It’s July and in Cleveland the sun is finally out. The summer sun brings with it the potential for sunburn. Sunscreen is essential to avoid the pain and potential long-term damage from getting burned, but when it works we don’t really notice its positive effect. Having bonds in a portfolio works the same way. They’re not flashy and when the market is doing well it is tempting to ask why hold bonds at all. Like sunscreen, fixed income’s utility is often recognized in hindsight, when it was missing at precisely the time it was needed. It’s far better to be able to rebalance into market volatility than to be caught without sunscreen and have to reach for the aloe the next day.
We get sunburn from the spots we miss. For me, that’s the top of my bald head. Nobody tells you about this when you first go bald or shave your head. It is only after my scalp got sunburned that it became obvious. The biggest risks are the ones we forget or don’t know about. Do I need to put on sunscreen and a hat every time I work outside this summer? Probably not. Every day won’t be bright and sunny, but I can’t go back in time and put sunscreen on in hindsight.
This is the double-edged sword of a diversified portfolio. When part of the portfolio experiences losses, another part should be holding steady. The other side of this is that while one part of the portfolio is booming, there is something else that is lagging. My family suffers from my atrocious taste in headwear, but my noggin stays cool while I’m grilling up burgers. It’s an easy tradeoff to make, especially if you’ve been burned in the past.