December 5, 2023

Welcome back to Advice, the advice column where real financial professionals answer real people’s questions. Topics can be anything in the world of finance, from retirement to taxes to wealth management—even advice within advice.

The U.S. government has been issuing bonds since the American Revolutionary War. For centuries, these bonds — essentially loans to the government, paying back the debt with interest — have funded Uncle Sam and provided investors with a stable, conservative alternative to stocks.

But do bonds still make sense in today’s economy — one that’s already unusual, to put it mildly?

Over the past year and a half, Americans have faced both a volatile stock market and record inflation. To keep prices in check, the Fed has raised interest rates 10 times in a row, taking the federal funds rate to 5% to 5.25% – the highest since 2007.

That’s both good and bad for bonds. On the one hand, the Fed’s actions have sent bond rates surging.For example, at the beginning of 2022, the yield of a six month treasury bill was 0.22%. Today it is 5.18%.

On the other hand, high interest rates depress bond prices.For example, by the end of 2022, the Barclays U.S. Aggregate Bond Index is down 13% – its worst year on record.

All of this leaves bonds in a confusing place. Do government securities still play an important role in investment portfolios? If stocks and bonds take a hit at the same time, can one hedge against the other? A novice investor in New York is grappling with these questions and turns to our finance-savvy readers for help. Here’s what he wrote:

Dear Advisors,

In this environment, is there a reason for relatively young people to allocate to bonds? If the Fed continues to raise interest rates, the value of bonds will fall. If the Fed lowers rates, bonds will appreciate, but stocks will likely appreciate even more.

I’m a 36 year old tech worker with about $100,000 invested in index funds and $30,000 in my 401(k) plan. I have two main goals: funding a startup I plan to launch soon, and saving for my retirement. I want to diversify my assets, but I just don’t see the advantage of investing in bonds. Am I missing something?


Skeptical SoHo

Here is the response from the financial advisor: