Why have a percentage of Bonds in a SIPP

[scot_aln]

Possibly an obvious one but I've clearly not researched or found the right links. So I have a 100% equity SIPP at the mo but frequently see that there should be a percentage of bonds of up to 40% depending on risk tolerance.

Now looking at below for example why would it benefit holding this when it's 1, 3, 5 & 10 year performance all seem to be negative.

https://www.hl.co.uk/shares/shares-search-results/...

.
I'm clearly missing something as I haven't really ever looked at Bonds.

[Derek Chevalier]

scot_aln said:

I'm clearly missing something.

2000-2010

[deggles]

The thing I have come to realise with bonds is, ideally you want to hold ones with maturity dates which match your investment horizon. Holding to maturity negates any interest rate risk. The reason people (myself included) have been burnt in the last few years is in holding long-dated bonds and mixed bond funds which plummeted in value when interest rates rose.

[C69]

scot_aln said:

Possibly an obvious one but I've clearly not researched or found the right links. So I have a 100% equity SIPP at the mo but frequently see that there should be a percentage of bonds of up to 40% depending on risk tolerance.

It really depends on your attitude to risk, investment time horizon and plans for your pension.

Traditionally, bonds were supposed to be less volatile and provide a hedge against equities, but recent experience shows that's not always the case (e.g. after the infamous September 2022 'mini budget'). That said, holding the vast majority of a SIPP in equities just before or during pension drawdown can still be an unpleasant ride (see the post-tariffs pensions thread on here).

There is a loose guideline that says the proportion of equities should be 100 minus your age. So, if you're 35, then 65% would be in equities. I'm not sure how relevant this is any more, given that people are generally living longer, they might be retiring later, and annuities are now less popular. To reiterate, it really depends on your personal circumstances.

[Derek Chevalier]

deggles said:

The thing I have come to realise with bonds is, ideally you want to hold ones with maturity dates which match your investment horizon. Holding to maturity negates any interest rate risk. The reason people (myself included) have been burnt in the last few years is in holding long-dated bonds and mixed bond funds which plummeted in value when interest rates rose.

See the performance of longer-dated bonds when we last had a big equity market fall (GFC).

[C69]

deggles said:

The thing I have come to realise with bonds is, ideally you want to hold ones with maturity dates which match your investment horizon. Holding to maturity negates any interest rate risk. The reason people (myself included) have been burnt in the last few years is in holding long-dated bonds and mixed bond funds which plummeted in value when interest rates rose.

This is a good point. It's important to understand what sort of bonds a fund holds and their average maturities.

[ATG]

deggles said:

The thing I have come to realise with bonds is, ideally you want to hold ones with maturity dates which match your investment horizon. Holding to maturity negates any interest rate risk. The reason people (myself included) have been burnt in the last few years is in holding long-dated bonds and mixed bond funds which plummeted in value when interest rates rose.

That gives you certainty, but it doesn't negate interest rate risk. Let's imagine you buy a 10yr bond at a yield of 2%, and 6 months later interest rates rise and you could then buy a 9.5yr bond at s 3% yield. Your return to maturity is now significantly below the fair market return.

[scot_aln]

Derek Chevalier said:

2000-2010

I've read many incredibly interesting posts from you but not sure I understand the point here. I think the Bond fund I reference was mentioned in one of your references to the "no brainer"

Is it as basic as the Bond fund basically pays a dividend so you are receiving a small percentage each year. But that over the last 10 or so years investment wise the value of the fund units has decreased.

So if say I'd invested 100k in a Bond fund 10 years ago would I really have just been receiving about 3% a year but now be sitting with 92K (based on appx 8% drop)

[ATG]

There was a massive rally in the bond markets through the late 90s and 2000s. Inflation seemed to have been killed.

[scot_aln]

ATG said:

That gives you certainty, but it doesn't negate interest rate risk. Let's imagine you buy a 10yr bond at a yield of 2%, and 6 months later interest rates rise and you could then buy a 9.5yr bond at s 3% yield. Your return to maturity is now significantly below the fair market return.

Before posting a new q I had read back through the various bond related responses google offered with 'Bonds and Pistonheads'

It was actually a response I saw from yourself to a similar question that helped realise I wasn't alone in understanding shares, equities, and funds but not Bonds and funds of Bonds which seem to add further complexity.

"Bond are really simple things once you manage to find a clear explanation. The problem really is just getting hold of a clear explanation."

[trevalvole]

Derek Chevalier said:

deggles said:

The thing I have come to realise with bonds is, ideally you want to hold ones with maturity dates which match your investment horizon. Holding to maturity negates any interest rate risk. The reason people (myself included) have been burnt in the last few years is in holding long-dated bonds and mixed bond funds which plummeted in value when interest rates rose.

See the performance of longer-dated bonds when we last had a big equity market fall (GFC).

My understanding is, though, that in the last century there have been periods of time, like the GFC where stocks and bonds have been negatively correlated, and periods, perhaps more inflationary times, where they have been positively correlated. Perhaps the case for holding bonds is just that they are higher up the capital stack and therefore you are less likely to lose your money, plus the interest/coupon will probably continue to be paid, whereas stock dividends may reduce? And anything more than this, like a negative correlation to stocks, is just a bonus that you shouldn't count on?

