In the realm of investing, no asset class has as great a chance of increasing your wealth over the long term as stocks. But reward comes with risk, and when you're nearing retirement, it's not a bad idea to shift gradually to a more conservative, value-preserving asset allocation -- one that features more bonds. But how should one do that?
In this segment from the Motley Fool Answers' January mailbag show, hosts Alison Southwick and Robert Brokamp -- and special guest Sean Gates, a financial planner with Motley Fool Wealth Management, a sister company of The Motley Fool -- dig into the bond world to help a 65-year-old listener decide how to deal with the non-stock section of his retirement portfolio.
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A full transcript follows the video.
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This video was recorded on Jan. 29, 2019.
Alison Southwick: All right, let's head to the first question. It's goes to Bro and comes from Jeff. "I am 65 years old and a little less than two years away from my planned retirement date."
Robert Brokamp: Congratulations!
Southwick: "Over the past two years I have been investing my sizable IRA into allocations close to those recommended in the RYR model portfolios for someone in retirement just to be conservative." Aw! They're listening to your advice in Rule Your Retirement.
Brokamp: I know. That's so great! And I'm sorry! No, just kidding!
Southwick: "As a Fool subscriber since the early 2000s, I'm pretty comfortable with buying and holding stocks for the long haul. I am not comfortable in the world of bonds and have only bought into bonds via the bond allocation recommended in Rule Your Retirement.
"About two months ago I sold all the bonds in the IRA to cash. I do get 1.9% on my cash in the IRA so I'm not too anxious to get my money back into bonds, but when should I be thinking about putting all that cash back into bonds? Is it better to be in bond funds or in actual bonds?" Bonds, bonds, bonds, bonds, bonds.
Brokamp: Bonds, bonds, bonds, bonds, bonds. So Jeff, thanks for subscribing to Rule Your Retirement! Of course...
Southwick: Keeping food on the Brokamp family table.
Brokamp: That's right! So the model portfolio for people in retirement is that classic split of 60% stocks, 40% bonds, although really the 40% is out of the stock market so it can be bonds. Could be cash. And particularly with what we call the "income cushion," which is three to five years' worth of portfolio-provided income that you're supposed to get from your portfolio, that's part of that 40%. That really should be safe and I'm perfectly fine with that being in cash.
Because, and we saw this last year, bonds do go down, particularly when interest rates go up. The Fed hiked rates four times last year. The prices of bonds dropped, but because of the interest they were essentially flat for the year, so they did underperform cash. Historically bonds outperform cash by about 2% a year. I'm cautiously optimistic that bonds will beat cash this upcoming year because the Fed is not going to raise rates four times.
But I'm only cautiously optimistic about that, because there could be a couple of rate hikes on the way, plus -- and we got a question about this, too, regarding something I had mentioned in a previous episode -- when you look at the bond market it is riskier, particularly the corporate bond market. Much more of the corporate bond market, now, is made up of debt that is just on the verge of falling into junk territory. The bottom line is I'm perfectly fine with you being in cash instead of bonds, certainly in the short term.
Over the long term I do expect bonds to outperform cash, but just by about 1%-2%. The riskier the make-up of your bonds, the more likely they actually will drop during the next recession. We saw corporate bonds drop during the last Great Recession. So if you want to play it safe, I'm fine with cash. If you're going to go into bonds, pay attention to the quality of the bonds and if you're going with a bond fund, you can look at that at Morningstar. Click on the portfolio tab and it will tell you what's in there.
The other question was whether individual bonds are safer. They provide more security, but they take more work. You can easily buy individual Treasuries straight from Uncle Sam at TreasuryDirect.gov.
Sean Gates is an employee of Motley Fool Wealth Management, a separate, sister company of The Motley Fool, LLC. The information provided is intended to be educational only, and should not be construed as individualized advice. For individualized advice, please consult a financial professional.
Alison Southwick has no position in any of the stocks mentioned. Robert Brokamp, CFP has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.