Are you avoiding bonds because of the near certainty that interest rates will be higher in the future?

Welcome to the club. Since higher rates inevitably lead to lower bond prices, fear of what higher rates would do to our bond holdings is nearly universal.

Believe it or not, however, that fear may be misplaced. That’s not because higher rates don’t lead to lower bond prices; they inevitably do. Instead, the reason not to be overly afraid of higher rates is because of the way in which most of us invest in bonds.

Most individual investors have their fixed-income allocations invested in baskets of bonds that maintain more or less constant maturities. Such baskets are remarkably resilient in the face of higher rates.

Let’s start by reviewing the period from 1966 through 1981, arguably the worst period in U.S. history in which to own bonds. Over those 16 years, the yield on the 5-year U.S. Treasury Note nearly tripled, from 4.7% to 13.6%. Nevertheless, according to Ibbotson Associates, a division of Morningstar, a U.S. Treasury portfolio that maintained a constant maturity of 5 years produced a 5.8% annualized gain over this period.

Better yet, this portfolio of 5-year Treasuries incurred minimal risk along the way. In only one of the 16 calendar years did it produce a loss, for example. And its volatility, as measured by the standard deviation of its yearly returns, was half that of the S&P 500’s (ticker: SPY ) —and 66% lower than that of small cap stocks.

Why wasn’t this bond portfolio decimated by the dramatically higher rates over this period? The answer lies in the higher yields the portfolio was able to earn when it reinvested the proceeds of maturing bonds. Those higher yields in large part offset the loss of principal.

Nor was this result a fluke, according to a study last year in the Financial Analysts Journal that analyzed the performance of constant-maturity bond portfolios when rates rise. The authors—Martin Leibowitz and Anthony Bova, managing director and executive director at Morgan Stanley, respectively, and Stanley Kogelman, a principal at New York-based investment-advisory firm Advanced Portfolio Management—found that, as a general rule, the greater yield earned during a rising-rate environment offsets the declining bond prices those rates cause.

They therefore concluded that investors in constant-maturity bond portfolios “need not be unduly worried about the impact of higher rates on their multiyear returns.”

The implication of this finding: The total return of a constant-maturity bond portfolio will be equal to, or very close to, its initial yield. That is a sobering prospect in today’s low-interest-rate environment, of course. The 5-year Treasury currently yields just 1.25%, for example. Regardless of whether rates go up, down or stay the same, therefore, that is the best guess of what your return will be by investing in 5-year Treasuries over the coming years.

That may very well be a good reason to avoid them, of course. As judged by the breakeven inflation rate, the bond market is collectively betting that inflation will average 1.36% annually over the next 5 years. If that turns out to be the case, a bond portfolio with a constant maturity of 5 years will lose purchasing power at an annual rate of 0.11%.

Note carefully, however, that this reason to avoid bonds has nothing to do with the probability of higher interest rates in the future. If low current yields are your reason to avoid bonds, you should just as much be avoiding them if you were convinced that rates would to stay the same in coming years—or even decline.

In any case, you should not conclude that the stock market is a particularly good bet just because nominal interest rates are so low and inflation-adjusted rates are even lower. Over the last 50 years, for example, there has been just a 2.7 percentage point annual spread between the S&P 500’s annual total return and that of intermediate-term bonds. If we were to extrapolate that equity premium into the future, that would mean that the stock market in coming years would produce a 4% annualized total return.

You may very well believe that isn’t high enough to compensate for the significantly greater volatility and risk that equities produce.

Would gold be a better alternative if you are turned off by bonds’ low yields and worried that equities won’t perform well enough to justify their greater risk? Claude Erb, a former fixed-income and commodities manager at mutual-fund firm TCW Group, thinks not. In an interview, he pointed out that gold over the past five decades has been far more volatile than the S&P 500—and far, far more volatile than a constant-maturity portfolio of 5-year Treasuries.

The Ibbotson data paint the same picture. Since 1970, when gold began to trade freely, it’s been 62% more volatile than the S&P 500—and more than three times more volatile than 5-year Treasuries. Furthermore, there has not been a big difference in the extent to which intermediate-term bonds and gold have been correlated with the stock market—which means they have largely similar diversification potentials.

As Erb argues, therefore, the net effect of substituting gold for bonds as a diversifier for your equity portfolio will be to increase its volatility.

The bottom line? The unfortunate reality of our low-interest-rate world is that expected returns going forward are low. But a wholesale dumping of bonds is probably not a good response to that reality.