Many investors who are young are tempted to look at throwing all of their holdings in the riskiest assets – stocks, commodities, etc. Bonds, which often melt into the background, are far less exciting than stocks, which may have the potential to double every few years. Still, bonds are a major part of mutual funds for a reason, and the security they provide isn’t just a way to round out an investment portfolio – it’s also for peace of mind.
First, there is no rule that says young investors must have bonds. This is even more true if they have low net worth versus the potential to earn a much higher income in subsequent years. Losses in the markets are easier to make up later in life with lower expenses or more income. However, the following reasons more than show why its wise to hold onto bonds.
The main purpose of bonds is to lend protection during major stock downturns. It’s a rare calamity for bonds to follow the stock market downwards. Holding limited amounts of bonds also makes one a real investor, one who balances their assets and hedges against poor performance in one type of investment. Owning bonds means you are weighing all your assumptions and are taking a truly calculated risk.
Since investors under 35 presumably have several decades until retirement, they can afford to take greater risks than older investors. Yet, keeping some bonds in a portfolio can actually outperform a 100% stock fund in certain cases.
For instance, let’s assume the market takes a temporary plunge halfway through the year, and then makes it up and more by the end of the year. During this period of downturn, bonds increase their return and also hold onto most of their gains. This scenario means that even a portfolio with just 10% in bonds would be just as good and less risky than a 100% stock strategy, and may even outperform it if bonds do significantly well.
In the end, the purpose of all investing is to grow your assets. This will provide for a more comfortable retirement by beating inflation, and adds net worth onto your savings. The only rare instance where it might be possible to operate without bonds is if you hold a significant number of assets by 35. Continuing to work and add onto this war chest means you can afford to take more risk, since it will be easier to absorb a serious blow by losing on stocks.
For most, though, this isn’t case. Moreover, young investors cannot predict the future with their own health, families, and careers. If you are forced to start selling investments to survive during an early phase of retirement or even before (in the event of some disaster like job loss), you may lose out if you’re selling during a market downturn.
Owning a decent portion of bonds can thwart this scenario, or at least ease the pain. Selling bonds in times of crisis is much better than stocks, since those depressed shares are likely to go up again if they are held long enough. Getting money for your bonds means you can keep the stock in the hopes it will rise once more.
Overall, it’s not mandatory for young investors to own bonds, but it is something they should consider. Bonds are excellent insurance against a volatile market. They may lack the excitement swirling around stocks, but this just as well. Think of bonds as dependable insurance, meant to help you sleep at night rather than provide cheap thrills.