There’s a reason investors are often advised to favor stocks over bonds when they’re in the process of trying to accumulate wealth: Stocks have historically delivered much higher returns, so if you load up on stocks over a 10-, 20-, or 30-year period, you’re likely to come away with much more money than you could have earned with a bond-heavy portfolio.
This is especially important when it comes to building a retirement nest egg, because you need to invest your savings in a manner that can keep up with or outpace inflation. If you don’t, you risk falling short on funds during your golden years. That said, there are certain situations where it might make sense to favor bonds and go lighter on stocks.
Here are a few you might encounter.
1. You’re nearing or are in retirement
Though stocks tend to deliver higher returns than bonds, they’re also far more volatile. When you have a long investment window to work with (say, 10 years or more), you have plenty of time to ride out the market’s ups and downs.
But once you get older and retirement looms or is already your reality, you can’t afford to tie up too much of your nest egg in stocks, because if the market tanks and you need to start taking withdrawals from your investments to pay your living costs before those investments recover, you stand to lose money.
Now, this doesn’t mean you shouldn’t hold any stocks in or close to retirement.
Rather, it might pay to focus more on bonds, and keep a smaller percentage of your assets in stocks.
One rule of thumb you can use to land on the right asset allocation is to take the number 110 and subtract your age from it to see what percentage of your portfolio should stay in stocks.
For example, if you’re 65, you’d want 45% of your assets in stocks, and perhaps the rest in bonds.
2. You’re extremely risk-averse
For some people, the idea of losing money on an investment is enough to keep them awake at night. If you’re the risk-averse type, you may be better off going heavy on bonds and putting a smaller percentage of your portfolio in stocks despite the limited growth potential involved. The reason? If you load up on stocks, you might panic, pull out, and lose money every time the market takes a tumble. Therefore, be honest about your personal risk tolerance, and make sure your portfolio reflects it — favoring bonds over stocks could be the right solution for you.
3. You need a steady source of income
The great thing about bonds is that barring a default, they can provide a steady stream of predictable income. Bond interest is paid twice a year, so if your goal in investing is to supplement your income, bonds are a good way to do so.
Stocks, by contrast, don’t offer the same guaranteed payment schedule. Even dividend stocks, which pay investors quarterly, don’t offer the same level of certainty on the income intake front. That’s because stocks aren’t required to pay dividends, and a company that has historically dished them out can stop if its financial circumstances change. Bonds, on the other hand, are legally obligated to pay interest, and as long as a bond issuer has the financial means of making those payments, it must stick to that schedule.
Make no mistake about it: Stocks are a solid investment for the long haul. But if you’re near or in retirement, have a low tolerance for risk, or are dependent on regular investment income, then it might make sense for bonds to hog the spotlight in your portfolio.
— Maurie Backman
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Source: The Motley Fool