Busting key myths about bonds
Famous investor Warren Buffett once commented that investors should never have more than 75% shares in their portfolio and never less than 25% bonds and they should also never own more than 75% bonds and never less than 25% shares.
Australian SMSFs, however, do not hold even close to Buffet’s recommended level, with less than 1% in bonds. This is in stark contrast to investors in the US, UK and Europe who hold much higher allocations. Much of the reason for this is a lack of understanding of the fundamental truth about bonds versus shares: the two different asset classes complement each other.
Bonds are lower risk than shares in the same company and help to protect your capital. The reason is that if a company gets into trouble and is wound up, there is a legal structure dictating how cash and the proceeds of asset sales are applied.
In the event of wind-up or liquidation, funds are paid to the most senior investors in the capital structure (senior secured debt) first and these investors must be repaid in full before any funds are paid to investors on the next level. Then each level must be repaid in full before funds are paid to the next level (see the diagram below).
The position of your investment in the capital structure is crucial in determining its risk and whether the return you are receiving is enough.
Shares should deliver growth and higher returns than bonds but they are the highest risk investment in the capital structure. In contrast, fixed income securities sit higher in the structure and are safer in the event of wind-up or liquidation. Generally they are lower risk and offer lower returns than shares.
Including bonds and other fixed income securities in your portfolios should lower risk and volatility and help smooth returns.
Simplified Bank Capital Structure
Source: FIIG Securities
So, if your portfolio is just shares and deposits, you’re missing out on all of the other rungs in the capital structure and the benefits of those investments.
To find out how FIIG can help you access direct fixed income exposure, please feel free to contact me directly.
Angus Knight
angusk@fiig.com.au
02 9697 8723
Frequently Asked Questions about this Article…
Bonds are a lower-risk investment compared to shares and can help protect your capital. They complement shares by providing stability and reducing overall portfolio volatility, which is beneficial for everyday investors seeking a balanced approach.
Bonds are generally lower risk than shares because they are higher in the capital structure, meaning they are prioritized for repayment in the event of a company's liquidation. However, they typically offer lower returns compared to shares, which are higher risk but have the potential for greater growth.
The capital structure determines the order in which investors are repaid in the event of a company's liquidation. Bonds and other fixed income securities are higher in the capital structure than shares, making them safer investments. Understanding this hierarchy helps investors assess the risk and potential returns of their investments.
Australian SMSFs tend to have a lower allocation in bonds due to a lack of understanding of how bonds complement shares in a portfolio. In contrast, investors in the US, UK, and Europe recognize the benefits of including bonds for risk reduction and capital protection.
Warren Buffett suggested that investors should never have more than 75% of their portfolio in shares and never less than 25% in bonds, and vice versa. This balanced approach helps manage risk and optimize returns.
Bonds can lower the overall risk and volatility of a portfolio, providing more consistent returns over time. This stability is particularly valuable for everyday investors looking to achieve steady growth without excessive risk.
Fixed income securities, such as bonds, play a crucial role in diversifying an investment portfolio. They offer a safer investment option compared to shares, helping to balance risk and provide a steady income stream.
Investors can access direct fixed income exposure by contacting financial institutions like FIIG Securities, which offer guidance and opportunities to invest in bonds and other fixed income securities. For more information, investors can reach out to experts like Angus Knight at FIIG.
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