Each week, one of ourinvesting experts answers a reader's
question in our the Q&A column at our sister site,
InvestingAnswers.com. It's all part of our mission to help
consumers build and protect their wealth through education. This
week's questionwill be answered byInvestment Analyst David
: When is the best time to buybonds ? And do they still have a
place in my portfolio? -- Tracy, Atlanta, Ga.
Tracy, by the time thestock market crashed in late 2008, many
investors had seen enough. Suffering through a second brutal market
meltdown in just one decade (after the dot-com implosion of 2001)
added up to all pain and nogain . And thanks to a series of
scandals related to Bernard Madoff and others, nearly 90% of
consumers have come to see the stock market as a rigged game
anyway... at least, according to this survey.
Yet despite their misgivings, individual investors are now
returning in droves to the stock market. Billions of dollars are
flowing back intoequity mutualfunds , thanks in large part to a
brightening outlook for the U.S.economy .
And the newfound ardor forstocks is coming at the direct expense
of bonds. In an era when interest rates are at generational lows,
stocks simplyoffer the chance of moreupside than bonds do.
Does thatmean that you should follow the crowd and shift your
assets out of bonds and into stocks? Yes, you should, unless you
are approaching retirement age.
Reason No. 1: Risk equals return
There's a simple, but powerful reason you should favor stocks over
bonds. Everyasset class delivers a long-term return that is
commensurate with the risk it represents. For example, holdingcash
in a checking account carries virtually no risk, but it earns
almost nothing. Bonds offer fairly tepid returns, but if they are
backed by ablue chip borrower like the U.S. government or
, then they are almost as safe as cash. Yet stocks, which clearly
carry short-term risk, tend to deliver superior longer-term
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 bonds at
various intervals, such as in the 1930s and 1970s; but for the most
part, stocks have been the winning asset class.
Although we don't know how stocks will fare during the next few
years, we have a pretty good idea about bonds: With interest rates
already at stunningly low levels, there isn't any room for rates to
fall much lower. Sobond funds (which rise in value as bond yields
fall) have no more room to rally. Moreover, you can find many
high-quality stocks that offer dividend yields that are twice as
high as current 10-year bond yields.
Reason No. 2: The rule of 100
But that doesn't mean that you should shun bonds. With the "Rule of
100," your base of assets (including stocks, bonds, home equity and
other assets) should represent lower risk as you age. 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, then 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.
Reason No. 3: Rainy-daymoney
Yet there is anotherfactor to consider when it comes to allocating
your funds among stocks and bonds. You should neverput money into
stocks that you may need to tap in the next year or two.
Simply put, the stock market is always capable of falling in value
in any given year, and as many retirees saw in 2008, their nest egg
shrank right at a time when they needed funds for everyday
As a rule of thumb, determine how much money you would need to
live on for the next year if you lost your other sources of income
-- and keep that money out of stocks. In this instance, bonds are a
perfectly good place to put your excess cash.
Bottom line , you want to look for bond yields that are
much more robust than the yields of dividends found on
Right now, the averagedividend yield in the S&P 500 is around
2%, roughly in line with theyield on the 10-YearTreasury bill . But
because stocks tend to appreciate at a faster pace than bonds, you
need to be compensated for the weakergains in bonds by securing
relatively higher yields.
Generally, a bond with yields in excess of 5% should be
relatively appealing when compared to stocks. And if yields
approach 7% or 8%, as was the case throughout much of the 1970s,
then bonds are the better deal -- hands down.
This article originally appeared on InvestingAnswers.com:
Ask The Expert: When Is The Best Time To Buy Bonds?
-- David Sterman
P.S. -- Have you heard about the $1.7 trillion "Dividend Vault?"
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David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.