Bonds may be the adult in the room, but they are certainly afraid of inflation. Bonds usually do their thing – they go up when stock markets get hit hard. They provide ballast. During periods of expected high inflation, or during rising inflation bond prices go down. That can create and contribute negative returns. The bonds can contribute to a portfolio decline. But not all bonds are the same. Ultra short bonds carry no price risk, while long term bonds can carry extreme price risk. It’s crucial that investors understand the ‘types of bonds’. To intermediate and long term bonds, inflation is Kryptonite. How do we battle that force?
As always, the following is not advice.
As a refresher, be sure to have a read of – Stocks are the unruly kids. Bonds are the adult in the room.
Too funny, a rare case when Cut The Crap Investing actually ranked high on search.
Inflation up. Bonds down.
Bond yields rise during inflation primarily because investors demand higher returns to compensate for the reduced purchasing power of future fixed interest payments. Furthermore, inflation often prompts central banks to raise interest rates, which directly drives up yields, while existing bond prices fall to align with new, higher-yielding securities. As interest rates rise due to inflation, new bonds are issued with higher coupon rates to attract investors. Existing bonds, which pay lower interest rates, become less attractive and must drop in price to remain competitive, which simultaneously increases their yield.
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We’ve had some recent experience with the inflation scare of 2021 and into 2022. The bond market (XBB-T) experienced one of its worst performances in 2022, losing around 11% or more as inflation surged, reversing a four-decade bull market in fixed income.
In the above chart we see that bonds provided no ballast. Quite the opposite. That said, we have to keep in mind that bonds have done their thing in every major recession. They stink the joint out, one time, and investors turn on them 😉
Traditional global stock and bond portfolios have delivered wonderful returns …
Inflation fighters and the all-weather portfolio
Last week we had a refresher on what works during inflation with – How do we defend against stagflation?
If you have dedicated inflation fighters in the portfolio you’re not too worried about bonds delivering negative returns. We know that stocks don’t always go up. It’s the same for bonds.
In the following chart, we’ll start in 2021. Markets think ahead of course and enough investors loaded up on inflation-fighting assets as inflation storms gathered in 2021. The Purpose Real Asset ETF (PRA-T) is a nice one-stop inflation-fighting shop.
PRA-T was up 23.5% in 2021 and 15.9% in 2022.
Add 20% PRA-T to 80% XBAL-T and we have annual returns over 10% with no negative years from 2021 through 2023.
Continue on into 2026 and it gets even better. PRA-T is up almost 16% in 2026.
Go short and clip the inflation price risk
Ultra short term government bonds (CBIL-T) do not carry price risk, they are cash-like. In fact they will provide greater and greater income as inflation expectations and yields rise.
The 5-year government bond can be a good predictor of where the bond market and mortgage rates are heading. We’re moving on up. Where she stops, nobody knows.
So, we’re having bad days for longer term bonds and good days for shorter term bonds. For retirees cash and GICs are a great place to store and protect you near-term spending needs. You might also use intermediate and longer term bonds if you want those shock absorbers for your equities.
Check out the GIC rates at EQ Bank
I separate those tasks within our portfolios, using CBIL-T for cash and XBB-T intermediate dated bonds. The effective duration for XBB-T is about 7 years. A duration of ~7 years means that if interest rates rise by 1%, the fund’s value would be expected to fall by approximately 7%. We have used GICs as well over the last several years.
For U.S. Dollar accounts I use UBIL.U and AGG.
And yes you can consider inflation protected bonds (TIPS).
When I trim winners (rebalancing) I move the proceeds to both bond baskets and at times, to defensive equities.
Where to find those bond ETFs
You can use this ETF screener for Canadian ETFs and this ETF Database for U.S. ETFs.
And here’s some ideas on putting your cash to work in Canada. In that post you’ll find links to the best current savings and GICs rates available in Canada.
Feel free to reach out with any questions in the comment section, or use Contact Dale to send a personal message.
The week in review
This past week, just as we have seen in the last month, it was energy that worked, that’s it.
Sometimes when the market pukes, it pukes up everything. Of course, cash has ‘worked’ as well.
The Canadian energy market had a fabulous week.
And cash …
With an all-weather portfolio, there’s always something working. That can help mathematically and emotionally.
The Sunday Reads
At Findependence Hub, how Fritz Gilbert of the Retirement Manifesto spends his time in retirement.
We’ll check in on Dividend Hawk’s portfolio activity for the week.
At Stocktrades Dan asks if this popular blue chip Canadian stock is losing it …
We own that stock by way of iShares consumer staples XST-T.
At Tawcan Bob interviews a reader who is doing some pre-retirement planning. That reader has more than they will need. It will likely be an exercise in creating a retirement cash flow plan that protects while seeking a robust and efficient gifting strategy.
And here’s Rhys on Canadians thinking (on average) that they need $1.7 million to retire.
On that front I ran some numbers at MayRetire.
Thanks for reading and watching. Please leave your thoughts and ideas in the comment section. Touch base by way of that Contact Dale button.
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Consider Justwealth for RESP accounts. That is THE option in Canada with target date funds that adjust the risk level as the student approaches the College or University start date.
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Make your cash work a lot harder at EQ Bank. RRSP and TFSA account rates are at 1.50%, other savings rates up to 2.75%. You’ll find some higher rates on GICs up to 3.85%. They also offer U.S. dollar accounts at 2.75%. We use EQ Bank, they have been awesome.
OUR CASHBACK CREDIT CARD
We make between $40 to $70 every month! And that’s on everyday spending. There are no fees with …
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For February we received $44.46 in cash from everyday spending. You can select 3 categories for 2.0% cash back. Remaining categories pay up at 0.50%.
That cash went into my TFSA account to help buy some CBIL-T, CHPS-T, HURA-T and bitcoin. I always top up the cashback dollars and make a few investments.
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Excellent. Thank you Dale. Love reading your posts.