Bonds explained: when and why to add them to your portfolio

Topic: Investment · Type: Evergreen · Reading time: ~8 min

Most investors under 40 hold almost no bonds and feel quietly smug about it. Stocks have outperformed bonds handily over most long time horizons, and that data point tends to close the conversation. The problem is that "long time horizon" does a lot of unacknowledged work in that sentence — and the year your bonds would have mattered is never the year you expected.

What a bond actually is (and why the analogy matters)

A bond is a loan you make to a government or company. They promise to pay you a fixed interest rate — called the coupon — at regular intervals, and return your original sum on a set date called maturity. Unlike a share, a bond does not give you ownership in anything. You are a creditor, not a co-owner.

That distinction shapes everything about how bonds behave. When a company struggles, shareholders often get wiped out; bondholders get paid first. When interest rates fall, existing bonds paying higher coupons become more valuable, so their price rises. When rates rise — as they did sharply in 2022 — new bonds offer better yields, making older ones worth less on the open market. This inverse relationship between bond prices and interest rates trips up even experienced investors.

The two things bonds bring to a portfolio are income (the coupon payments) and diversification. That second one — diversification — is where most explanations go thin. It is not simply that bonds are "safer" than stocks. It is that high-quality government bonds, specifically, tend to move in the opposite direction to equities during growth shocks and market panics. During the dot-com crash, the 10-year US Treasury returned 39% while the S&P 500 fell 23%. During the 2008 financial crisis, Treasuries returned 17% while equities lost the same. That negative correlation is the whole point.

The 60/40 debate — and why 2022 muddied the waters

The classic 60/40 portfolio — 60% stocks, 40% bonds — was pronounced dead approximately forty times between 2022 and 2024. The criticism was fair: that year was historically unusual because inflation drove both stocks and bonds down simultaneously, something that had not happened at scale in decades. The Morningstar US Moderate Target Allocation Index, a proxy for the 60/40 approach, lost 15.3% in 2022. People noticed.

What happened next got less attention. In 2025, the same 60/40 benchmark returned roughly 15%, approximately double its average return over the prior twenty years. Bonds did not just recover — they served their function: providing ballast when equity volatility returned.

Worth knowing: Since 1975, annual bond returns have outpaced inflation 71% of the time. The equivalent figure for cash is just 57%. The after-inflation return for bonds averaged 3.1% annually; for cash, 0.6%. Bonds are not the same thing as cash, and treating them that way costs you.

Who actually needs bonds — and when

Here is the part most articles get wrong by defaulting to age as the only variable. Age matters — but it is a proxy for two things that matter more: time horizon and sleep quality.

Time horizon: If your money is locked in for thirty years, short-term volatility is largely irrelevant. A 100% equity portfolio for a 28-year-old saving for retirement is not reckless — it is probably optimal. But if you are saving to buy a home in four years, or funding a child's university fees in seven, you cannot afford to watch a 30% equity drawdown and wait it out. That money needs some protection. Bonds provide it.

Sleep quality: This is the metric nobody puts in a spreadsheet. Empower data on real investors shows that people in their 20s and 30s hold less than 5% of their portfolios in bonds on average. That is a reasonable allocation — until market volatility arrives and they panic-sell at the bottom. A 90/10 stock-bond split that you actually hold through a crash beats a 100/0 allocation that you abandon in March. If seeing a 25% paper loss causes you to make decisions you will later regret, a bond allocation is not sacrificing return — it is protecting you from yourself. That is worth something.

A rough framework: if you are over a decade from needing the money and have steady income, bonds are optional. If your timeline is under ten years, or you are entering drawdown (living off your investments), a meaningful bond allocation — somewhere between 20% and 50% depending on your situation — earns its place. This is not about age. A 35-year-old with a three-year savings goal for a house deposit has a shorter relevant horizon than a 60-year-old still thirty years from touching their pension.

If you are building a diversified portfolio from scratch and thinking through the full asset mix, it helps to understand how to build a diversified portfolio from scratch before deciding on the bond allocation that fits your goals.

The types of bonds that matter for most investors

You do not need to understand every corner of the bond market. Most investors are best served by three categories:

Government bonds (called Gilts in the UK, Treasuries in the US, Bunds in Germany, OATs in France) are issued by national governments. They carry low credit risk — governments rarely default — and provide the strongest diversification benefit against equity crashes. They are the "core" of any sensible bond allocation.

Investment-grade corporate bonds are issued by large companies with strong credit ratings. They pay more than government bonds because the credit risk is slightly higher, but defaults among investment-grade issuers are historically rare. They sit in the middle ground between safety and yield.

High-yield bonds (sometimes called "junk bonds") are issued by companies with lower credit ratings. The yields are higher, but so is the risk of default — and high-yield bonds tend to correlate more closely with equities during downturns, reducing their diversification benefit. They belong in a portfolio only as a small complement to core holdings, not as a substitute.

For most investors, a globally diversified bond index fund does the job without requiring you to pick individual bonds or sectors. The iShares Core Global Aggregate Bond UCITS ETF (ticker: AGGH), available to European investors — with EUR-hedged versions available on major exchanges to manage exchange rate exposure — covers investment-grade bonds across governments and companies worldwide at a total expense ratio of 0.10% per year. That is the kind of specific number worth knowing before you buy anything.

Understanding how bonds fit alongside equities is also the natural context for understanding index funds vs picking stocks — both are questions about market exposure and cost.

The interest rate problem — and how to think about it

The reason bonds confused so many investors between 2022 and 2024 comes down to one mechanism: as interest rates rise, existing bond prices fall. This is not a flaw — it is simply how fixed income works. If the market now offers 5% on a new bond and you hold one paying 2%, yours is less attractive; its price drops until the effective yield matches the market rate.

The implication: long-dated bonds (maturing in 20+ years) are far more sensitive to rate movements than short-dated bonds (maturing in 1–5 years). When the US Federal Reserve raised rates rapidly in 2022, long-duration bond funds lost heavily. Short-term bond funds were largely unaffected.

As of early 2025, with aggregate bond yields implying a forward five-year return of approximately 4.7% according to J.P. Morgan Private Bank analysis, bonds are once again priced to compensate investors for credit and duration risk in a way they simply were not during the decade of near-zero rates. Whether that return materialises depends on what happens to inflation and central bank policy — but the starting point is more attractive than it has been in years.

This context matters for understanding how rising interest rates are reshaping your personal finances more broadly, including mortgage costs, savings rates, and the opportunity cost of sitting in cash.

What to do this week

If you have never held any bonds and your investment horizon is more than ten years, you probably do not need to rush. Keep investing in a diversified equity portfolio and revisit this when your timeline shortens, your goals crystallise, or you notice that market drops disturb you more than they should.

If you are within a decade of a major goal — retirement, property purchase, funding education — it is worth modelling what a 20–30% bond allocation does to your portfolio's worst-case outcome. The trade-off is real: bonds dampen upside as well as downside. But for money you cannot afford to lose at the wrong moment, that is a trade worth making.

The path of least resistance for most investors is a low-cost, globally diversified bond ETF — not individual bonds, not active bond funds with higher fees and variable results. Start there, and add complexity only if you have a specific reason to.

Bonds are not exciting. That is more or less the point.