Is it time for a no-bond portfolio?

Given current yields and future worries, it’s worth considering

Living in the modern world means living with a constant feeling of impending doom. You could lose your job! The market could crash! Your dog could be an alien!

In recent weeks, the biggest fear of the day has been that interest rates would rise, clobbering bond funds and ruining the plans of Joe Btfsplk, the only person in the United States who hasn’t refinanced his mortgage in the past seven years.

And those fears have some merit. The bellwether 10-year Treasury note yield is hovering near 2.20%, up from the low of 1.40% set in July 2012. And even at current levels, it could be a long, painful rise to the average long-term yield of 6.44%. So perhaps it’s time to consider a nobond portfolio.

Let’s start at the beginning. In recent weeks, several prominent investors — Warren Buffett, CEO of Berkshire Hathaway, Bill Gross, manager of Janus Unconstrained Bond, and Jeremy Grantham of GMO — have warned that the long bull market in bonds could be at an end.

The bull market is, after all, more than three decades old. In the upside-down world of bonds, a bull market is a sustained period of falling interest rates. (More on this in a moment.) Interest rates have been falling since Sept. 30, 1981, when the 10year note yielded an astonishing 15.84%.

Falling rates mean rising prices for bonds. Think of it this way: Suppose you owned a bond that paid 5% annual interest. Investors who owned bonds yielding 2.25% would treat you like a god. They would wax your car to a high gloss. They would even pay you more than the face value of your bond, because your yield was more than twice what they could currently get.

Could Treasury yields go lower? Sure, and they have. And government bond yields overseas are somewhere in the third sub-basement parking lot. The 10-year German bund yields 0.59%, and the Swiss 10-year note yields 0.10%.

Nevertheless, you should be aware that at least a partial un- winding of the bond bull market is likely. When rates rise, investors make videos of your 2.20% bond and mock it on the Internet — because, after all, newly issued bonds yield more. Should you want to sell your bond, you’ll have to cut the price, and your 2.20% yield will provide little cushion.

If you own individual bonds, a bond bear market isn’t much of an issue, unless you sell before your bond matures. If you hold your bond to maturity — barring a default — you’ll get your interest and principal back. But bond mutual funds have to price their holdings every day. And for most bond funds, rising rates mean lower share prices.

Bond bear markets tend to be less severe than bear markets in stocks, but they make up for that

by lasting a long time. It’s a bit like being attacked by box turtles.

Consider the period January 1971 through September 1981. The Barclays index of long-term Treasury bond prices fell 33.8%. With reinvested interest, the index actually eked out a 16.7% gain. Bear in mind, however, investors were collecting substantial interest: The average 10-year T-note yield was 8.3% for the period. But what investors gained was taken from them in the form of inflation, which soared 74%.

Most investors hold some bonds in their portfolio, because bond prices often — but not always — rise when stocks fall. You would have been glad indeed to own bonds during the 2007-2009 bear market in stocks, because interest rates plunged and bond prices soared.

A Wealth of Common Sense, an excellent blog by Ben Carson, points out that bonds served a useful purpose in portfolios in the 1950s. Even though interest rates rose gradually in the 1950s, bonds fared well during the 1957 bear market in stocks.

Gross, Buffett and others who think rates will rise aren’t predicting the kind of soaring inflation that busted bonds. And it may be that bond yields have a long period of drifting upward.

But if your reason for investing in bonds is to reduce the brainboiling volatility of the stock market, you may want to rethink owning bonds, or at least cutting back. Instead, consider using cash as your go-to ingredient for dampening the stock market’s moves.

From 1971 through September 1981, the one-year Treasury note gained 77% — slightly more than inflation. A typical balanced portfolio — 60% stocks and 40% bonds — would have gained about 104%. Had you swapped out cash for bonds, you would have gained 128%, and had a somewhat smoother ride in what was a generally harrowing period for both stocks and bonds.

Currently, a one-year T-bill yields a miserly 0.25%. These yields will rise, however, when the Federal Reserve raises interest rates. You may get better yields from one-year CDs from banks or credit unions. Locking into current rates for any longer than a year — particularly if you expect rates to rise — makes about as much sense as asking your dog to take you to his leader.

Bear in mind that moving entirely out of bonds means that you’ll lose out if we see rates fall to German or Swiss levels. And you’ll lose some diversification in your portfolio. But given current yields, you probably wouldn’t be terribly harmed by stepping aside and waiting for yields to return to more or less normal levels. And you’ll remove at least one cause of that sense of impending doom you have. Now you’ll be able to concentrate on snakes. They love to come inside when the weather gets warm, you know.