On Feb. 11, 2020, I bought some investment-grade bonds that were scheduled to mature in August 2026. With that purchase, I extended a bond ladder that then stretched from March 2020 through August 2026 -- around six and a half years long. I didn't realize it at the time, but that purchase wound up being part of the best investment I made to help guide me through the COVID-19 crisis.
As it turns out, I made that bond purchase right around the time of the stock market's pre-coronavirus peak. In hindsight, that turned out to be one of the best times to reduce risk by shifting to bonds from stocks, but that's only part of the reason that investment turned out to be such a great one. Read on for three additional reasons.
First: Cash to invest when the market started to panic
A key reason that investment worked out well was what the bonds in that ladder did during the worst of the coronavirus crisis. Despite the stock market's panic -- and even as the bond market temporarily dried up -- as the efforts to combat the coronavirus intensified, the bonds in that ladder continued to make good on their promises.
The bonds due in March, April, and May 2020 all paid in full and on time. The bonds due in June 2020 were actually redeemed early by their issuer, at exactly the expected early redemption amount. The longer-term bonds in that ladder that were expected to pay interest did pay interest. Every cash flow expected from those bonds were delivered from those bonds, as the issuers knew that defaulting on their obligations would cause them a world of hurt.
Those interest payments and maturing bonds gave me something that was (at least temporarily) in short supply during the worst of the crisis: cold, hard cash. That's cash I had available to go bargain hunting with after the coronavirus stock market crash. Had that cash been invested in stocks instead of bonds prior to the crash, it would have fallen right along with the stock market instead of being available to pick up bargains.
Second: A critical safety net
Another key reason those bonds were so useful is that the cash they generate could be put to other, more urgent uses than investing. One of the toughest economic impacts from the coronavirus is the fact that over 30 million Americans have lost their jobs from the shutdowns put in place to try to slow the disease's spread. Although I have so far been able to remain employed, there are no guarantees that will remain the case. That makes it important to have ready access to cash, just in case.
With a few clicks of my mouse and a couple of days for the money to transfer, the cash from the next set of bonds' interest and maturing principal payments could get made available to cover our costs. That would come in incredibly handy in the event of a job loss at a time when the stock market is down.
Although bonds are only as good as their issuing companies' promises to pay, the fact that bondholders have a priority over shareholders makes a difference in enforcing that promise. In essence, it means that if a company can make its bond payments, it will make its bond payments, since the alternative turns out worse for the company's shareholders. That property makes shorter-term, high-quality, investment-grade bonds a far better supplement to an emergency fund than stocks.
Third: Financial flexibility to meet fairly near-term goals
Those reasons made that bond ladder an incredible asset to have during the worst of the coronavirus crisis, but I had no idea that would hit when and how it did. I did have a pretty decent idea that the market would crash at some point, but no idea when. What I did know for certain is that my family has several large expenses coming up that we can't cover from salary alone. In particular, we're close to entering a twelve year stretch where we expect one and often two kids in college at once.
With that set of facts at play, it made sense to switch up our asset allocation plan to get some money into investments with a fairly clear set of cash flows and a high likelihood of paying as expected. After all, money you expect you'll need to spend within the next five years or so does not belong in stocks. That's a key driver of what originally led to setting up the bond ladder. The market's crash as the coronavirus shut much of the economy down simply showed why that sort of move was valuable.
If the stock market hadn't crashed, those bonds would still have matured and been available as cash. That cash could still have been put to use, but probably for another purpose. That's the beauty of cash -- it represents the ultimate of financial flexibility that can be put to use when and where it is needed.
Sometimes, the trade-off is worth it
Overall, and over long periods of time, stocks have a much higher likelihood of providing strong positive returns than bonds do. Still, if you ever plan to use the money you have invested, it makes sense to have some of it socked away in investment-grade bonds. That particularly holds true if you have a decent line of sight to when you need the money and that time frame is within the next five or so years.
Whether it's due to the next wave of coronavirus infections shutting down the economy again, general recession fears, or some new panic, the one thing that's certain is that the market will crash again. You may not know when or why before it happens, but if you're prepared for that eventuality when it does take place, you'll be certainly glad you were.