To buy bonds or not to buy bonds? This is the question of the hour. Here’s some information that will help you determine the answer.
To Buy Bonds or Not to Buy Bonds?
Reader question from Justin at Rootofgood.com
“I don’t know about the bonds. Experts say put money in bonds. I’m still almost 100 percent stocks although the market is getting high enough where I’m thinking about taking some profits.
I know I should have some bonds in my portfolio, but the rates are still near record lows. Should I still invest in bonds, knowing there’s a decent chance I will lose money over the short to intermediate term?
When I was working, I had a stable enough income that I didn’t care if my portfolio swung 30 percent in a year, so I preferred the big returns of stocks. Now that I’m retired, we are supposed to have some bonds to help with volatility, but I can’t pull the trigger and buy bonds that barely pay more than inflation.
Serious question, and I keep punting from making the decision. 🙂”
Apart from the fact that Justin is in the enviable position of being 33 years old and retired, he’s asking a question that is a concern to many investors.
Understanding Bonds-The Backstory
Justin’s question is pertinent now because it is a certainty that when interest rates rise, bond principal values fall. That means anyone holding an individual bond or bond fund will experience a drop in value when interest rates go up. The amount of decline in the bond’s (or bond fund’s) value depends on the duration or average time to maturity. Higher duration bonds are more volatile than shorter term bonds.
On the flip side, as interest rates rise, dividends reinvested into a bond fund (or into new bond issues) will be reinvested at a lower price per share and with a higher coupon rate and higher yield.
So what is the investor, who wants a diversified investment portfolio to do?
I’ve been reading a lot about this topic, thinking about it for our family’s portfolio, and also discussing the issue with trusted colleagues in the finance world.
Given my findings, I’ll share several viewpoints and discuss the pros and cons, and then leave it up to you to decide.
Option 1: Continue with a 100% Stock Portfolio
Justin is in his early 30’s and I expect he is not living off the income from his investment portfolio.
Historically an all stock portfolio returned an average of about 9 percent per year.
If Justin has a high risk tolerance and can handle huge portfolio declines, without selling, then an all stock portfolio might lead to the greatest long term returns.
But, be aware and don’t go into an all stock portfolio blindly.