How bonds can strengthen your portfolio

When investing for future goals, it's important to craft an enduring plan that inspires confidence and discipline. However, sticking to that plan isn't always easy, especially when economic factors tempt us to make impulsive decisions or question our long-term investing strategy. Recall 2022—when the Federal Reserve raised interest rates to combat high inflation. Bond investors experienced losses as yields rose and bond prices fell. Some may have adjusted their portfolios in response, seeking either more stability or potentially higher returns in other asset classes.

It's more common for investors to experience volatility in stocks—and they may be more prepared to stomach those ups and downs—but much less so when it comes to bonds. But each asset class has a role in a diversified portfolio. Understanding and incorporating this principle can help you maintain a long-term perspective and stick with your investment strategy.

Here are 4 reminders about the value of bonds that can keep you aligned with your long-term goals.

1. Bonds play an important role as a source of both stability and income

Bond prices tend to move in the opposite direction of stock prices. When stock prices are down, bond prices tend to be up, and vice versa. Bonds spread out your portfolio's risk and help reduce the overall chance of loss. Higher bond yields can offer a “coupon wall” to soften the downside and a stronger base to grow on the upside. Just as with any other asset class, it's important to make sure your bond holdings are appropriately diversified to reduce risk.

2. Bond returns may offer more secure inflation protection than cash

In 2022, many investors sold bonds to move into "safer" cash when yields rose and bond prices dropped. But keep in mind that each asset class has a part to play in your target portfolio mix. In addition to offering more balance against stocks, bonds have shown themselves to be much better at keeping up with inflation over time compared with cash.

Since 1975—50 years—annual bond total returns have beat inflation 71% of the time compared to only 57% of the time for cash. The after-inflation return for bonds averaged 3.1% versus only 0.6% from cash.¹

Check out these portfolio allocation models to help you decide how much to invest in bonds and stocks.

3. Diversifying your bond portfolio can help manage risk

Broad-based bond funds and ETFs are a simple and effective way to get exposure to the U.S. and international bond markets. A single bond fund may hold hundreds—or thousands—of individual bonds, potentially offering diversification across different issuers, qualities, and maturities. Investors may consider either passively managed index strategies, actively managed funds, or a mix of both.

It can take time and capital to build a well-diversified portfolio of individual bonds. If you only have individual bonds for fixed income assets, you might consider supplementing your portfolio with bond mutual funds or ETFs. 

Check out our bond funds

4. Focus on what you can control

It's natural for economic factors to test your resilience and discipline, but market volatility shouldn't drive major changes to your portfolio. When you're concerned, take a step back, look at the bigger picture, and consider why you're investing in the first place.

You can't control the economy, but you can control your asset allocation. Stick to Vanguard's Principles for Investing Success (PDF) and focus on a balanced portfolio aligned to your personal goals.

Keep your eyes on the road ahead

When stock and bond values are down, you may be tempted to abandon diversification or skip rebalancing your portfolio because they "didn't work." However, straying from your asset mix at those times can compromise your portfolio's long-term strategy.

This is why it's so important to take advantage of rebalancing and reinvestment opportunities—so you don't miss out when markets turn around and hinder your progress toward your goals.

Not sure if you need to rebalance your portfolio?

Looking for a framework to navigate market volatility? Vanguard's Portfolio Watch tool can help you determine if you've drifted from your target mix. You can access it directly by logging in to your Vanguard account and selecting Portfolio Watch.

You can also include non-Vanguard funds to get a more holistic view of your accounts and determine whether you need to make any adjustments. To do this, select Add an outside investment at the bottom of your Holdings page.