Bonds aren’t for young people

Ramit Sethi · September 20th, 2006

Bonds aren't for young people
Seriously, they’re not. Read more at All about stocks and bonds.

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  1. Transcendental Success

    Bonds are wicked awesome. They are a stable income stream, plus the bonds themselves can change in value.

    The most conservative government bonds are the ones that pay a few percent, but corporate bonds are readily available for 7% coupon rates from chase and citicorp, and I even found one for over 12% from primus. Those are decent rates, far better than cash in the bank.

    The other trick is that bonds can be sold like a stock. This is fantastic if you buy a bond and then interest rates go down, all of a sudden you can sell your bond for more than you paid.

    Stock market is pure gambling. Most stocks don’t even pay a dividend. With a bond, at least you’re buying something real — the income stream.

    I’m not recommending bonds over stocks, but they are at least worth considering. If you’re into “diversification” like all the good portfolio theorists then bonds are a fantastic way to achieve that.

  2. Maybe I should rethink their place in my portfolio.

    I use a small position in a corporate bond ETF to balance out the stock ETFs, and also to get some nice gains in case interest rates are lowered.

  3. Common advice is to take 100 minus your age, and have that percentage in stocks.

    If you’re 25, invest 75% stocks and 25% bonds.

    Of course this all depends on your risk tolerance. Some people will never invest in anything riskier than CDs, and that’s fine if it’s all they can handle. At least they’re investing something which is better than what most people do.

    Another good “safe” investment is in yourself or in your home. Many people invest primarily in their own real estate.

  4. Bonds are the new stocks.

    What is more convential wisdom, than stocks outperforming bonds?

    Who holds the most bonds, elderly, back in the 70s who held the most equity, elderly.

    Why do they now hold bonds more than youth because they just might be wiser and more up on the long-term stock-bond tango?

    Read the Four Pillars of Investing, besides being a great investement tome by Bernstien, it’ll send shivers up our collective backs with regards to our faiths in equities (as now is a period of stability, and high prices, probably not a great time to buy…) I’ve recently converted from a 5 year love affair with equity to a new love affair with bonds…

    Okay, I’m still only going to be max at 35% in bonds…but that’s only because its so hard to leave the comfort of convention.

  5. I’ve heard from various sources that with today’s lifespan growing that we should subtract our age from 120 and that percentage should be in stocks.

    As far as bonds go, sure 12% is good … if the company doesn’t renig. Sure you can sell your bonds when the interest falls … if someone wants to buy it.


  6. Hey Geoff,

    What kind of bonds are you getting 35% in?

    Elderly hold the most equity because they’ve had the most time to save and invest.

  7. Bill Gross… enough said. He’s run circles around plenty of stock fund managers.

  8. Transcendental Success

    Bonds can also be free money. Individuals can borrow from the bank on their homes usually for less than the bond return. Investing home equity in stocks can be very risky, but far less so with a bond. Get a mortgage at 5%, buy bonds yielding 7 or 8 with the same maturity as the mortgage.

  9. MyNameIsMatt

    Bonds are bad for basically everyone (expect for special short term needs). Bond Funds, however, are great for basically everyone. How much of your portfolio you allocate to fixed income such as bond funds or equity such as index funds is all based on your risk tolerance. The younger you are, generally, the higher your risk tolerance and hence you will hold a smaller percent of fixed income (this is more than just bonds, but usually is a majority of bonds).

    There are no hard set rules on what allocation a person should have really, but almost no one can handle a pure equity portfolio. The volatility is just too great, and unless you’re trying to fooling yourself, don’t do it.

    Also, there are some advantages in holding bond funds as they are not correlated with movements (volatility) in equity, and this provides the benefit of greater diversity, lowering risk, while increasing the return on a portfolio. However, you need to be careful with what class of bonds you are buying because in the case that Transcendental brings up with corporate or high yield bonds that provide higher returns, they also act more like equity meaning that they’re creating a less diversified portfolio, and should almost be considered equity even though they are technically fixed income.

