What You Are Actually Buying
Bonds: The Shock Absorber
Bonds: The Shock Absorber
A bond is a loan you make to a government or corporation. They promise to pay you interest (the coupon) and return your principal at maturity. Simple.
Why does this matter for an index investor? Because bonds and stocks often move in opposite directions -- especially during crises. When stocks crash and investors panic, they tend to flee to the safety of government bonds, which drives bond prices up.
How Bonds Behave in a Portfolio
During the 2008-2009 financial crisis:
- S&P 500: -57%
- US Total Bond Market: +5.2%
During the COVID crash of March 2020:
- S&P 500: -34% in 5 weeks
- US Total Bond Market: +3% over the same period
Bonds do not eliminate volatility. They dampen it. A portfolio of 80% stocks and 20% bonds will fall less during crashes than a 100% stock portfolio -- and the difference in long-term returns is smaller than most people expect.
What BND Is
BND (Vanguard Total Bond Market ETF) holds over 10,000 US bonds -- government, corporate, mortgage-backed. You own a diversified slice of the entire US bond market with one purchase.
Who Needs Bonds and Who Doesn't
You probably do not need bonds yet if:
- You are under 40
- You have a stable income
- You will not need this money for 20+ years
- You can genuinely stomach watching your portfolio drop 40% without selling
You probably want some bonds if:
- You are within 10 years of retirement
- You know from experience that you panic-sell during crashes
- You need to draw down the portfolio within the next decade
The purpose of bonds is not maximum returns. It is to keep you invested during crashes. A 100% stock portfolio that you abandon at the bottom is worse than an 80/20 portfolio you ride out.
What is the PRIMARY reason to hold bonds in a long-term portfolio?