Episode 4: Bonds: Short-Term Safety and Long-Term Risks

lawyerfipodcast
Sep 15
3 min read

When most people think about bonds, one word usually comes to mind: safety. Compared to the rollercoaster ride of stocks, bonds have a reputation for being steady, predictable, and a natural choice for the risk-averse. But is that reputation entirely deserved?

In this post, based on Episode 25-004 of the LawyerFI Podcast, we’ll explore one of the most important investment decisions you’ll ever make: how much of your portfolio should be in bonds versus stocks. And we’ll uncover why bonds, while safer in the short run, may not always be the “safe” choice over the long term.

Why Bonds Feel Safe in the Short Term

Bonds—especially U.S. Treasury bonds—are backed by the full faith and credit of the U.S. government. That means if you buy a Treasury bond, you’re effectively lending money to the federal government in exchange for steady interest payments and a promise of repayment at maturity.

In turbulent markets, bonds tend to hold their ground. For example:

During the 2008 financial crisis, stocks lost more than half their value. Bonds, on the other hand, went up.
In the COVID crash of 2020, stocks dropped 34% in weeks. Bonds were down only about 1%—with some segments even gaining.

That stability isn’t just about numbers on a chart—it’s also about psychology. Bonds can reduce the sting of portfolio losses and help investors avoid panic selling. As J.L. Collins, author of The Simple Path to Wealth, puts it: bonds are the ballast of the ship. They won’t make you go faster, but they help keep you upright when the seas get rough.

The Long-Term Risk Lurking in Bonds

While bonds protect against short-term volatility, they carry a more subtle long-term risk: inflation.

Inflation quietly erodes the purchasing power of your money. And since most bonds pay a fixed interest rate, rising costs can outpace returns, leaving you worse off in real terms.

Historically, the U.S. stock market has delivered about 7% annual returns after inflation, while bonds have returned closer to 2%. That difference may not feel huge in one year—but stretched over decades, it can mean the difference between reaching financial independence and falling short.

So the real question becomes: Which is safer? The relative calm of bonds that struggle to keep up with inflation, or the volatility of stocks that historically build wealth over time?

What’s Inside a Total Bond Market Index Fund?

For those who want broad bond exposure without hand-picking individual bonds, Total Bond Market Index Funds are a simple, low-cost solution. These funds include:

U.S. Treasury bonds
Mortgage-backed securities
High-quality corporate bonds

Examples include:

Vanguard Total Bond Market Index (VBTLX or BND)
Fidelity’s FXNAX
Schwab’s SWAGX

With expense ratios as low as 0.025%, these funds offer cheap diversification. But remember—they still carry risks like interest rate changes and inflation. Their role is stability, not growth.

When Do Bonds Make Sense?

Your bond allocation depends on your time horizon, goals, and tolerance for risk.

Younger investors with decades to invest may lean heavily toward stocks, using bonds sparingly.
Approaching retirement? Bonds can add stability and help preserve wealth.
Retirees often hold much larger bond allocations—sometimes 50–70%—to reduce volatility while drawing income.

There’s no one-size-fits-all rule. For example, Paul Merriman holds a 50/50 stock-to-bond allocation in his late 70s, while J.L. Collins prefers about 75% stocks and 25% bonds in his 60s. The right mix is personal—it’s about what you can stick with through good times and bad.

Final Thoughts

Bonds may not be exciting, but they’re a critical tool in designing a portfolio that works for you. They:

Provide short-term stability
Reduce emotional decision-making
Allow stocks to do their job—drive long-term growth

But they also come with a hidden cost: inflation risk. That’s why your stock/bond allocation may be the most important investment decision you ever make.

The key isn’t finding the “perfect” mix. It’s creating a portfolio that balances your timeline, temperament, and long-term goals—one you can stick with no matter what the market throws your way.

So, what’s your current stock/bond allocation? And more importantly—why did you choose it?