If you are building your investment portfolio, one of the most important things you need to decide early on is what percentage to allocate to certain asset classes. The most common asset classes, bonds, and stocks should have different weights on your portfolio depending on your goals and investment strategy.
In this guide, we will analyze how much of your portfolio should be in bonds and what factors you need to consider to make this decision. We will also analyze different strategies you can use when building your portfolio to balance it between bonds and stocks.
Should bonds be part of your portfolio?
You don’t have to invest in bonds to generate safe returns, and they should not be automatically included in every portfolio. To decide whether or not bonds should be part of your portfolio, there are 3 main factors you should consider before making that decision.
Every investor has a different risk tolerance and appetite. Since not all of us are the same, the idea of including bonds in a portfolio should be based on the risk level you can withstand and deal with.
Bonds tend to be safer, and they are also less volatile, but the returns they generate are, on average lower than stocks. If you are risk-averse, you should definitely consider investing a more significant percentage of your portfolio in bonds.
Your ability to deal with volatility and risk should also be a factor to consider. Some investors can see their portfolio decline 50% in value without affecting them. In contrast, others will not be able to sleep at night, knowing their holdings have momentarily lost 50% of their value.
Therefore if you cannot deal with volatility, it is always better to increase the percentage of bonds in your portfolio. Bonds are safer investments, and you will receive the principal at maturity. Therefore you can easily deal with the risk and volatility, knowing you will receive your initial investment back.
Your age should also be vital when deciding how much of your portfolio should be allocated to bonds. A younger individual in his 20s that is saving for retirement or has a long-term investment horizon can easily invest his whole portfolio in stocks.
For someone with 50 to 60 years old, closer to retirement age, when the returns generated are not as important as making sure that their portfolio doesn’t lose a lot of value, including bonds, becomes essential.
Generally speaking, the younger you are and the longer your investment horizon, the higher the percentage of your portfolio that should be in stocks relative to bonds. For someone under 40 investing for retirement, the best approach is to put all his money into stocks, whether they are individual stocks or index funds.
When do you need the money back?
Lastly, another factor that also should be considered is when you will need the money back, or essentially the investing period. If you are investing for the short term, you want to avoid taking on too much risk or approaching the end of your investment period and having a portfolio worth less than what you initially invested.
In this case, you want to increase the percentage of bonds in your portfolio to make sure you don’t end up with less money than you invested initially. If you are investing for a medium-term period, you will not a high percentage of bonds in your portfolio, and you can adjust it slightly based mostly on your age and your risk level.
Finally, for someone with a long-term investment horizon that is probably looking at an investment for retirement, you can exclude bonds from your portfolio and just stick with stocks. On average, stocks provide higher returns over the long run, and it will make more sense to only invest in stocks if your risk investment horizon is longer.
What percentage of your portfolio should bonds be?
Determining exactly what percentage of your portfolio should be in bonds will depend on the factors mentioned earlier and also on your investment strategy. There are a few portfolio investment strategies that define early on how much you should allocate to bonds in your portfolio.
100% Bond portfolio
If you are over a certain age, like 60 years old, one of the investment approaches you can take is to put all of your portfolios in bonds. This ensures that the risk and volatility in your portfolio are extremely low, and you protect your capital in case something goes wrong. This type of investing strategy is often used by highly risk-averse investors nearing their retirement age and who do not want to take additional risks.
The 60/40 portfolio is also another common investment strategy that dictates that you should allocate 60% of your portfolio to stocks and 40% to bonds. While this strategy has not worked very well in the past decade due to the extremely low-interest rates, which push bond yields lower, it is starting to become a valuable strategy after central banks worldwide started increasing rates.
This is a very safe way to build your portfolio, and it provides you with risk-adjusted returns for individuals with a medium risk tolerance. Since 60% of your portfolio is allocated to stocks, you are sure to get higher returns on more than half of your portfolio. In comparison, the 40% in bonds provides enough safety and prevents the portfolio from being too risky and volatile.
Bonds by age portfolio
Finally, another common portfolio investment strategy is allocating a percentage of your age to bonds. If you are 20 years old, you can allocate 20% of your portfolio to bonds and the remaining 80% to stocks. As you grow older, your risk tolerance becomes lower, and therefore every year, you should increase 1% of your portfolio allocation to bonds.
This strategy is extremely simple to follow and works exceptionally well to adjust the returns, risk, and volatility depending on your life stages. The only downside to this approach is that it works better if you are investing for the long run.
Using bonds in a stock portfolio
Even if you just invest in stocks, bonds have a place in your portfolio, and you should be investing in them. If your portfolio mostly stocks, you can still use bonds, especially for the excess liquidity. So if you keep a percentage of your portfolio in cash, you can instead invest in bonds that are sure to generate additional yield, and they won’t lose value if you want to buy stocks at some point.
Keeping cash in your portfolio without generating any returns is counterproductive, which is why bonds still have a place in your portfolio even if you do not invest directly in them.
Bonds are an essential asset class that has a place in pretty much every investment portfolio. Understanding how your risk tolerance, age, and investment horizon play a role in determining the percentage of bonds in your portfolio will help you build your portfolio in a way that reflects your investor profile and investment goals.