may not make sense now that rates have risen from the March 2020 lows. Remember, the principal value of your bond decreases when interest rates rise. But what people could be missing in today’s upside-down environment is the role that bonds should or should play in a portfolio. Security, not income According to Larry Swedroe, co-author of Your Complete Guide to a Successful Retirement and director of research at Buckingham Strategic Wealth, the primary function of fixed income in your portfolio should be security, not profitability, not income, not the cash. flow. In other words, if all else goes bad, if stocks crash, bonds are there to provide security for capital, at least at maturity. Also, the bonds are there for diversification purposes. Bond prices should go up when they are in value when other assets, for example stocks, are going down in value, and vice versa. “Rule # 1 that every investor must adhere to is that you want to ensure that your portfolio has a sufficient amount of secure fixed income to reduce the overall portfolio risk to an acceptable level,” he said. “Because if you don’t, and the stocks fall, which they tend to do once every 10, 15 years or so, 40, 50% or whatever, then you’re going to exceed your tolerance for risk.” At best, he said, he won’t be able to sleep, enjoy his life, and everything else. And in the worst case scenario, you will be involved in the worst thing you could do: panic and sell. “And once you sell … I think you’re virtually doomed unless you’re lucky.” Simply put, Swedroe: “You must have enough safe bonds.” Now, how much you should invest in bonds, stocks and cash is, according to Sébastien Page, author of Beyond Diversification and director of global multiasset at T. Rowe Price, “is without a doubt the most important portfolio-building
decision a investor. “How much to invest in bonds? According to Swedroe, how much you should invest in fixed income depends on your ability to take risks. And your ability to take risks is determined by four factors: your investment horizon, the stability of your earned income, your The need for liquidity and the options that can be exercised if a plan B is necessary. In addition, Swedroe said that owning bonds whose maturity is beyond your investment horizon assumes more risk than is inappropriate. investment (years) Maximum capital allocation (%) 0-3 0 4 10 4 20 6 30 7 40 8-9 50 10 60 11 70 12-15 80 16-19 90 20+ 100 Source: Your Complete Guide to a Successful and Secure Retirement Like Swedroe, Page also believes that the decision depends in part on human capital, the present value of his future salary income. And once a person’s human capital is taken into account, which according to Page acts more like a bonus that as an acc Ion, the answer is a balanced portfolio with a healthy allocation to stocks, not bonds. To be fair, the allocation to bonds is not static throughout the life cycle in the Page or Swedroe model portfolios. For example, in Page’s model portfolios, you would allocate 15% to bonds in the 20 years before retirement, 45% in retirement, and 69% in about 20 years after retirement, which is close to the Rule of thumb that would have subtracted your age from 120 to determine how much to invest in stocks and how much 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 Objectives Investing in the right bonds is just as important as investing in bonds, said Massi De Santis, a certified financial planner at DESMO Wealth Advisors. According to De Santis, the right bonds help you avoid unnecessary risk and get the most out of your portfolio, especially in a low interest rate environment. What are the right bonuses? That depends on your investment objective. For growth portfolios, De Santis recommends that the bond component be diversified across the entire bond universe, including government, government agency, investment grade corporate, and global bonds. The duration should be in the intermediate range (around 5-7 years). Vanguard Total Bond Market Index Fund ETF US: BND, SPDR Bloomberg Barclays International Treasury Bond ETF US: BWX and iShares Core US Aggregate Bond US: AGG are ETFs that would work for this purpose. For conservative portfolios, De Santis recommends highly rated short-to-intermediate bond durations that are similar to the target horizon. IShares US 0-3 Month Treasury Bond: SGOV, SPDR Bloomberg Barclays 1-3 Month T-Bill ETF US: BIL; Vanguard Short-Term Treasury Index Fund US: VGSH, Vanguard Short-Term Bond Index Fund US: BSV; iShares Core 1-5 Year USD Bond ETF US: ISTB, and iShares 1-3 Year International Treasury Bond ETF US: SHG are ETFs that would work for this purpose. And for income-focused portfolios, De Santis recommends investment-grade, inflation-protected, government corporate bonds, where the target duration is average maturity. The iShares TIPS Bond ETF US: TIP and the Vanguard Long-Term Bond Index Fund ETF US: BLV are examples of ETFs that would work for this purpose.