The beginning of 2022 has been a rough year for investors. Most people know that the stock market has dropped. However, not a lot of people know that bonds have dropped just as much as stocks (as of 5/2/2022).
Typically, investors look to bonds to be the safer part of their investment portfolio. A traditional portfolio would have 60% stocks and 40% bonds.
Why are bonds losing as much as stocks right now?
The short answer is Interest rates are going up. When interest rates go up, it drives bond prices down. The opposite is true when interest rates go down, bond prices go up.
Investing When Stocks and Bonds Are Both Going Down
Currently interest rates are going higher because The Federal Reserve is increasing rates to help lower inflation.
This may make you think that bonds are a bad place for money to be invested right now. But, where should it be invested to still be the conservative part of my portfolio?
For an investor, there are a lot of variables that can go into constructing a portfolio:
- Time Horizon
- Account Type
- Use of the Money in the Future
- General Risk Tolerance
If the goal is to hedge stock market drops, one way to do this would be to buy Put Options to act as portfolio insurance. Options have a lot of variables that go into the pricing. So, consult with a financial advisor that is familiar with how these may work for your specific financial situation.
Interest Rates and Bond Prices
Below is a chart showing how it would look using a Put Option vs just owning the Stock.
In the red is how the risk/reward diagram would look vs the black, if there was no Put Option bought. In the black, you take on the full risk of losing your whole investment. However, you have an infinite return potential. In the red, you pay a premium to buy the Put Option. So, your gain will always be less than if you just owned the stock without insurance. Additionally, there is a defined stop loss based on the strike price and the time until the Put expires.
Utilizing Put Options
Another option to insurance on your portfolio using Put Options would simply to be put more in cash to buy stocks as they go lower. Or you could just leave in cash for future withdraws, if you’re actively taking money from the portfolio.
Most people that have money invested in a 401k plan use what’s called a target date fund based around their projected retirement year. These all use a mixture of stocks, bonds, and cash. Right now may be a good time to look at the exposure to bonds you own within your 401k to make adjustments needed based on your goals. If you have old 401k plans, this would be a great opportunity to roll your 401k into an IRA so you have more investment options that allow you to have the money better invested.