December 17, 2024
Dear Investors and Friends,
This month, we begin a three-part series designed to explore the fundamentals of fixed-income investing. Today’s letter, Why Bonds, lays the groundwork by addressing their role in balancing risk and reward in a portfolio. Future letters will cover What Bonds to Buy and How to Buy Bonds.
Equity Returns Beat Bonds Over the Long Term
If we look solely at historical returns, equities seem like the obvious choice. The chart below illustrates that from 12/31/1991 to 11/29/2024, equities have significantly outperformed bonds in annualized returns. Based on this, one might wonder why anyone would choose bonds at all.
Introducing Risk
Before drawing conclusions, let’s examine risk—specifically, the concept of maximum drawdown. To illustrate, if you had invested $100 in the S&P 500 on October 9, 2007, that amount would have fallen to just $44.75 by March 9, 2009—a loss of 55.25%. This is what we call drawdown, or the peak-to-trough decline during a specific period. The chart below shows the maximum drawdowns for equities and bonds from 12/31/1991 to 11/29/2024.
What does this mean for investors? While equities offer higher returns, they also come with significantly higher risk.
Balancing Risk and Reward
To see how reward and risk relate, let’s look at the chart below.
Here, annualized returns are plotted against maximum drawdowns, with a trend line indicating a strong correlation (R² = 96.3%). The takeaway? Higher risk tends to deliver higher returns, but the tradeoff is clear and consistent.
While other measures of risk, like volatility, would reinforce this conclusion, we aim to keep things simple. If you’d like to see those analyses, we’d be happy to share them.
Practical Implications for Investors
So, why bonds? Their ability to reduce risk and match assets to liabilities is critical. As an investor, it’s essential to segment your capital into liability “buckets” based on time horizon:
- Short-Term Needs: Capital needed within a year (e.g., tax payments) should go into short-duration Treasuries, which carry minimal risk.
- Long-Term Needs: Retirement savings, with a horizon of 10+ years, are best suited for equities, allowing time to weather drawdowns.
- Intermediate Needs: Funds for medium-term goals (e.g., tuition payments) may be allocated to corporate or municipal bonds to balance risk and return.
In short, bonds are the cornerstone of risk management and liability-driven investing, allowing you to appropriately match your assets to your financial goals. They reduce risk while preserving the flexibility to address both near-term and long-term needs.
As the year comes to a close, we want to wish you a happy holiday season. We hope you enjoy time with family and friends, and we look forward to continuing to serve you in the coming year.
Warm Regards,
David and Mike
Disclaimer
Roosevelt Capital Management LLC is a registered investment adviser. The information presented is for educational purposes only and is not intended to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.
Past performance is not indicative of future performance. Principal value and investment return will fluctuate. No guarantees or assurances that the target returns will be achieved, or objectives will be met are implied. Future returns may differ significantly from past returns due to many different factors. Investments involve risk and the possibility of loss of principal.
While all the values used in this report were obtained from sources believed to be reliable, all calculations that underly numbers shown in this report believed to be accurate, and all assumptions made in this report believed to be reasonable, Roosevelt Capital Management LLC neither represents nor warrants the values, calculations or assumptions and encourages each prospective investor to conduct their own review of the audits, values, calculations and assumptions.