When Is The Best Time To Buy Bonds?
When Is The Best Time To Buy Bonds?
If you’re looking at your investments, you may be asking two very important questions: When is the best time to buy bonds? Do they still have a place in an investment portfolio?
The best time to buy bonds depends on:
- how close to retirement you are
- how comfortable you are with the variability of certain investments
- when you’ll need to access the invested cash
Let’s dive in so you can make a more-informed decision.
Stocks vs. Bonds
Both stocks and bonds make up a portion of a diversified investment portfolio. Stocks carry more risk than bonds, but they can also offer a higher return while bonds carry less risk and less return. There’s no denying that the past volatility of the market has caused some apprehension around investing.
Market Crashes Make Investors Nervous
By the time the stock market crashed in late 2008, many investors saw their portfolio value drop – again.
They’d already suffered through a second brutal market meltdown after the dot-com implosion of 2001. This was an “all pain, no gain” situation for their current stock market investments. In addition to market crashes, a series of scandals (e.g. Bernard Madoff) caused over 85% of consumers to view the stock market as a rigged game.
For both these reasons, investors turned to bonds instead of stocks. These kinds of investments carry less risk and provide a steady (small) return.
More Stability Since 2009
Since 2009, individual investors have started to return to the stock market with renewed optimism. Billions of dollars started flowing back into mutual funds and index funds. It was again seen as the path to wealth and eventually a stable retirement plan.
Both stocks and bonds have their advantages, but you should buy bonds and stocks according to your overall long term strategy, and not the up and down of the market. That said, stocks are considered the ‘better’ investment when it comes to returns- let’s take a closer look at this.
Are Stocks Better Investments Than Bonds?
Despite the up and down of the market, one thing remains true: Investments in stocks tend to have a higher return than bonds over time.
On average, large stocks have returned 10% per year over time, with bonds returning about 6-7%. For people who are years away from retirement, this makes investing in stocks – even with such volatility – a better choice than bonds: Stocks simply offer the opportunity for greater returns than bonds, but also greater risk.
Does that mean that you should shift your assets out of bonds and into stocks? Yes – but not all of your assets.
3 Rules for Deciding When to Buy Bonds vs. Stocks
The following rules will help you make a decision of when to buy bonds, as well as how much of your portfolio should be allocated to bonds or stocks.
Rule 1: For High Returns, Choose Stocks Over Bonds
There’s a simple but powerful reason that most investors favor stocks over bonds: Every asset class delivers a long-term return that corresponds with the risk it carries.
For example, holding cash in a high-yield savings account carries little-to-no risk, but it also earns very little (about 1%). Bonds offer fairly tepid returns as well (but also very low risk). Stocks – which carry short-term risk because they move up and down with the market – tend to deliver better longer-term returns. Risk is tied to returns, and often they are relative to each other.
In an ongoing analysis conducted by New York University's Stern School of Business, $140 invested in stocks in 1928 would be worth $167,000 by the end of 2011. About $100 invested in Treasury Bonds would be worth just $6,700.
Of course, stocks badly lagged bond returns at various intervals throughout history (for example, in the 1930s and 1970s). These instances are rare, however, and for the most part, stocks have been the highest-returning asset class.
Although we don't know how stocks will fare over the next few years, we have a pretty good idea about bonds: With interest rates already at stunningly low levels, there isn't much room for rates to fall much lower. Bonds will have a predictable return, which makes them less risky, but stocks will have a higher return over time.
Rule 2: Buy Bonds According to Your Age
Rule 1 doesn't mean that you should shun bonds all together. Instead, you can use the "Method of 100," to determine how much of your portfolio should be composed of bonds.
Your base of assets (including stocks, bonds, home equity, and others) should represent a lower risk as you age. To determine when to buy bonds, simply subtract your age from 100 to figure out how much exposure you should have to the riskiest asset class – stocks.
For example, if you are 25 years old, you should have 75% of your assets in stocks. If you are 60 years old, then the percentage devoted to stocks should fall to 40%. The remainder should be tied up in bonds, along with your homeowner's equity.
Rule 3: You Can Buy Bonds to Store Excess Cash
The stock market is always capable of faltering in any given year, and – as many retirees saw in 2008 – nest eggs shrank at a time when funds were needed for everyday expenses.
Never put money into stocks that you may need in the next 1-2 years. Instead, consider using bonds to store cash that you’ll need in the next year or so.
Determine how much money you’d need to live on for a year if you lost your other sources of income. Keep that money out of stocks. Bonds are a perfectly good place to put excess cash. They carry much less risk and can be accessed quickly by cashing them out at financial institutions.
In a Nutshell: When Are Bonds a Good Investment?
Due to their lower risk, bonds are a good investment choice the closer you are to retirement age. Bonds are also a good place to keep an emergency fund if you don’t need immediate access (unless you experience a loss of income).
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