The New Math on Bonds — Nobody Expected This

In 2022, bonds had their worst year on record and almost every financial publication ran some version of the same headline. The 60/40 portfolio is dead or bonds are dead. Then 3 years later that same portfolio has compounded at roughly 16% a year. The funeral, it turns out, was held in the middle of a recovery. But of course, that's what the financial media loves to do. They love to shout and scream and get a reaction out of us because that's how they sell ad dollars.

And today we're once again seeing an environment where we're starting to see some pressure on bond prices because of inflation. So what I want to do in this video is answer the question, are bonds dead in 2026 or are we just terrible at owning them? But first, my name is Kevin Lum. I'm a certified financial planning professional and this channel is dedicated to helping a million people retire without worry. Now before I dive in, I have to tell you that this is not investment advice.

You should not make any decisions about your life or your portfolio based on anything I say here. I'm just a guy on the internet who likes to run his mouth and for whatever reason a few people decided to start listening. But I need you to know that I am a financial advisor, but I am not your financial advisor. Everything I say here is for educational purposes. Okay, with that long caveat out of the way, let me start with a basic idea.

Because a lot of people own bonds without understanding what they own. When you buy a bond, you are not buying a piece of a company. When you buy a stock, you own a piece of a company. You own a company. They agree to pay you interest, usually twice a year, and then return your original investment when the bond matures, right? That is a very simple explanation of bonds and that's essentially how most bonds work. Here's what trips people up.

Think of a bond price and interest rates like a seesaw. When interest rates go up, right? Because often because of inflation or some other reason, interest rates go up, bond prices go down. The value of the bond goes down because newly issued bonds are paying higher interest rate. When interest rates come down, bond prices go up because newly issued bonds are paying a lower interest rate, and so you've got this bond that pays a higher interest rate, and so now that bond has a higher value, right?

That's a relationship. And for about 40 years, that seesaw tilted in one direction the entire time. It was just like this. If you ever sat on a seesaw by yourself, it just stays in one position. And that's basically how it's been since I was born. In 1981, the 10-year Treasury had a yield of 15.7%. Now, that is a great return. The Fed's fund rate that same year hit almost 20%. What was happening was the Fed chair, a guy with the name of Paul Volcker, was trying to strangle inflation by making borrowing incredibly expensive.

What happens is the economy becomes really hot cuz if you have low interest rates, it spurs a lot of economic growth. Economic growth can often end up driving up prices because often there's a supply and demand issue, and so the Fed chair was trying to squelch the growth to bring prices down. If you were alive during that period, you remember we had runaway inflation in this country. And so what Volcker was doing was he was using interest rates to strangle inflation by making it incredibly expensive to borrow, so it slowed down the economy.

And it worked. Over the next four decades, rates came down, and they came down, and they came down all the way to nearly zero in 2022. And as rates dropped, bond prices climbed. People weren't just collecting interest anymore, they were also getting a price on the appreciation on top of the income, right? Because remember there's the seesaw, and so bond prices were going up. So, this is why you start to get total return bond funds.

Like PIMCO had these bond funds that were going up significantly in value. So, it wasn't any longer just about how much money you were making on the interest, it was also about price appreciation. That's why bonds became so popular. For years, people loved bonds. But by 2020, for a number of reasons, first the financial crisis and then the COVID crisis, yields had collapsed almost nothing. And one thing was obvious, there was nowhere for bond yields to go but up, right?

There was a period of time we were not using bonds for our clients. So, if we were, we were using ultra short duration. I remember talking to people and they're like, "What kind of financial advisor are you? You're not using bonds." And I kept trying to explain over and over again, when rates were at zero, they're going to have to reset upwards, and when they do, bond prices are going to get crushed. Your portfolio is going to get crushed.

You were better off leaving your money in cash or in some other instruments, right? Because when yields go up, prices go down. That's exactly what happened. So, in 2022, rates rose faster than almost anyone expected. The Bloomberg US Aggregate Bond Index, which is basically the benchmark for the entire US bond market, lost 13% that year. Can you imagine? You don't have to imagine, you lived through it, right? You've been sold bonds as being safety in your portfolio, and they're down by 13%.

That, by the way, was the worst calendar year for US bonds in the index's 50-year history. So, congratulations. Most of you watching, actually probably all of you watching, unless there's some very young children watching very boring content, you lived through this. Before 2022, the worst year was 1994. And in 1994, bonds lost less than 3% of their price. But here's what made it even worse. Morgan Stanley's research showed that a 60/40 portfolio, right, the safe haven where everyone put their money because they've been sold to 60/40 being a great place to retire, it fell 17.5% in 2022, which was the its worst performance since 1937.

