Should Bonds Be a Part of Your Investment Portfolio?

by Hank

Should you invest in bonds? Well, it depends. Most members of the military are too young and too far away from actual, full retirement (Age 65) to benefit from investing in bonds and bond mutual funds. Bonds are safe investments that earn a low interest rate. Governments and large businesses issue bonds to fund a multitude of projects as diverse as new interstates to new corporate plants to make auto parts. Many times large institutions need more money than a bank can provide to them. So, they turn to investors and offer long term debt in the form of bonds. A bond is a loan and investors are the lender. The borrower agrees to pay the investor back a certain percentage over specific intervals just like you would pay a bank for your car loan. The problem for young investors arises from the fact that bond interest rates are too low to be useful to save if you are far away from retirement. You get more “bang for your buck” by investing in stocks and stock mutual funds. Most Servicemembers are so far away from retirement, they can weather any bumpy storm in the stock market like the one we are currently in now.

Investopedia explains the difference between stocks and bonds very well. “Bonds are debt, whereas stocks are equity. This is the important distinction between the two securities. By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government).”

The very first mutual fund that I invested in right out of college was a balance mutual fund. I did not realize just how much of the mutual fund was invested in bonds for several months. There was no reason for me in my 20’s to be invested in a mutual fund that had almost 40% of its assets in bonds. I transferred the money I had invested to a new mutual fund that is almost 100% invested in common stocks.

The federal government’s version of a 401-k retirement plan is the Thrift Savings Plan (TSP). And, the TSP offers five Lifecycle Funds, called L Funds, which are target date funds where a professional money manager adjusts the mix between stock and bond allocations inside the investment. The closer an investor in the L Funds gets to retirement, the asset allocation will automatically add more bonds to the investing mix making the portfolio more conservative to ensure capital security as you get closer to the target date of the fund. The problem for many young investors is that the L Funds are too conservative and have too much money invested in government bonds and cash equivalents. You can see the asset allocations for the five L Funds in the graph below.

 

The “F Fund” is a bond index fund and the “G Fund” invests in government Treasury Bills.

The rule of thumb for bonds is to subtract your age from 120 and that is the percentage of all your investments that should be invested in stocks. The remainder should be in bonds. For example, a Soldier who is 28 years-old should have no more than 8% of his or her investments in bonds or bond mutual funds (120-28=92% in stocks, 8% in bonds). A person who is 40 years-old should have not more than 20% of his portfolio invested in bonds.

The closer you are to retirement, the more conservative your investments should become. Bonds are a great addition to your portfolio if you are about to retire.

If you enjoyed this posting, you might also like these:
1. An Army Second Lieutenant (2LT) Will Earn Over $100,000 in 2032
2. How to Pick a Good Individual Stock to Buy? – Part 1
3. Certificates of Deposit (CDs) Are a Waste of Time!

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