• April 19, 2024

Don’t stop believing in bonds

Given current fate and darkness, with the occasional relief from rising interest rates, does it still make sense to invest in bonds as one is saving for retirement or living in retirement?

Well, it sure didn’t seem to make sense when interest rates were (and still are) at historic lows. Who in their right mind wants to earn 0.318% with a 10-year treasury of what they earned about a year ago?

And it might make no sense now that interest rates have risen from the lows in March 2020. Remember that when interest rates rise, the net present value of your bond will decrease.

But what people might be missing in the wrong environment right now is the role bonds should or should play in a portfolio.

Security, no income

According to Larry Swedroe, co-author of your complete guide to a successful retirement and director of research at Buckingham Strategic Wealth, the main role of fixed income in your portfolio should be security, not yield, not income, not cash flow.

In other words, when everything else goes into the pot, when stocks get cratered, bonds are there to keep capital safe – at least when it matures.

Bonds are also used for diversification purposes. Bond prices should rise in value as other assets, such as stocks, decline in value, and vice versa.

“Rule # 1 that every investor should adhere to is that you want to make sure that your portfolio has a sufficient amount of safe fixed income to keep the portfolio’s overall risk at an acceptable level,” he said. “Because if stocks don’t and stocks fall, which they usually do every 10, 15 years or so, 40, 50% or whatever, then you’re going to exceed your risk tolerance.”

At best, he said, you won’t sleep, enjoy your life and everything else. And worse, you’ll end up embarking on the worst you can do: panic and sell. “And once you’ve sold … I think you’re practically doomed if you’re not just lucky.”

Conclusion for Swedroe: “You have to have enough secure bonds.”

How much to invest in bonds, stocks, and cash is undoubtedly the most important portfolio building decision an investor makes, according to Sébastien Page, author of Beyond Diversification and head of global multiassets at T. Rowe Price. ”

How much do you have to invest in bonds?

How much you should invest in fixed income securities depends on your risk tolerance, according to Swedroe. And your ability to take risks is determined by four factors: your investment horizon, stability of income earned, your liquidity needs, and options that can be exercised should a Plan B be required. In addition, Swedroe said owning bonds with maturities beyond your investment horizon involves more risk than inappropriate.

Ability to take risks

Investment horizon (years)

Maximum share allocation (%)

0-3

0

4th

10

4th

20th

6th

30th

7th

40

8-9

50

10

60

11

70

12-15

80

16-19

90

20+

100

Source: Your Complete Guide to a Successful and Safe Retirement

Like Swedroe, Page believes that the decision depends in part on human capital, the present value of your future salary income. And when you factor in a person’s human capital, which Page says looks more like a bond than a stock, a balanced portfolio with a healthy allocation to stocks rather than bonds is the answer.

To be fair, the full life cycle allocation to bonds is not static in either Page or Swedroe’s model portfolios.

For example, in Page’s model portfolios, you would assign bonds in the 20 years before retirement, 15%, 45% in retirement, and 69% in the 20 years before retirement, which is close to the rule of thumb that this would have you subtract your age from 120 to determine how much to invest in stocks and how much to invest in bonds. So if you were 47 you would invest 73% in stocks, and if you were 87 you would invest 33% in stocks.

The right bonds depend on your investment goals

Investing in the right bonds is just as important as investing in bonds, said Massi De Santis, certified financial planner at DESMO Wealth Advisors. According to De Santis, the right bonds will help you avoid unnecessary risk and get the most out of your portfolio, especially in a low interest rate environment.

What are the right bonds? That depends on your investment objective.

For growth portfolios, De Santis recommends diversifying the bond component across the entire bond universe, including government bonds, government agencies, investment grade corporate bonds and global bonds. The duration should be in the medium range (approx. 5-7 years).

The Vanguard Total Bond Market Index Fund ETF
BND, -0.32%,
the SPDR Bloomberg Barclays International Treasury Bond ETF
BWX, -0.70%,
and iShares Core US Aggregate Bond
AGG, -0.29%
are ETFs that would work for this goal.

For conservative portfolios, De Santis recommends highly rated short to intermediate bond maturities that are close to the horizon of the target. The iShares 0-3 Month Treasury Bond
SGOV, + 0.02%,
SPDR Bloomberg Barclays 1-3 months T-Bill ETF
BIL,
,
Vanguard Short-Term Treasury Index Fund ETF
VGSH,
,
Vanguard Short-Term Bond Index Fund
BSV, -0.11%,
iShares Core 1-5 Years USD Bond ETF
ISTB, -0.02%,
and iShares 1-3 Year International Treasury Bond ETF
SHG, -0.10%
are ETFs that would work for this goal.

For income-oriented portfolios, De Santis recommends government bonds, inflation-linked corporate bonds, and investment-grade corporate bonds where the target maturity is the average maturity. The iShares TIPS Bond ETF
TIP: -0.38%
and the Vanguard Long-Term Bond Index Fund ETF
FSVO, -0.79%
are examples of ETFs that would work for this goal.

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Jack

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