It's fourth worst return in probably the last 200 years, the best we can figure. People who thought bonds were the safe part of their portfolio watch stocks and bonds fall together. That's not supposed to happen, at least at the rate it did. And if you were a year or two from retirement or you just retired or you were in retirement, you watched your supposedly conservative portfolio drop dramatically along with your stomach, right?

You felt it in the pit of your stomach. And so now a lot of you watching are incredibly skeptical about fixed income. Now, interestingly, what Wall Street did is they used this as an opportunity. I think it was Rahm Emanuel quote that says something like never waste a crisis. Wall Street saw this as an opportunity begin selling people very expensive alternatives. There was this massive explosion in people being interested in alternatives in people's portfolios.

Lots of big firms were selling alternatives. And Wall Street loves alternatives because as there had been fee compression in the broader market, right, ETFs had come down to basically zero cost, alternatives on the other hand paid a large premium, often 2 to 3%. And so you saw this explosion in private credit, which is now beginning to have its own problems and may end up unraveling in really destructive ways, but that is for another video.

So what Wall Street did is when people were afraid of bonds, they're like, "Hey, we have something better for you. It's expensive, but trust us, it's safe." Now we're wondering if it's actually as safe as we were told, surprise, surprise. But here's the part that no one in the financial media comes back and revisits.

The same rate hike that caused those 2022 losses did something else. They reset bond yields to levels we hadn't seen in a long time. And that changed the math going forward. Because after the worst year in a generation, the 60/40 came roaring back. In 2023, it had a return of somewhere around 17% according to Morningstar. Again in 2024, it's around 17%. 2025, probably around 15%. Right, three straight years of double-digit returns.

Better than its long-term historical average. Better than most retirees expected for the future of their bond portfolio or their 60/40 portfolio when they were panicking in 2022. And almost no one in the financial media has bothered to come back and write a correction saying, "Actually, all those articles about the death of the 60/40, they might have been overstated." But those articles declaring the death of the 60/40, they got millions and millions of views.

And those articles quietly admitting it's one of the best three-year stretches in decades, eh, not many people are reading those. Because admitting you were wrong or admitting that the sky isn't falling doesn't drive clicks. And this is one of the most important lessons I can give you about investing and about retirement investing in particular. The financial media, you should underline this, right? CNBC, Barron's, all the financial media has a very different incentive than you do.

They get paid to make you scared and to make you click. You're trying to fund your retirement for 30 years, right? They have a very short-term profit goal. You have a 30-year investment time horizon. And I know you know this, but those goals are not the same and they are at odds with each other.

So, where are we now that we're in 2026? The 10-year Treasury is sitting around 4.6% as I record this. That's up from about 4% earlier in the year. Because inflation data has come in hotter than expected. You know this if you've been to the gas pump or or you've been to the grocery store recently. And long-term yields have been stubborn, right? Sticky is the word that bond strategist keep using. Kathy Jones, who runs fixed income strategy at Charles Schwab, she expects the Federal Reserve to cut these short-term rates a couple more times, which would put the Fed funds rate at somewhere in the three to three and a half range over the next year, but they expect the 10-year to hold at 4 plus percent because of a couple of reasons, right?

Because of sticky inflation, rising Treasury supply to fund federal deficits, and rising global yields. And all that is going to continue to make borrowing more expensive. One of the analysts at Fidelity points to something called the term premium coming back. In plain English, the market is demanding more compensation for holding longer-dated bonds. After years of investors basically lending the government money for free, at least long-duration bonds, right?

For free, right? Very little return. Now people are demanding a bit of a premium. They want to get paid. So what does all this mean for you? And I know this is a bit complex, and I may have gone a little too deep. I I try to balance making sure you have all the information you need without getting too overly complex. It's a hard balance. Ultimately, what it means for you is that bonds are paying a real return again, right?

You can actually make money from a bond yield. And the case for owning them in 2026 is, in my opinion, and is more about income and not about big price gains. The coupon payments right now are doing most of the work. Remember, you get paid twice a year. The income is more of the reason you want to hold bonds and also protection against volatility. Those are the reasons you want to hold bonds, less because you think you're going to get some great price appreciation like you did during the '80s and '90s. And that's a very different situation than when we were in 2020 or 2021, when yields were near zero and there was nothing to do but hope that rates would not go up, right?

