Bonds are debt instruments issued by companies or the government that pays a certain amount of interest, and the full principal amount at the maturity date. The interest rate for bonds depends on a variety of factors, such as the current market interest rates, the maturity date, and the creditworthiness of the issuer. In general, investing in bonds alone is not enough to help you meet all of your financial goals. However, fixed income securities can help you reduce risk and preserve your principal. This makes them especially handy when the stock market goes south.
Bond Prices and Interest Rates
Many investors think that the price of a bond stays constant, but this is not the case at all. Bond prices fluctuate more than most people realize.
- What makes the bond prices fluctuate? Interest rates. In general, when interest rates go up, bond prices fall; and when interest rates fall, bond prices rise.
- When is the best time to buy bonds? When interest rates rise, bond prices tend to fall, and the yield increases to match prevailing interest rates. This is usually an excellent time to buy, especially if you plan to hold them until they mature.
However, trying to time the bond market is about as futile as trying to time the stock market. Instead, you should determine how much risk you’re willing to tolerate and build an investment portfolio that matches your risk tolerance level. Hold more bonds if you are risk-averse, or if you are closer to retirement and can no longer afford the risk.
Rule of Thumb for Investing in Bonds
There’s a popular rule of thumb that states an investor should have a percentage of his portfolio that is equal to his age invested in bonds. For example, if the investor is 20 years old, then 20% of the portfolio should be in bonds. This is a bunch of baloney! The percentage of bonds in a portfolio has nothing to do with the age of the investor. As mentioned above, a portfolio’s bond allocation should be based on an individual’s risk tolerance level — not just the age alone.
Andy is a 30-something New Yorker who turned his financial life around. He took charge of his finances, got out of debt, and is now working his way toward financial success. He is the owner and publisher of WorkSaveLive.com.
The age to bonds ratio is somewhat outdated to say the least. Considering that most people are living longer and healthcare is so expensive, some financial planners suggest to use a number like 120 minus your current age to set your bond percentage allocation.
As far as best time to buy bonds, it’s certainly not now. The Treasury did another bond issue today that sold at 0.0001% or something extremely minuscule. Scary times.
Thanks for this great primer. I especially like the focus on risk tolerance. Investing is a personal thing, and you should make decisions based on what’s best for you — and what you can handle in terms of risk.
In my mind a bunch of different things matter when you allocate your investments to bonds and other investments. Risk tolerance is one of the most important factors, but so is the time left until you want to reap the benefits of your investments. As for bonds, a very important element of bond investing is the income you get from bonds. When that income turns very low (as interest rates go lower right now) I wonder how investors expect to tap into the income bonds are supposed to generate. If rates hit close to zero, it does not sound like… Read more »
@Matt SF — You’re right. The “120 – Age rule” is the updated version.
@Vilkri — Like Matt said…scary.
“120 -age rule.” so, if I’m twenty, I should be 100% in bonds, then, when I near retirement, my percentage of bonds should go down and down and down???? I don’t think so.
Can somebody quote this rule in a way that makes sense?
I want to buy some bonds for my Ira next year and wondered if I need to worry about interest rates when buying if I use a etf such as vangaurds BND to hold for 12 years.Thankyou for any advice.
Look at I bonds they are bonds that keep up with inflation. Currently 4.6% but changes rates every 6 months. Due to change again Nov.1st. Buy them at any bank at no cost. You will not be able to buy these at the banks after January 2012. They will then be available on line.