Sure, the stock market can correct sharply and high yield bonds can follow along, causing deep, painful portfolio losses for a number of months. If they choose to sell their high yield bonds after the correction, they lock in their losses. For instance, selling high yield bonds at the end of 2008 would have resulted in a loss of -26.2% over the prior 12-month holding period.
However, if they had chosen to hang on to those investments, they would have realized significant profits in their high yield bonds by year three.
In most cases over the long term, nearly all total returns generated by diversified bond portfolios come from their income. Bonds are issued at par and mature at par. So long as defaults are not significant, cumulative returns are a function of the amount of income distributed and the investor’s hold time.
How does investor discipline factor into the equation? If investors have the discipline to avoid the temptation of bonds that could produce short-term losses greater than they can handle, or be willing to continue holding bonds that have delivered painful short-term losses , they can generate solid returns regardless of fluctuations in the broader markets.
This article was written by Sage Advisory Services, Portfolio Manager of the AdvisorShares Sage Core Reserves ETF (HOLD).