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With the market at all-time highs, many investors are piling into stocks. While investing is good, many people put all their eggs in one basket with stocks, making themselves susceptible to risk if the stock market crashes.
This is where bonds save the day. Bonds allow you to meet short-term cash flow needs and provide fresh powder to invest in stocks when the market is on sale.
Key Takeaways
- Your time horizon should guide your bond allocation and comfort with risk.
- Bonds provide reliable cash flow, which can reduce stress when markets are volatile.
- Holding bonds allows you to buy stocks at discounted prices during downturns.
- With today’s higher interest rates, locking in longer-term bonds can help secure a steady income for years to come.
- A balanced mix of stocks and bonds helps protect both short- and long-term goals.
What I’m Telling My Clients
Understanding Bonds
When you buy a bond, you are lending money to an entity. You will be paid interest along the way and get your principal back on the maturity date. The beauty of individual bonds is that you know how much money you will make, and when you will receive that money. The downside? You won’t have the potential to make as much money as possible with stocks.
You can buy bonds individually or through bond mutual funds and exchange-traded funds. Like stocks, owning bonds in funds provides broad diversification and reduces the risk of losses from a company or municipality going belly-up.
Warning
Interest rates are steep right now. Locking in those high interest rates with longer-term bonds you can hold to maturity is a great way to keep more money rolling in once interest rates go back down.
How Much Should You Have in Bonds?
Your bond allocation depends on two factors: your cash flow needs and your comfort level with risk. If you will need money from your portfolio within the next decade, consider holding 40% to 60% in bonds or other forms of fixed income. If you don’t need your money anytime soon, consider 20% to 30%.
Important
Why hold bonds at all if stocks have much greater earning potential in the long term? The stock market crashes periodically, or as I like to say, “The stock market goes on sale!” A bond allocation gives you the cash to buy stocks when prices decrease during a market slump.
The Bottom Line
Bonds may not seem sexy or exciting, but they are essential to a well-rounded portfolio. They provide stability, predictable income, and the flexibility to take advantage of opportunities when markets dip. No matter your time horizon, keeping some allocation to bonds ensures you’re prepared for both your short-term and long-term financial goals.