    I disagree that bonds are the “new stock”. Bond funds are simply being reconsidered (after being forgotten by Wall Street) as an essential part of a person’s portfolio. This has come to light at this time because of the large number of retirees coming up who are all really interested in fixed income providing regular income when they retire. However, that doesn’t mean that everyone should sell their equity for bonds. Still, bond funds are an essential part of a properly diversified asset allocated portfolio (even if you only hold 10% fixed income).

  10. Bill Gross? Isn’t that the guy who almost went bankrupt because of his overspending? I don’t want advice from him.

  11. kai chang

    Global declarations are great for aspiring gurus to shout from the mountaintops. “All X is bad. Never do Z. Always buy Y.”

    But on an individual basis, those ‘always’ and ‘never’ rules reveal their weaknesses. As mentioned by a commentor above, bonds are a negatively-correlated asset class to equity (stocks), which means that when the equity indexes decline, bond indexes tend to rise. According to Modern Portfolio Theory, there is an optimal blend of equity and bond exposure for each level of risk tolerance – and even very aggressive investors benefit from bond exposure by reducing the volatility for any given target expected return.

    The psychological element shouldn’t be ignored either; there are investment neophytes for whom the mental barrier of equity investment is too daunting to take on, and a bond portfolio allows them to get their feet wet and acclimate the, to the idea of taking risks to earn a better return.

    Finally, for young peeple in high-income tax brackets, the benefits of municipal securities (which are exempt from state and federal taxes) may make more sense than a straight corporate bond with a higher coupon.

    Of course, “You shouldn’t have too many bonds, but they are probably ok in some circumstances depending on your investment experience and tax bracket” is probably too wordy for a snazzy internet graphic. 😉

  12. Transcendental Success

    Bonds are what they are. If you are looking to gamble and the excitement of volatility, don’t go to bonds, or go to junkier bonds where the company may go under.
    I agree with some of the folks above — bond funds might be good because it is hard as an individual to build a good portfolio of bonds with various maturity dates. In general I hate managed mutual funds, but in this case they provide a service.

  13. Your contrarian assertions have all the ill-considered brashness of youth. This statement about bonds is remarkably debatable. So why take an extreme view? To shock readers? I regret that you haven’t taught me anything, so far as I remember, about being rich yet.

    Let’s say some joker’s in the 25% tax bracket, or higher. Treasury bills are tax free. Equities are speculative. Hey, how about that inverted yield curve! Time to jump into stocks now? WAKE UP, KID.

  14. I think the Bill Gross he’s talking about would be the great bond investor at PIMCO, not the Idealab Bill Gross that defaulted on a $50 million personal loan. This is from Wikipedia (William H. Gross) concerning the PIMCO Bill Gross – “According to Forbes in 2004, he is the 278th richest person in America, with a net worth of over $1 billion. His annual salary from PIMCO is $40 million.” He must be doing something right.

  15. Whoever said the stock market is pure gambling is incorrect. And unfortunately, I know a 27 year old woman who feels the same way and wants to stash all of her 401(k) money in “stable value” funds because she’s not a “gambler”. I hope she comes to her senses. I don’t think Warren Buffett has slapped together over half a decade of pure luck.

    • if your not greedy, bonds are great. i like bonds. my interst buys my stocks. no hurry, no panic.
      I like dividend payers too. I refuse to own any business that dostnt pay a dividend.

      so far, my stable value is beating the pants off the sp 500 as prices head into correction.
      I buy stocks when markets bear. At pe 20 today, dont expect good returns.
      Average is what, 15 ish… thats only the average pe.

      Though the market returns average is pretty good, the price you pay determines your
      rate of return with any business. today, the stock indexes arent cheap.

      Also, look at japan..

  16. Sorry, half a decade should say half a century, which is an even more remarkable streak.

  17. Hi Carlin,

    Thanks for the info about Bill Gross.

    I know what you mean about the stock market. My girlfriend is afraid to invest any money in it because her father lost some money due to some ill-advised advice. So now she wants to put everything away in measly 5% CDs. I guess that’s better than nothing, but she could do much better safely.

