As Dow soars, don't give up on bonds just yet
Long term, bonds still make sense in any portfolio. Here's what to consider now.
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"To the extent that cash protects a portfolio against inflation, it does so tardily and after the fact," David Ranson, of H.C. Wainwright & Co. Economics in Hamilton, Mass., writes in a recent analysis.
Bonds or bond funds? Bond funds can be simpler to buy than individual bonds. And it can be hard for small investors to know whether they're getting a good deal on bonds sold by brokerage firms, especially corporate issues. But for TIPS or Treasury bonds, you can often lower your costs by buying on your own. Newly issued securities are available at www.treasurydirect.gov. In the secondary market, outfits like Trade King (www.tradeking.com) and Fidelity offer low-commission bond-trading desks.
Unlike corporate bonds, all Treasury debt is considered to be of virtually zero risk of default. But you'll need to plan your own "ladder" of bond durations, perhaps buying bonds of several different maturities to achieve the balance you desire.
"People have no business buying individual corporate bonds," says financial author William Bernstein in North Bend, Ore. But "buying Treasuries is a good idea, and buying TIPS in particular." The percentage of your investment portfolio that should be devoted to bonds can vary widely, even among people of similar age or means. It can also depend on your goals and risk tolerance, financial experts say. If your goal is to reduce the possibility of a sharp drop in your portfolio, bonds are useful for two reasons: They are less volatile than stocks, and they often zig when stocks zag.
"We expect stocks to outperform bonds in the future," says John Thompson, a portfolio manager at Ibbotson Associates, a Chicago firm that specializes in how to allocate money among various types of assets. But "bonds are an important diversifier," he adds.
A typical mix, for many people, might be 60 percent stocks, 40 percent fixed income (mostly bonds and some cash). Other advisers, departing from that classic mix, suggest that your bond percentage should equal your age, minus 10. If your goal is to build up money for a future need, bonds may play a dominant role if the target date is less than 10 years away.
For income during retirement, many advisers recommend both bonds and a fixed annuity that converts some of your savings into a guaranteed monthly income for life.
"The first question you have to ask is not how risk tolerant are you, but do you even know how risk tolerant you are?" says William Bernstein, author of "The Four Pillars of Investing." "If you lived through a bear market and you actually bought more stock ... then you are truly risk tolerant."
He expects future returns from the stock market to be in the range of 6 to 7.5 percent annually, not all that much better than the 5 percent or so he expects from bonds.
Mr. Bernstein adds that a 50-50 mix of stocks and bonds could post returns that compare pretty well with stocks alone, and with much less risk.