Now you actually have a decent return on bond yields, even though you're probably not going to get a large price appreciation over the next couple of years. So this is the part I really want you to focus on. And if you kind of zoned out while I was talking about everything else, that's fine. It was a lot of information, but you need to understand that all bonds are not created equal.

Underline that. There's three things you need to understand: duration, quality, and purpose. Duration is basically how long it is until a bond matures. It also tells you how sensitive the bond is to interest rate changes. The longer you're locked in, the more pain you'll feel if rates move against you. Let me explain why that is. So let's say you have a 30-year rate that you locked in at 3% and the par value is $1,000.

That's typically how bonds are priced. So you have a $1,000 par value and you have a duration of 30 years and the coupon rate, the interest rate it's going to pay is 3%, meaning that for every bond you have, right? For each $1,000 par value, you get $30 in yield. So you get two coupon payments, typically $15 twice a year. So you've locked this in for 30 years. Now what you need to understand is assuming the company does not go out of business, as long as you hold that bond to duration, if you hold it for 30 years, each year they're going to pay you your 3% and at the end they're going to give you back your original par value, which is $1,000.

But during that time period, interest rates go from 3% to 6%. Well now other people are getting paid 6%. You're only getting paid 3% and you're like, this is a major bummer. My buddy over here is getting $60 a year from his bond. I'm only making $30 a year. I don't want this crappy bond anymore. The problem is no one is going to pay par value, going to pay you $1,000 on a bond that's only clipping 3% a year. So if you're like, I want out of this bond.

I need the cash. I need money for retirement or whatever it might be. I need to sell this bond. No one's going to pay you a thousand. You're going to have to sell for a discount and that discount is going to have to adjust to the the prevailing rate. And I haven't done the actual math, but let's just assume the bond is a thousand dollar par value. You might have to sell it for $900. So, if you have to sell before duration, you're not going to get the full thousand dollars you invested in the bond.

Now, if you held it to the end of the 30 years, they're going to pay you every year assuming they don't go bankrupt and they're going to give you back your thousand dollars. The problem is you need to sell it early. That's why duration matters because in retirement in particular, if you're using it to fund income or you're using it for liquidity and you have too long a duration bonds and you need the cash to live, you might have to sell it early.

Short-term bonds are flexible and less affected when the rate moves. Long-term bonds historically have given you more income, but they swing much harder in value. Now, there is a case to be made for long duration bonds as a protection against stock market crashes because historically when stock markets have crashed, longer duration bonds have spiked in value. They are also much more sensitive to rate moves. If you don't believe me, go to Google, type in TLT and look at the price return for the past five years of the 20-year Treasury.

It's down nearly 40% not taking into account coupon payments. And so, the first question to ask about your bond isn't how much does it pay me? The question is how long am I locked in, right? That's the question you need to care about first of all because if you have a five-year bond and you need the money in one year and interest rates move, you might have to sell it for less than what you invested in. On the other hand, if you held it for five years to duration, assuming the company doesn't go bankrupt, you're going to get your money back.

The second thing you need to be thinking about is credit quality. Government-issued bonds by the Treasury are historically the safest. Then you have investment grade corporate bonds, they're next, right? So you you earn the least for government bonds and you earn a little more for corporate bonds. And then you've got what are called high yield bonds, they're a little more risky. So they pay out a slightly higher yield.

They're sometimes called junk bonds, right? The more risk you take, the more interest you pay, but they also have higher default rates. For most retirees, you want to be very careful about the yield you're going to get from junk bonds because often the extra volatility, in my opinion, isn't worth it. You'd probably be better off in stocks than junk bonds. You can make a case for junk bonds, but cuz you have a higher upside.

There might be slightly more volatility, but junk bonds are pretty volatile and you just don't have near the upsides, especially when markets get rough and those bonds start behaving more like stocks than bonds. So the first thing you need to think about, just quickly to recap, is is duration. How long is this bond? The second thing you need to think about is quality. Is it a government bond, a corporate bond, is it a junk bond?

And then the third piece is purpose. I'm going to put all this together in just a minute. This is what a lot of people get wrong. In a retirement portfolio, bonds have a couple of jobs. They're not to make you rich, they're there to reduce volatility, potentially to generate income, and to provide a cushion when stocks fall. But ultimately, what I'm most interested in when I'm putting together a portfolio is the protective nature of fixed income, right?

I don't want you to be forced to sell equities at the worst possible time. So let me give you an idea of what this would look like if we were putting together a portfolio for a client.

