One personal finance question asked widely online recently was: “Should I put my 401(k) in bonds?”
Well, some — but not the whole enchilada.
If you’re a young investor, and even if you’re anxious about the effects of the coronavirus pandemic, most of your 401(k) should be invested in stocks, with a smaller share in bond funds — mutual funds or exchange-traded funds that invest in a mix of bond types. That’s because while stock prices have more ups and downs, they generally have a bigger payoff over time and are your best tool for saving what you need for retirement. You hold stocks for growth, and bonds for relative stability.
When you buy a stock, you purchase a share of ownership in a company. Bonds are different; they are a type of debt. Think of it this way: When you buy a bond, you are lending money to the company or government that issued the bond. In exchange, the borrower pays you interest on a regular basis. If you keep the bond until it “matures” — in six months, or 10 years, or 30 years — you get your investment back. Because most bonds pay a predictable fixed interest rate, they’re generally considered a more stable investment.
But they’re not risk free, partly because of gyrations in market interest rates. The value of a bond generally depends on prevailing interest rates. When market interest rates fall, the prices of bonds typically rise, and the opposite is true, too. It’s like a seesaw. Sophisticated investors buy and sell bonds in response to changing interest rates, rather than holding them to maturity.
When the stock market plunges, as it did this week, big investors load up on trustworthy U.S. Treasury bonds, to wait out the turmoil in a relatively safe haven. That pushes up bond prices and drives down returns, or “yields” in bond speak. Spooked investors this week put so much money into 10-year Treasury bonds that yields fell to historic lows.
So right now, financial advisers say, many bonds are quite expensive. “Bonds had a nice rally, but it’s not a time to buy them,” said Elissa Buie, a financial planner with Yeske Buie in San Francisco. If you moved all your holdings out of stocks and into bond funds now, you would most likely be selling (stocks) low and buying (bonds) high.
Don’t do it.
The best approach is to choose a mix of stocks, bonds and cash that you’re comfortable with. There are various rules of thumb for how much to keep in each basket. One holds that you should “hold your age” in bonds, meaning if you are 25, you should hold 25 percent of your investments in bonds and cash. Other guidelines suggest even lower bond holdings, especially if you are in your 20s or 30s. Another suggests a 50-50 split of stocks and bonds for any investor expecting to live at least 15 more years. It all depends on how much risk you can tolerate.
If you don’t want to keep track of the relative holdings yourself, consider a target-date retirement fund, which shifts the assortment automatically according to when you expect to retire.