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Every so often, a stock market crash comes along. And investors across the country or the globe panic. This is understandable because when you have all or most of your money invested in stocks, a crash can be the worst news.
But here’s a secret. If it seems like the market might go through a bad phase, you can protect your capital easily with one simple strategy: diversifying into bonds.
Usually, when the stock market dips, bonds become attractive. Just last year, the US market witnessed this phenomenon when the MSCI’s global equities index fell, but US Treasury yields hit a new record high.
But why are bonds attractive when the equity market is bearish? Let’s find out.
The Inverse Relationship Between Bonds and Stocks
When the stock markets crash, investors panic. They pull their money out of equities and move it into safer assets. And bonds are usually one of the top alternatives many investors choose. This means the demand for bonds surges, pushing bond prices up even as stock prices fall.
That’s the inverse relationship between bonds and stocks in a nutshell.
When the price of one falls, the price of the other usually goes up. But why does this happen? The answer comes down to risk appetite.
During a crash, investors stop chasing returns. Instead, their main goal switches, and they want to focus on keeping their money safe. And bonds, especially government bonds, give you two benefits in one:
- Guaranteed returns
- Capital protection
This makes the bond market a natural safe haven if the equity market is falling. The more the share market bleeds, the more attractive bonds become.
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5 Reasons to Choose Bonds if the Equity Market Crashes
Still wondering why bonds may be a good choice of investment if the equity market is falling? Here are 5 reasons to consider.
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Bonds Deliver Known Returns
When the equity market crashes, your stock portfolio may lose 20%, 30%, or even more in a matter of weeks. But bonds don’t work this way.
When you invest in a bond, you know exactly:
- How much interest you’ll earn
- When you’ll receive your payouts
- When you’ll get your principal back.
This is incredibly valuable, especially when the equity market seems uncertain. Also, bonds pay you regular interest at fixed rates. So, even if your equity portfolio is performing poorly, your bonds will steadily be putting money back in your pocket.
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G-Secs are Backed by the Government
When you buy a government security, you’re lending money to the government. And as per the RBI, this is considered highly secure because the government practically never defaults on its debts. The Indian government, in particular, never has.
This matters a great deal during a market crash. When companies are struggling, and corporate bond defaults are on the rise, G-Secs typically still continue to pay out as promised. That’s because the government can always:
- Print currency
- Raise taxes
- Borrow more to meet its obligations
These are options that private companies do not have. That’s why G-Secs are the closest thing to a risk-free investment you’ll find.
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Bonds Give You the Benefit of Liquidity
During a market crash, liquidity becomes as important as safety. You may need quick access to your money for various reasons. For instance, you may need to:
- Free up cash to meet emergency expenses
- Rebalance your portfolio
- Purchase promising stocks at lower prices
- Cut exposure to a specific bond if credit conditions worsen
Bonds give you this much-needed liquidity. You can sell G-Secs and corporate bonds in the secondary market even before their maturity dates.
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SGBs Also Offer the Benefit of Potential Price Appreciation
Most bonds protect your capital and pay you interest. Sovereign gold bonds (SGBs) also do this. But they don’t stop there. They also give you something extra.
Since these bonds have denominations in grams of gold, your returns directly depend on gold prices. And gold is one of the few assets that consistently rise when the market is falling.
So, with SGBs, you’re getting:
- Fixed annual interest at 2.5% per year
- Capital appreciation linked to gold prices
- Complete tax exemption on gains if you hold the bonds till maturity
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Bonds Reduce Your Portfolio Beta
The beta of a portfolio tells you how sensitive your portfolio is to market movements. If the beta is high, it means the portfolio swings wildly with the market. For instance, if the Nifty drops by 10%, a high-beta portfolio may drop 15% or more.
Bonds, however, have a near-zero or a negative beta. This means they don’t move in sync with the stock market at all.
So, what happens when you add such bonds to an equity-heavy portfolio? You bring its beta down.
Practically, this is what it means:
- Smaller drawdowns when the market falls sharply
- Less volatility in your overall portfolio
- More stability, so you can stay invested without panicking
Expecting a Market Crash? Diversify Into the Right Bonds
Truth is, you can never know for sure when the market will crash. Experts may make predictions, but you have to learn to read the signals on your own. Usually, the following indicators may precede a market fall:
- Rising inflation
- High unemployment rates
- Slowing GDP growth
- Record-high PE ratios
- Rising VIX
- Inverted yield curves
- High levels of margin debt
If you notice a combination of these signs, it may be a good idea to have a backup plan to invest in the bond market.
GoldenPi offers many options for investors interested in bonds. Whether it’s your first time in the bond market or you’re looking to expand your bond portfolio, you’ll find a wide range of bonds on this platform. If you want to balance risk and reward better, you can even choose from the extensive selection of corporate bonds.
Bond Investments FAQs
1. Are bonds completely safe during market crashes?
Not completely. Government bonds can be extremely safe, but corporate bonds can still be affected. That said, bonds may be far less risky than equities during a crash.
2. How do bonds protect my portfolio during a market crash?
When stock prices fall, investors move their money into the bond market. So bond prices go up. Because of this inverse relationship, your portfolio may be protected from heavy equity losses.
3. Which type of bonds are safest if the equity market is volatile?
Government bonds and sovereign gold bonds (SGBs) are generally the safest options. They have minimal default risk. They also tend to hold their value well when the markets get volatile.
4. Is it too late to invest in bonds if the market crash has already begun?
Not at all. Bonds can still offer stability and decent returns even if you invest in them mid-crash. Just avoid long-duration bonds if you expect the interest rates to go up further.
5. How do bond prices move when the stock market crashes?
They tend to move in the opposite direction. As equity prices drop and they’re sold off, the demand for bonds goes up. This pushes the price of bonds upward.
Disclaimer:
This information is for general information purposes only. GoldenPi makes no guarantee on the accuracy of the data provided here; the information displayed is subject to change and is provided on an as-is basis. Nothing contained herein is intended to or shall be deemed to be investment advice, implied or otherwise. Investments in the securities market are subject to market risks. Read all the offer-related documents carefully before investing.
Fixed Deposit schemes are regulated by the Reserve Bank of India. GoldenPi Securities Private Limited is a registered debt broker and acts as a distributor and not as a manufacturer of the product.
