In my last column I wrote about bonds and their usefulness in investment portfolios. Today, I want to talk about how to position bonds within your portfolio.
This is really the art in portfolio design as it relates to bonds. You need to determine what percentage of your portfolio should be composed of bonds, and what types of bonds you want to buy. Even within a bond category—say, corporate bonds—there can be quite a bit of variability. Apple, which I used as an example in my last column as paying a 4% hypothetical coupon rate, is a massive, financially healthy company that can offer a fairly low rate of interest on their bonds. After all, you’re not worried that Apple will go bankrupt in the next 5 years, are you? Meanwhile, a company with weaker credit quality might have to offer a bond paying a 7% coupon rate to attract your investment. Remember, you should be paid more for taking on a riskier investment.
How much of your portfolio should be made up of bond investments depends a lot on how risky you want your portfolio to be. Generally, I believe that the longer your money will be invested before you need it, the higher the percentage you should have in equities, with less in bonds. As your “use it” date gets closer, you likely want to progressively increase your bond holding. This helps to steady the portfolio as you’re getting ready to tap in to your investments. It would be a shame if the market dropped 25% just before you retired, and then you had to sell stocks at a discount to fund your retirement.
On the other hand, stocks tend to dramatically outperform bonds over the long run. If you can stomach the risk and have a long enough timeframe, an ideal portfolio will tend to have a higher percentage of equities versus bonds. For reference, a “classic” portfolio model for folks nearing retirement is 60/40, meaning 60% equities and 40% bonds. That doesn’t work for everyone, but it is fairly popular.
In addition to determining the allocation of bonds you need, you should think about which kinds of bonds you want in your portfolio. Do you want individual bonds, or bond funds? Bonds from businesses, or government bonds? Short duration bonds, or long duration? Investment grade, or high yield (“junk” bonds, as they are sometimes called). Each of these types of bonds can serve a purpose, and the larger your portfolio, the more likely you are to have slices of each of these.
My third and final article on bonds will get into the risks of bond investments, but for the moment, let me leave you with this: the longer the duration of your bond, the more volatile its value will be. A 30-year bond’s price will fluctuate much more than a 3-year bond’s price. If you are using bonds to dampen the volatility in your portfolio, this is an important consideration.
How ever you choose to use bonds in your portfolio, invest smartly and invest well!
Larry Sidney is a Zephyr Cove-based Investment Advisor Representative. Information is found at https://palisadeinvestments.com/ or by calling 775-299-4600 x702. This is not a solicitation to buy or sell securities. Clients may hold positions mentioned in this article. Past Performance does not guarantee future results. Consult your financial advisor before purchasing any security.