So you come to me and you spend $100,000 a year. I know some of you are like, who can spend that much? It just makes it easier for me when I'm calculating numbers. So you got a $2 million portfolio, you spend $100,000 a year. So when we're putting together a portfolio, we'd often put, right now, a couple hundred thousand, maybe 2 years of living expenses in ultra short Treasuries or some ultra short cash equivalent.

Why? Because the ultra-short duration, basically 30, 60, 90 days, has almost no interest rate risk, right? You Whatever the yield is, you're going to get, that's what you're going to get in income. 4%, 3 and 1/2%, 3%, whatever that might be, but there's almost no interest rate risk. So, you know that you're going to have $200,000 there to spend, no matter what happens in the market. Then we have another tranche, another couple hundred thousand that tends to be in short duration bonds.

So, think that two, three, four-year time period. And often we do that because as the Fed cuts the Fed funds rate, right? They keep cutting it from four to three and a half, this is why your CDs and your bank interest and everything is going down in value. As that gets cut, that you've locked in a slightly higher yield with the short duration. Now, there is a bit more interest rate risk in that short duration bucket, but if you hold it to maturity, you're protected against a lot of it.

That's the one thing that's important to know about bonds. As long as it doesn't go companies don't go bankrupt. That's why you use a broad diversified fund of bonds. As long as you hold the duration, you get your original par value back, the amount you paid, plus you get paid your interest. It's when you sell before the end of the duration, and so you're forced to sell at a discount. So, couple of years of living expense in cash equivalents, couple of years in short duration bonds.

Then, depending on your risk profile, we might put another two to four years, another 200 to 400,000 in this situation, of living expenses in intermediate bonds, right? This is what's often called a bucket strategy or a liquidity strategy. There's some interesting research that shows that it's not actually that different than a 60/40, assuming we end up somewhere around a 60/40 in in this allocation, but it is from a behavioral standpoint, just much easier to hold because you understand what happens in a crash.

Because if there is a prolonged crash, that six to eight years of liquidity, right? The money in the ultra-short, the money in the short, and the money in the intermediate bond helps make it so you don't have to sell your stocks into a crash, which is the most dangerous thing you can do in retirement is to be forced to sell into a crash in order to be able to fund your living expenses. And so if you can match duration at least to some extent, you reduce some of the risk of the bond portfolio, but it also gives you time to sit through a down market.

And then in this situation, so we've got 800,000, 8 years of living expenses and fixed income, there's still 1.2 million more and that goes into a balanced equity portfolio. That's how we would think about putting together a portfolio for client.

And what we see over time is that bond protect you from one of the biggest risk in retirement, which is being forced to sell your investments when they're down. That's what can actually wreck a plan and bonds along with high yield savings or cash equivalent are some of the simplest tools we have to protect ourselves. So here's the question, are bonds or 60/40 portfolio, are they dead? Right, should we hold bonds in 2026 despite all the eulogies that have been written?

The honest answer is that the 60/40 in my opinion is probably not dead. I'm hedging this here because this is not investment advice. But Vanguard's chief economist for the Americas has shown that a 60/40 portfolio returned 8.8% annualized from 1926 through 2021. That's nearly a century of data through depressions and World Wars and stagflation and dot com crashes and global financial crises and terrorist attacks. Now here's the question, what's the future going to look like? We have no idea. 2022 showed us that when inflation is running hot and the Fed is aggressively raising rates, stocks and bonds can fall at the same time.

That correlation risk is real and it's not going to go away. It's why by the way you keep that ultra short bucket. But if you're close to retirement and you're already in retirement, I'm not going to just blindly say that you should have a 60/40 and you should call it a day. I'd ask, what type of bonds do you own? What's the duration? What's the credit quality? And does my withdrawal strategy account for the possibility of stocks and bonds having a down year together?

For some of you watching this, a 60/40 is the right move. And for others of you watching, depending on your risk tolerance, maybe a 70/30 makes more sense or an 80/20. The thing is, there's no universal answer. But be careful what you read online that pretends otherwise. So, are bonds dead? No. Bonds are not dead. Bonds are not going away. But the version of bonds that worked for the past 40 years, where you just clipped coupons and watched its price drift higher and rate as rates keep falling, that version is probably dead.

And what replaces it will be a strategy where bonds provide income, and they protect you against volatility. I have gone on way too long talking about bonds. My guess is that no one is left watching. But if you are, and you heard me mention that Kitzes study, and that most people in his study that used the 4% rule with 60/40 end up with way more money at the retirement, you're like, "What did he say? I want to hear more about that." Well, you're in luck. So, I have a whole video where I go deeper into that study, and you can watch it now.