Portfolio Performance Using False Benchmarks

The interest rate drops caused increases in the value of bonds. It is a fact of nature that the value of bonds reacts inversely to the interest rates. When rates increase, bond values drop. When rates decrease, bond values increase.

I suggest another fact. The average investor that buys bonds do so with the expectation they will not lose any money on the bond and that they will get a fixed interest payment for the period of the bond and the full face at maturity. A corollary to this is that they will not expect to make a profit on holding the bond, other than the interest payment. Yet, when investment managers, and investment and newsletter reporters write about the bond performance they always refer to gains and losses in the values of the bond portfolio. Another way they refer to this is like the “total return” which is supposed to be good or bad depending upon what “news” they are trying to convey. I think this is all bull doody.

Lately, long term interest rates have dropped causing really high increases in the values of bond portfolios. This is discussed as being very good for owners of bonds and “proof” that a portfolio with the right balance of bonds is the perfect way to be diversified. I think this is nonsense! They are using false benchmarks.

Let me give an example. Assume someone buys a $100,000 20 year bond with a 4% coupon and they expect to hold the bond for the entire 20 years while receiving $4,000 a year interest. This means that they will not be planning on selling the bond before maturity, and hopefully, they won’t have to. At the end of the 20 years, they will receive the $100,000 back.

Well during that 20 year period the market interest rates for the then remaining period of the bonds will fluctuate widely, i.e. rates will rise or fall causing the bond values to fall or rise. However, the increases or decreases in values will have no effect on their situation since they will be holding the bond until maturity. When that is the case, does it matter what the bond values are? If the values dropped, did they really lose money? If they increased, did they really make any money? Maybe on paper but not in their real world. If they were a bond trader then that might be the case, but they are not. They are just trying to secure their financial future with some guaranteed cash flow from the bonds, and when that is the situation the fluctuations are not relevant or meaningful to the investor. And since that is so, then what does it matter what the current value is?

There is a lot of noise out there and much of it is scary, but if you have a plan and execute it properly, then it really doesn’t matter what goes on as long as it is not for a major change in the dynamics of investing. If you ignore the noise, the total return gibberish, the talk about the “outperformance” of bonds over stocks and all of the other bull doody, your life will be a lot calmer. Ignore the false benchmarks.

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