25 Mar Choosing bonds for your portfolio
Q. I know a portion of my portfolio should be in bonds. I’m 45 and I have a pretty high risk tolerance, so 90 percent of my investments are stock-based. How do I figure the right amount of bonds, and then, how do I decide what kinds of bonds I should buy?
A. That depends on many factors, and there is no right answer that would apply to all investors.
Part of your decision depends on your risk tolerance, and you said yours is pretty high.
When you look at risk tolerance, you should look from both a quantitative and qualitative perspective, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.
He said on the quantitative side, there’s enough data to suggest that asset allocation seems to work over time, and at the very least, provides the ability to compress volatility.
For example, Gobo said, over the past two years (2013–2014) the S&P 500 returned 32.4 percent and 13.7 percent, respectively. A typical asset allocation model of 60 percent stocks and 40 percent fixed income returned 15.0 percent and 5.2 percent for that same period.
“If we look at the last 10 years (2005–2014), however, the S&P returned an average of 7.7 percent while that same asset allocation portfolio returned 6.7 percent,” he said. “One may argue that the difference of 100 basis points was worth the risk, however, did your risk appetite allow you to absorb the drastic swings in portfolio value during that period? Keep in mind that your `stock-based’ portfolio may not have the same results as the S&P.”
Gobo said this where the qualitative analysis is important. Does your emotional fortitude allow you to hold and wait it out during a period when the portfolio could be down 20 to 30 percent?
“That being said, we tend to favor asset allocation models that are not single dimensional,” Gobo said. “The type of fixed income instruments you choose are dependent on a variety of factors, however, in your case, in order to mitigate the systematic risk of your equity portfolio, investment grade bonds may be more suited to you.”
Vince Pallitto, a certified financial planner and certified public accountant with Summit Asset Management in Florham Park, said general growth allocations have 80 percent in equities and 20 percent in fixed income investments.
He said we’re coming to the end of a bull market for bonds when interest rates fell from the high teens to under 1 percent.
“Interest rates have nowhere to go but up so long-term bond prices will fall,” he said. “I have my clients in total return or high yield bond funds and tell my clients that if interest rates rise, their total return may not be hurt as much as straight long-term bond funds.”
He said investor have a short memory, so he asks his clients how they would feel if their account value falls 25 percent less than where it is today.
“If the answer is not too good, then there is no harm taking stock market profits at these levels,” he said. “The upside potential is minimal compared to the downside risk.”
He said we’re six years into a bull market created by the Federal Reserve, and most bull markets do not last much longer than five or six years.
“Last, the markets rallied last week because the Federal Reserve said they may not raise interest rates as soon or as high as they thought because the economy is still struggling,” he said. “They also cited lowering their first quarter GDP estimate and yet the markets rallied. Be careful.”
You might want to consider working with a financial advisor who knows all the details of your situation before you make a move.
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This post first appeared in March 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.