four factors in particular have somewhat altered my opinion. The first is the eye-watering level of US public debt. True, a default by the US Government is still highly unlikely. There again, a few highly unlikely things have come to pass in the US in recent times. There is no such thing as a riskless asset, and that includes Treasury bonds.
The second factor is the return to more normal levels of interest rates. With Cash ISAs and fixed-rate savings bonds now paying up to five percent or even more, cash has once again become an attractive alternative to government debt.
The third reason why my enthusiasm for bonds has cooled is that, the older I get, the more I appreciate the value, and indeed the necessity, of investing for the very long term. As Charles Ellis recently wrote in the Financial Times: “Most individual investors incorrectly define ‘long term’ as a typical ‘market cycle’ of a few years. The reality of investment horizons stand in stark contrast to these conventions.” (2)
Most people, Ellis went on, “begin investing at about age 30 and continue to invest until their late 80s — suggesting that their real investment horizon spans half a century. These longer time horizons should be used to frame their critical investment policy decisions, including their allocation to bonds.”
The final reason why I now believe that many investors are over-exposed to government bonds is that, when deciding on their allocation, they tend to focus on their investment portfolio rather than their overall wealth.
Most Brits of retirement age now have equity value in their homes. Yes, house prices have fallen sharply in the past, but domestic property has been a relatively stable asset for the last 30 years. Also, most of us are entitled, at least for now, to at least a basic pension from the state. Those two things provide significant sources of wealth alongside their long-term investments.
For all of these reasons, my own view is that, in most cases, the old rule of thumb that your percentage allocation to bonds should match your age no longer applies. For a 50-year-old to have a 50% allocation to bonds today makes little sense.
Still worth a place in most portfolios
But are government bonds worth including in most portfolios? I think so. Short-duration, high-quality bonds still act as a fairly reliable buffer in the event of a growth shock. Inflation-protected bonds such as TIPS also provide an additional hedge against inflation shocks.
As we’ve just been reminded, staying invested when others are rushing for the exits can be a real challenge. "Even the intelligent investor,” wrote Benjamin Graham, “is likely to need considerable willpower to keep from following the crowd… It is important to have a certain amount of your money in bonds, as a form of psychological crutch if nothing else.”
However, I do think that, when the tariff crisis finally dies down, we need to have a serious debate about the size of government bond holdings in portfolios.
As always, these are my own opinions, not Timeline’s, and they do not constitute financial advice. Whether you agree with me, or disagree strongly, we would love to hear your views.
This article is produced by us for Financial Advisers who may choose to share it with their clients. Timeline Planning and Timeline Portfolios do not offer direct-to-consumer products.
ROBIN POWELL is a freelance journalist and edits The Evidence-Based Investor.
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