Investing: Get the right mix of bonds
Retirees could once generate enough income from safe-haven bond investments to cover living expenses. But those days are long gone, thanks to years of low interest rates.
In a changing market, it’s time to remember why we hold bonds. Some bonds provide a counterbalance to stocks by holding steady when stock prices plummet. Others act as safety nets, preserving money you need shortly. Some debt still generates decent income, while other bonds hedge against inflation.
No single type of bond, or bond fund, can fill all these roles. By understanding what your portfolio needs and choosing funds best suited for those needs, you can build a bond portfolio that’s right for you.
Set priorities
“In a low-rate, low-inflation environment, how you use bonds and which types of bonds you use have to change,” says Ekta Patel, a director at Altfest Personal Wealth Management.
A lot depends, too, on your age or time horizon. If you’re younger and holding 80% of your portfolio in stocks, stick with high-quality debt that zigs when stocks zag. Older investors with 80% in bonds and 20% in stocks might skew a portion of their fixed-income portfolio toward securities that can generate measurable income, even if it entails a bit of risk.
Diversify from stocks
When stock prices fall, the bonds you hold as ballast should rise in value, or at least stay steady. Classic holdings in this category are U.S. Treasuries and other government-backed debt, such as agency mortgage-backed securities. High-quality corporate debt — issued by firms with credit ratings of triple-A to triple-B — can play a role, too.
Bonds to avoid: High-yield corporate debt (IOUs issued by companies with credit ratings from double-B down to single-C), bank loans, emerging-markets bonds and preferred stocks. The prices of these securities tend to move in step with stocks, which is counter to the objective.
Generate income
Reset your expectations for how much income your bonds can generate. Prior to the financial crisis of 2007–09, for instance, 10-year Treasuries yielded nearly 5%.
“To earn that today, you’d have to put all of your portfolio in high-yield bonds,” says Gene Tannuzzo, deputy global head of fixed income at Columbia Threadneedle Investments. And that is too risky.
That said, with a careful blend of bond funds, you can eke out a yield of 2% to 3% with only a bit of risk.
Lean on high-quality, investmentgrade corporate bonds — those rated between triple-A and triple-B — which currently yield 1.40% to 2.29%. That sounds low, but it’s better than what you’ll earn on cash.
High-yield debt, in small doses, can also spice up your income exposure.
Preserve capital
To avoid the loss of money you’re going to need within three years or so, high-quality short-term bond funds are the best bets. Risk of default is negligible. These funds are also less interest-rate sensitive, which can provide a hedge against rising rates.
Hedge against inflation
Treasury inflation-protected securities, or TIPS, act as an insurance policy against rising prices. They pay a fixed coupon rate on top of principal that is adjusted for inflation, and they come with the full faith and credit of the U.S. government. You can buy TIPS directly from Uncle Sam at www.treasurydirect.gov.