The COVID-19 crisis and resulting economic recession and bear market are a reminder that investors should always be prepared for anything. When it comes to the economy, short-term factors can derail growth or create uncertainty at any time.
The same is true for the stock market where market swings can occur without warning. For investors – especially those growing their wealth to achieve financial goals or a sound retirement – holding a mix of stocks and bond investments through ETFs can help in volatile markets.
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The End of the Bull Market
This was especially true in the first half of 2020. Once it became clear that the novel coronavirus would spread quickly throughout the world and in the U.S., the stock market began taking a tumble. The S&P 500 index fell 34% from a record high in late February to the bottom just weeks later in March. This was the largest drop since the 2008 global financial crisis and officially ended the previous bull market.
Although the stock market did recover sharply after this decline, this most likely didn’t prevent some investors from panicking. After all, a global pandemic was raging around the globe and, for the first time in history, the economy was shut down across the country. It’s understandable that, facing these circumstances, investors might worry about their portfolios and make drastic adjustments.
The Benefit of Holding Stocks and Bonds
With the benefit of hindsight, and based on other historical bear markets and corrections, we know that investors who had the fortitude to stay invested would have fared well. Fortunately, there is one approach which helps investors to do exactly this: holding an appropriate mix of both stocks and bonds. With the wide array of products and tools such as ETFs in today’s market, finding the right balance has never been easier.
Chart: The benefit of holding the right mix of stocks and bond investments is that portfolio volatility can be managed while maintaining upside growth potential over the long run.
Why Bonds Are Doing Better Right Now
Not only have high-quality government and corporate bonds performed well this year, but at the moment, diversified bond indices are among the best-performing asset classes. There are two important factors to understand that help bonds cushion investor portfolios.
First, when interest rates fall, many bonds become more attractive since they may pay higher interest on a relative basis. Thus, when COVID-19 hit and the Federal Reserve cut its main policy rate to zero, this helped to boost fixed income prices. Other economic drivers that affect interest rates, such as slower economic growth for a period, more broadly helped to push bond prices up as well.
Second, bonds tend to perform well during times of stock market uncertainty. This is because investors may shift to bonds for safety and thus drive up their prices. So far this year, the Bloomberg Barclays U.S. Aggregate – a diversified index of bonds – has risen 7%. In fact, many bonds have held onto their gains even as the stock market has recovered.
Diversification Stabilizes Your Portfolio
Combined, these characteristics allow bonds to behave differently from stocks and helped investors stabilize their portfolios during the recent COVID-19 bear market decline. In turn, a more stable portfolio helps investors to stay calm amid market panic.
Of course, stocks are still needed to grow portfolios over years and decades. But holding the right mix of stocks and bond investments can help investors to potentially have their cake and eat it too by building portfolio wealth in the long run while helping to protect it in the short run.