In a recent Blog post, I revealed how Millennials may want to think about fixed income in their portfolios. Bonds can play an important role in managing portfolio risk, even if you have a long investment time horizon. What’s more, bonds aren’t just for people in retirement or Millennials; they can be incredibly useful for other life stages as well.
Bonds for your First Home
If you’re saving for a particular milestone, such as buying your first home, you may want to consider investing in bonds. Bonds help you to lock away a certain amount of money for a specific purpose, while collecting income at regular intervals until you receive the principal at maturity. Think of it this way: instead of investing entirely in equities to maximize your return potential, you can instead aim to reduce risk by allocating a percentage of your portfolio to bonds that mature around the time you expect to purchase your first home. This helps you estimate how much money you will have when it comes time to make that future purchase. There are even term maturity ETFs like iBonds® in the market that have a specific end date like a bond. The word used in finance for this application is immunization. Essentially you are immunizing yourself against a future expenditure by putting that money aside today in a bond or term maturity ETF.
Bonds and 529 Plans
Bonds also have a place in your child’s college savings plan. Here the role they can play builds off of both of the topics we discussed earlier: bonds as a potential risk mitigator and bonds as an immunizer for future expenditures. The challenges presented by saving for college are not that different than those faced by Millennials. Both are trying to build portfolio value over a long time period. In this way you can think of children as mini-Millennials. Depending on your risk tolerance, the mix of stocks and bonds in a 529 plan may weight more heavily towards equities initially, but as high school graduation approaches many investors will start to shift into bonds and money market funds to reduce risk. When the child is getting closer to college, you may want to think about using bonds to build a short-term bond ladder. You could invest in bonds that mature at different intervals, such as one, two, three and four years in the future. The principal received at maturity could then be applied to a tuition payment. This is similar to the buying a home example above, but here we are looking at a series of cash payments that you will need to make in the future instead of just one. Again it’s the same immunization concept.
So where does that leave us with bonds? They can potentially play a role in almost any portfolio. From the retiree looking for income, to the adult looking to save for a home, to the recent grad looking to build their portfolio and manage risk. And even to the kid who can’t yet walk yet, but who someday will want to go off to college (where they could even study…bonds!).