Bonds - The Great Diversifier In Volatile Markets

The continuing high volatility on sharemarkets underlines once again the critical role of bonds as a diversifier or ballast for a diversified portfolio.

As a diversifier, bonds counterbalance the volatility of shares and other growth assets to reduce the variability of portfolio returns.

In recent years, many investors may have been tempted to abandon appropriately-diversified portfolios by reducing their allocation to low-yielding bonds in an effort to boost or at least maintain their returns with higher-risk assets.

The latest bout of sharemarket volatility is a clear reminder of the fundamental role of bonds to provide diversification and income throughout investment conditions.

Vanguard’s economic and investment outlook 2015, Australian edition, released early this year, encouraged investors to "evaluate carefully" the risk/return trade-off involved before shifting into higher-risk asset classes in their pursuit of returns.

In this long-term outlook for investors, Vanguard economic and investment specialists wrote that the investment environment is likely to be "more challenging and volatile in the years ahead". And balanced portfolios were expected to produce returns over the next decade below their long-term historic averages.

Such expectations for more volatile investment markets with muted long-term returns from diversified portfolios should also reinforce the use of bonds for diversification, income and capital stability.

In lower-return, more-difficult investment climate, investors have a greater incentive to keep their investment costs to a minimum. In short, lower investment costs means higher than otherwise investment returns.

An increasingly popular means for investors to reduce their investment expenses is to use low-cost traditional index funds or Exchange Traded Funds (ETFs) tracking broad indices as the core of their diversified portfolios.

Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia.

As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.

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