When is it smart to invest in bonds or bond funds? When is it smart to buy stocks or stock funds? These are excellent questions which this post will help you answer.
Before we get started it’s important to have a basic understanding of how bonds and stocks work. Most people think that bonds are less volatile than stocks and that’s generally true. If all goes as planned, you buy the bond, collect the bi-annual interest and get your capital back when the bond matures. If you own a bond fund the manager buys the bonds, collects and distributes the interest and then re-invests capital as bonds mature.
Does this mean that bonds aren’t volatile? No. As interest rates change, bond values shift. Read this post for a thorough discussion of how this works. Also, if you buy bonds that have longer maturity or are lower quality, they might have even more volatility.
Stocks and stock funds also rise and fall. If the market as a whole is climbing, that will help individual stock prices rise. Also, if the company itself has some major positive development the price of that stock could go up.
Over time, stocks tend to do better than bonds (on average) but in any given year stocks can be much more volatile than bonds. At some point the market hits rough waters. When that happens less disciplined investors abandon their investment approach. That is often what’s behind the catastrophic losses that change lives in a negative way. Ugly.
This general discussion is great, but it still doesn’t answer the question………
Which is better for you – stocks or bonds?
I wish I had a one-size-fits-all answer but I don’t. From an academic standpoint investors have greater potential to make more money with stocks over long periods of time than they do with bonds. But people are emotional and we all need a little “sleep at night” security blanket.
Having all your money in stocks might look great on paper but it might blow you out of the water when things get rough. Investors need to balance their need to grow their assets with their need to feel comfortable and go the distance. This is where having a financial plan can really help.
What if you want income?
Some investors believe that the only way to generate income is by purchasing bonds or dividend paying stocks but that is far from the truth. Most of the clients I work with want income from their portfolios at some time or another and we explore quite a few different ways to achieve that goal.
One very attractive alternative is to use growth and balanced mutual funds to create monthly income. If you’d more information about that, let me know. But please understand that you don’t have to restrict your investment search to bonds just because you want a monthly income check. You have alternatives.
What if you are risk averse?
Once people retire or near retirement, portfolio safety takes on a whole new meaning. That nest egg has to last a lifetime. You can’t afford to take undue risk at that stage of the game.
I get that, but your portfolio also has to provide income and battle inflation at the same time. And it has to do these things for many years. Some people find that with the right portfolio mix, asset allocation and appropriate investment strategy, they can find a balance they are comfortable with and one which will provide the financial benefits they are looking for.
What is best for you? Stocks or bonds? Why?