In an investment arsenal, a diversified retirement portfolio is your No. 1 weapon against the market's twists and turns. Bonds offer that, but do younger people need them?
Wait a minute. What I mean is: Bonds. Fixed-income bonds.
OK, a cheap trick to lure you in, but c'mon. Would you have made it this far without it? I don't have a bevy of babes or fancy spy tools. And unlike 007, bonds of the financial type have little sex appeal. But James understands the dynamics of risk. And bonds can help investors of all ages manage it. So I still think it's worthwhile to throw a bone to the staid investment class. After all, a diversified retirement portfolio is your No. 1 weapon against the market's twists and turns.
Do you necessarily need bonds to be diversified, especially if you're young? Financial folks have differing opinions.
But first, if you're like many investors, you probably need a quick definition. A bond is an IOU that a company, a government or other entity issues to an investor promising to return their money at a specified time, plus interest.
(The financial industry has cooked up a batch of more complicated securities, such as "collateralized debt obligations." These types of bonds are making headlines now because of the troubled subprime mortgage market. But that's another story.)
Compared with stocks, which have no guaranteed investment return, bonds are generally a conservative investment (although you can certainly lose money as a bondholder). And, because bonds are less risky than stocks, they return less, on average, over the long run.
That's where the debate about young investors owning bonds, sometimes referred to as fixed-income investments, comes in. Because young people have decades to work until they retire, can't they afford to be more aggressive with their portfolios? Put another way: Can they afford not to?
According to Ibbotson Associates, an asset allocation specialist, stocks have returned an average of about 10 percent over the past 80 years compared with about 5 percent for U.S. government bonds.
A common rule of thumb has been for investors to take their age and subtract it from 100 to determine the ratio of stocks and bonds in their portfolio. So a 25-year-old would have 25 percent bonds, 75 percent stocks.
But not everyone agrees.
"That's completely obsolete in my mind, because people are living longer," said Gregg Cummings, a certified financial planner with Smith Barney in St. Paul. "I don't think you should be in bonds until you're about 50 [years old]." He advises his younger clients to be "invested for growth," as long as they're comfortable.
Those who wish to diversify beyond a broad mix of stocks but are looking for more upside than what most bonds deliver might consider putting a small portfolio pie slice into a real estate investment trust or commodities instead of bonds, Cummings said. "Almost every client should have an 'other' [asset class]."
Across the river, James Bryan, president of Bluestone Wealth Strategies in Edina, advises even his most aggressive clients to have at least 10 percent of their portfolio in fixed income. Why? Because bonds and stocks respond differently to economic events, often moving in different directions.
Bonds are "nice to have in a bear market," he said. Investors may also underestimate their reaction to substantial dips in their portfolios. "Everyone can be a Vikings fan when they're 15-1," he said.
Bonds are typically less volatile than stocks and help smooth out any valleys caused by a stock market downturn. Not only that, but Bryan points out that, just because you're young doesn't mean you're comfortable with risk.
But being too conservative is also risky. Most experts agree that even the most financially conservative young people should have some stocks in their portfolios. Otherwise, there is the danger that your savings won't grow enough to beat inflation and fund a satisfying retirement.
Michael Atkin, Putnam Investments' managing director of core fixed-income, suggests that investors who have small portfolios should look for a well-diversified bond mutual fund that owns everything from mortgage-backed securities to high-quality corporate bonds.
That way, individuals don't have to be thinking about "is this the year for high-yield" bonds, Atkin said.
Cummings and Bryan both mentioned global bond funds, although those are scarce in most 401(k) plans.
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