Also, I'm inclined to agree with deggles about matching maturity to your investment horizon. It seems to me that sometime, presumably hundreds of years ago, the idea of a secondary market in bonds was invented to allow people to cash out before maturity. However, these days, it seems like the secondary market and the bond funds that buy and sell there are the main thing about bonds, which seems to have introduced capital risk into these investments which isn't there if you hold to maturity.

[Derek Chevalier]

C69 said:

Traditionally, bonds were supposed to be less volatile and provide a hedge against equities, but recent experience shows that's not always the case (e.g. after the infamous September 2022 'mini budget').

https://www.timeline.co/blog/everything-you-thought-about-risk-is-wrong

"If your investment thesis is based entirely on the last 20 or even 40 years, you probably got a nasty surprise. If you base your thesis on a 100+ years however, the returns of 2022 fits into the range of outcomes within that dataset. "

"Many people are making a big deal of the fact that both equities and bonds posted a negative return in 2022. However, If you look at every 12-month scenario since 1900, it turns out that 1 in 10 scenarios ended up with bonds and equities posting a negative return in nominal terms."

[ATG]

Reason to invest in bonds: They are inherently less volatile than equities. Low credit risk bonds tend to give you a partial hedge against equity market falls. E.g. in a recession equity markets may perform badly, but bonds will rally if the market anticipates that Central Banks will start cutting rates to stimulate economic activity. So you're getting diversification, and a relatively low risk pot of assets as a backstop if the spicier stuff in your portfolio goes to pot.

[Derek Chevalier]

scot_aln said:

Derek Chevalier said:

2000-2010

I've read many incredibly interesting posts from you but not sure I understand the point here. I think the Bond fund I reference was mentioned in one of your references to the "no brainer"

Is it as basic as the Bond fund basically pays a dividend so you are receiving a small percentage each year. But that over the last 10 or so years investment wise the value of the fund units has decreased.

So if say I'd invested 100k in a Bond fund 10 years ago would I really have just been receiving about 3% a year but now be sitting with 92K (based on appx 8% drop)

Equities had a really challenging time during 2000-2010 - broadly flat. Bonds doubled (approximately). It's therefore important to go as far back in time as possible to get an idea of the range of outcomes.

[Derek Chevalier]

trevalvole said:

My understanding is, though, that in the last century there have been periods of time, like the GFC where stocks and bonds have been negatively correlated, and periods, perhaps more inflationary times, where they have been positively correlated.

trevalvole said:

And anything more than this, like a negative correlation to stocks, is just a bonus that you shouldn't count on?

Agreed on both points, and if you are able to see how this has played out in challenging times (e.g. WW1), there shouldn't be much that comes as a surprise.

For example, see the -11% return of the 50/50 portfolio from 1917-1922 vs 34% from 2019-2024.

[Derek Chevalier]

ATG said:

Low credit risk bonds tend to give you a partial hedge against equity market falls.

Worth emphasising that point. Junk bonds (low credit quality) tend to behave more like equities during times of market stress.

[scot_aln]

Derek Chevalier said:

Equities had a really challenging time during 2000-2010 - broadly flat. Bonds doubled (approximately). It's therefore important to go as far back in time as possible to get an idea of the range of outcomes.

Thank you. Most platforms only seem to show 10 year so hadn't appreciated that historical info. Was primarily playing with equities and chasing the housing market in that period.

[VR99]

I admittedly don't fully understand the mechanics of bonds (yet) but did add a global Agg ETF and Gilt ETF to my ISA for the first time last year (FWIW am early 40's).

My limited understanding is they provide a dampening effect when Equities are crashing/dropping (meant to be inversely correlated but not always the case?) and it seemed to work effectively during the recent Trump-induced shenanigans. SIPP and work pension still 100% Equities as have a longer timeframe to access both and hopefully it results in better growth.

[Phooey]

Don't forget bonds also provide a yield - currently 4.7% on the 10yr gilt / 5.5 on the 30, so if you want some 'fixed income' in your portfolio - gilts/bonds are a cheap way to do this. Current and expected Inflation/interest rates will obviously add some volatility so just be mindful of the duration and quality of what you buy. Funds are a cheap and easy way to add bonds/gilts but have a different behaviour to buying individuals as they are an aggregate of many individuals so are always recycling their holdings due to inflows/outflows/matching the funds duration etc so always best to buy a popular big fund and again consider it's duration. Bonds can be as easy or as difficult to understand as you want them to be - stick to the basics.

[RSTurboPaul]

Derek Chevalier said:

trevalvole said:

My understanding is, though, that in the last century there have been periods of time, like the GFC where stocks and bonds have been negatively correlated, and periods, perhaps more inflationary times, where they have been positively correlated.

trevalvole said:

And anything more than this, like a negative correlation to stocks, is just a bonus that you shouldn't count on?

Agreed on both points, and if you are able to see how this has played out in challenging times (e.g. WW1), there shouldn't be much that comes as a surprise.

For example, see the -11% return of the 50/50 portfolio from 1917-1922 vs 34% from 2019-2024.

Noob question alert...


How does that work when inflation is, er, 'over the 2% target rate'?

Do you get paid back (e.g.) a 100k investment in 100 years, but now it only buys a sandwich at Starbucks? lol