  18. Transcendental Success

    To Carlin: Stocks are not gambling to Warren Buffet, just like poker is not gambling to those guys at the WSOP final table. But to the rest of us stock picking is gambling. That’s why the sensible advice to the non-pro is buy-and-hold an index fund.

  19. Sort of on topic:

    Bonds are simple.

    The stock market is not.

    I already worked hard for my money, why should I have to work hard to invest it so it ‘works for me’ ? I have money and I dont’ want to *lose* it. I don’t want to have a second job of messing around with the stock market to maximize my capital gains and whatever people do when they actually know what they’re doing. I’m not a financial advisor, I’m a technical support rep and a software tester.

    I thikn that’s probably where the allure for things like bonds come in. They’re not risky, they take little effort.

  20. Index funds are pretty simple too, Hawk. If you have not looked into them I’d recommend it.

  21. TS: Your previous statement was that investing in the stock market is pure gambling, and that is what I was addressing. Because Warren Buffett is a better investor than the average person doesn’t make him lucky, which is what he would have to be if the stock market was like a slot machine. He proves that people can generate consistent returns by following an investing philosophy and doing research. If you don’t speculate in the stock market, then you aren’t gambling.

  22. finance girl

    Wow, that’s advice I would NOT give to anyone. Perhaps bonds should not make up over 20% of a young person’s asset mix, but they absolutely do have a place in a young person’s asset mix! Perhaps you instead are referring to “bonds don’t belong in a young person’s retirement account?” which makes more since but is still a fallacy imo.

  23. finance girl

    Wow, that’s advice I would NOT give to anyone. Perhaps bonds should not make up over 20% of a young person’s asset mix, but they absolutely do have a place in a young person’s asset mix! Perhaps you instead are referring to “bonds don’t belong in a young person’s retirement account?” which makes more since but is still a fallacy imo.

  24. I was going to make a point about the value of negatively correllated asset classes, but several people beat me to it.

    The second positive point about bonds is that over the next several decades they may outperform stocks. Most bonds are offering at least 5-7%. Many experts expect that over the next several decades stocks will return about 4-6%, far lower than they have over the last several decades. Growth consists of real growth (the rise of companies earnings and dividends), inflationary growth, and speculative growth (increase in the public’s desire to own stocks). In the long run, real annual growth in corporate EPS has averaged 1.5% to 2%. I have seen figures saying that dividends are abou 1.4% right now. So barring any speculative growth, stocks will provide a real (inflation-adjusted) return of about 3%. I do not believe there will be any speculative growth in the next several decades, and this is where most of the growth of the last few decades has come. With the growth of 401k and 403b accounts, more people are putting more money into stocks, and bidding up their prices (P/Es were at all-time highs a few years ago, and continue to be very high). With the retirement of the baby boomers, this flow of money will slow and then reverse. If anything, we may see a speculative decline! So it may be unrealistic to expect more than 4-6% from stocks over then next 20 years. At that level, bonds are quite competitive.

  25. Some experts say the stock market is only gonna average 6% and some others say we’re about to hit a big boom again.

    I’ll think long term and stick with index funds. I’m not in the business of guessing.

  26. Emil Elgaard

    I’d say bonds are okay. It depends on your temper. Although bonds are usually the saftest choice you can get in them in more or less speculative variations. Junkbonds/High Yields bonds are for example more speculative than bluechip stocks in my opinion.

    Bonds however are great if you have an amount of money you wont need for a couple of years, say 2-5. Generally you get more by putting them into stocks but if you really need to make sure that you have the money when you need it, bonds are they way to go. And I mean governmentbonds, not junkbonds.

  27. Sean Harnett

    Hey Ramit, have you read The Intelligent Investor? Warren Buffet has called it “by far the best book about investing ever written”. The book recommends approximately an equal split between stocks and bonds, for everybody. Not just old or rich people.

  28. Bonds are great outside of retirement accounts, especially for young people, as they will be needing that money for their downpayment on their new house.