Saving for Retirement? How to Know When It’s Time to Move Into Bonds

For years, investors have been advised to move a certain percentage of their assets away from stocks and into bonds as they age. The reason is easy to understand. After all, bonds are considered a safer asset, and younger investors have more time to recover if their stock-heavy portfolios dip in value.

Let’s see why this approach makes sense — and how it might apply to your own situation.

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Stocks vs. bonds

For decades, it was all about “age-based asset allocation.” Age-based asset allocation refers to shifting the mix of assets you hold as you age. The goal is to move away from the market’s volatility and into the relative safety of bonds. In fact, you’ve probably heard the formula: Subtract your age from 100, and that’s how much of your portfolio you should hold in stocks.

For example, a 40-year-old might allocate 60% of their portfolio to stocks and 40% to bonds. That was the old formula, though. Today, investors are told to subtract their age from 110 or 120 to determine how much they should keep in stock and how much should be dedicated to bonds. So, the same 40-year-old investor would hold 70% to 80% in stock.

The change in formula has to do with how much longer Americans are living today than when age-based asset allocation was first introduced. With stocks come greater risks but also greater financial reward, and the thinking is that stocks are more likely than bonds to help you meet your long-term financial goals.

However, these are in no way hard-and-fast rules. Instead, there are general guidelines that encourage you to consider your own asset allocation strategy. And if you look around, there are dozens of different suggested allocations. The goal is to determine what’s right for you.

Your allocation should be specific to you

If you were to discuss asset allocation with friends and family (and who doesn’t?), you’d likely find that theirs differs from yours. And that’s for good reason. Chances are that their situation is not a mirror image of yours. What they need at this point in their lives is quite different.

Here are three questions to answer as you consider when to move more of your investments into the relative safety of bonds.

1. How many years do I have before retirement?

If you have decades longer to work and you’re looking for growth, there’s little harm in sticking primarily with stocks. After all, your portfolio has time to recover from a recession, bear market, or whatever drop in the market it’s impacted by (and there will be drops in the market).

However, if you don’t plan to remain in the workplace long enough for your portfolio to recover from a severe drop in value, bonds are one of the best ways to preserve your capital. Bonds are also a great way to diversify and balance your portfolio.

2. What’s happening with the interest rate?

Bonds may be considered a safer investment than stocks, but that doesn’t mean they’re without risks. Bond values are impacted by several factors, including interest rates. Bond prices have an inverse relationship with interest rates. Existing bonds become less attractive (and less valuable) when rates rise because their fixed payments are lower than those paid by new bonds.

On the other hand, bond prices typically rise when interest rates drop. According to Fidelity, the best way to earn a high return from a bond or bond fund is to add them to your portfolio when interest rates are high but expected to come down. That way, you’re locked into earning a higher interest rate.

3. What’s going on with inflation?

Observing the current inflation rate is essential, but can be tricky. While you can guess what inflation may do over the next year or two, it’s impossible to know for sure. Still, it’s important to acknowledge that inflation erodes the purchasing power of the bond’s fixed interest payments and can significantly reduce your return. If you want to move into bonds slowly, regularly check the inflation rate to understand what your bonds are up against.

However, if you’re close to retirement, growth is likely to be less important than security, and even if your bonds don’t enjoy the same kind of growth your stocks do, it’s good to know your capital is being preserved.

It’s never a bad idea to meet with a financial or retirement advisor before deciding how much to move into bonds. Advisors look at hundreds of portfolios a year, and most have a strong sense of what has (and hasn’t) worked for others. You don’t have to take their advice if it’s not right for you, but it does give you a different perspective to consider.