Bonds in portfolio

This is probably a dumb question, but why is it always recommended you hold bonds as part of your portfolio instead of cash? I don’t know much about returns on bonds, but it seems like most bond indices I’ve looked at seem to give similar returns to just holding cash (in a savings or GIC, which is about 4-4.5% right now). Thanks

Interesting question, and I’ve wondered this myself sometimes. I think there are some advantages: 1) you do tend to get a slightly higher return than cash, and bonds have a nice diversifying effect on the portfolio because of relatively low correllation with equities and (almost by definition) zero correllation with cash. 2) portfolio assets applied to fixed income are definitely “deployed,” whereas cash may look like it is dry powder available for the rightequity purchase, so it can lead you to an overconcentration in other asset classes. Just too tempting. 3) bonds may have additional risk premia (liquidity, credit risk, optionality) that can diversify therisk factors you are getting paid for. But the idea of all cash instead of bonds isn’t completely wacky. David Swenson doesn’t think the returns are substantial enough to warrant bonds for anything other than liabilities management (ie making sure you have a bond coming due at some point that you know you need cash.

How about the fact that over any 20-year period since the 1950’s, if you held a broad-based portfolio of bonds with 10-year maturities you would have earned about 2.5 times as much from bonds as T-bills?

True but it still hurts buy bonds that yield the same as cash, especially with inflation where it is. I seem to remember that when yields are low, a change in interest rates has a more dramatic effect on the price of the bond… so I guess that is a factor when buying bonds at these prices (in the context of a portfolio).

I agree with that, but recession is in the wind and bond yields need to account for that.