Bonds should be a part of every stock investors portfolio. They provide a counter to the volatility of the stock market and can be a source of income.
What percentage of your holdings should be in bonds? Generally, the closer you are to retirement, the greater percentage of your holdings should be in bonds.
The old rule was your age subtracted from 100 gave you the percentage of stocks you should own. For example, if you are 55, then 45 percent of your holding should be in bonds (100 - 55 = 45).
However, since people are living longer you may want to adjust that percentage based on your tolerance for risk.
An important issue to consider is whether to own bonds directly or indirectly through a mutual fund (or exchange traded fund).
Both methods have advantages and disadvantages. You may choose to own some bonds directly and others (such as bond index funds) indirectly.
Here are some factors to consider.
Owning bonds directly:
- You can buy Treasury bonds directly from the government, which lowers transaction costs.
- You can hold bonds until maturity or trade them on the open market before they mature.
- You pay no holding costs, but do pay commissions on bonds you buy through your broker.
- It is important to find a broker with experience in evaluating and finding bonds that fit your financial goals.
- Trading bonds (buying and selling on the open market before maturity) carries as much risk as trading stocks, however the bond market is not as transparent as the stock market.
Owning bonds indirectly:
- Mutual funds and exchange traded funds are managed by professionals who probably have more experience and access to more information than you do.
- Fund managers can buy and sell bonds as market circumstances dictate.
- Funds may trigger tax consequences as they buy and sell bonds.
- Funds charge fees, which will eat into your return.
- Funds that have performed well in the past may not do so in the future.
The bottom line is most investors will find benefits in both forms of ownership. For example, you may consider buying bonds directly and using the dividend (coupon) payments to supplement current income.
You may also want to invest in bond funds, especially index funds. These funds can evaluate and trade bonds in a manner that individuals will be hard-pressed to duplicate (what do you know about the foreign bond markets, for example).