Yes, it’s true that stocks outperform bonds, but that doesn’t mean you shouldn’t have bonds as a part of your portfolio. Bonds help to hedge your investments and bring higher yields in the future. It’s no secret that diversification is essential for a strong investment portfolio. A good portfolio is going to have bonds, stocks, and cash in varying percentages. These percentages will depend on your individual circumstances and objectives.
All investments are connected to you income needs and your tolerance for risk.
What is great about bonds is that they pay out semiannually and that can offer you an income stream that you can count on. Having future income that you can depend on is just one of the reasons that bonds should be a part of your portfolio.
Too many investors think that bonds are only for the people who are too afraid of risk, and worse, that they are missing the boat on better investments. I say otherwise…
Great stocks are going to outperform a bond, that’s just that way it works. But stocks are volatile. The numbers connected to stocks are going to rise and fall. Yes, overall, stocks do better than bonds, but that doesn’t mean that all stocks perform better than bonds individually. Plus, the fact that stocks perform better than bonds now doesn’t mean that is going to continue to be the case.
When the stock market experiences severe and significant crashes this can be really damaging to an investor’s portfolio, but stock crashes don’t affect bonds.
When the stock market is performing and gaining people are happy to play the market, ignoring bonds, but when the market falls those same investors start looking longingly at the bonds that they thought were too beneath them before the crash. The recent investment markets have caused people to lose over half of their investments, some even saw losses of up to 75 percent. It’s no wonder those investors wished they had had some of their money in the security of bonds.
The most important thing that you need to remember when it comes to investments, retirement, your portfolio, and your money is that you are in it for the long term. And when it comes to stocks there are no long term guarantees
Just keep in mind that bonds don’t come with guarantees either, but their potential for losses is much lower than with stocks. This also means that their potential for gains is lower. So adding bonds into your portfolio is going to make any highs and lows less of a spike in both directions.
Here are a few things to keep in mind when you start to look at bonds.
When interest rates start to go down, the interest rates for bonds rise. But holding onto that bond investment until its due date will get you back the face value of that investment and whatever interest is due at that time.
Don’t think that investing all of your money in bonds is a good idea, because it isn’t. Diversification is the name of the game. Don’t put all of your eggs in one basket, especially a basket that won’t bring you a big return.
There are tax exempt bonds. These are municipal bonds that yield less than taxable bonds will, but if you are concerned about your taxable income, this might be a good option.
Bonds are a great way to get some steady income coming into your portfolio. If you want some of that security in your money, look at short and medium term bonds rather than long term.
Bonds are the second safest investment, right behind cash. If you want to set some money aside for emergencies, keep that money in cash. For money that you will want to use in the medium-term, bonds can be your reserve that still gives a reasonable return.
There are also many different kinds of bonds and they all have their own special advantages. It’s good to have a clear idea of these differences before putting your money into any of them.
U.S. Treasuries – These are the most secure of all the bonds available. Plus, the interest is exempt from state and local taxes, but not from the federal taxes. They offer a low yield, but that is because of the low risk. There are several different forms of U.S. Treasury bonds. These are known as:
- Treasury Notes
- Treasury Bonds
- Zero-Coupon Bonds
- Inflation-Indexed Treasuries
Mortgage Securities – These are connected to mortgage loans that have been issues by specific government agencies. The interest is taxable. They require a higher investment minimum and are considered more volatile, especially with the recent crash of the housing market.
Corporate Bonds – These bonds are connected to specific companies that offer them and the value of these bonds is related to the value of the credit of that company.
Municipal Bonds – Also called munis, these investments are issued by either state or local governments. The interest is exempt from most taxes, including federal. They have lower yields, but great tax advantages.
Guest Post from Kolton Green at Financial Money Tips, A personal finance blog intended to help you and ourselves to increase financial knowledge.
Kurt Fischer says
“Great stocks are going to outperform a bond, that’s just that way it works.” Really? I’d suggest this statement should conclude ‘that’s just the way it has worked.’ If I knew for a fact that one asset class “is going to outperform” another, why would I invest in anything else? We diversify precisely because we can’t predict the future, no?
Kolton @FMT says
You’re right, your assessment on that statement holds truth but I will say that history repeats itself. And just because a particular asset class out performs bonds, does not mean that particular stock, or say mutual fund will out perform the bond. And yes, that is precisely why we diversify.
Jai Catalano says
I think diversification is key and no one thing will be too sure for too long. All I know is that this time once the shoe shine guy starts buying I am running from the market. 🙂
Julie @ Freedom 48 says
High grade bonds are a huge appeal to us. They’re an excellent balance between security and risk. However, we do invest in stocks as well – but it’s nice to diversify.
Bonds have outperformed stocks over the last 10 years. Also don’t forget about high yield bonds, they have outperformed the stock market over the last 20 years with much less risk. Check out this post about the Fidelity High Income Fund.
Cherleen @ Barbara Friedberg Personal Finance says
I agree. I believe that we should not “put all our eggs in one basket”. There should be diversity of investments. Although we only have our personal savings and stocks for our investments at the moment, we are also looking forward to putting some of our savings on bond certificates. Still saving up for it.
Robert @ The College Investor says
Bonds are important, but don’t put too much in them right now. As rates rise over the next few years, longer term bonds and bond funds will lose a lot of value. Stick with shorter term bonds to be safe.
I agree that bonds are an important part of an investors portfolio. My only concern is that so many investors flooded into bonds as a safe haven from the stock market. Once they see stocks rising and become comfortable, many are going to start moving back to equities. This will have downward pressure on bonds. I’m not in the camp that there is a bond bubble, but I do feel that they are overpriced. I just hope investors realize that you can lose money in bonds.
Brent Pittman says
I bonds and TIPS might be the way to go for a few years, but hey that’s just a hunch that inflation is coming.
You may be right here Brent, have a the same feeling.