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Stocks vs Bonds for your Retirement PortfolioPosted by SEP-SOLO-IRA-401k-ROTH on: 2007-06-25 10:43:14 in category:
Retirement [ Print | Permalink / 0 Comment(s) ] Stocks are riskier than bond. You hear this all the time. It's true that there are some signficant differences between stocks and bond. A bond is set up like a loan to a business, but with stocks you actually own part of the business. The key advanatge to holding a bond is that up front you know the income you will be getting. You know the dividens you will receive and when you will receive it. As an example, if we assume you have a bond with a 5% yield, it would probably pay 2.5% twice a year. If you keep it until in matures, you will receive the face value of the bond as a final payment. You need to remember that holding to final maturity means keeping it for 20 to 30 years. Sometimes that's a problem. If you can't hold the bond to maturity you would have to sell it on the open bond market. There it will be be sold at prevailing market interest rates. If interest rates have gone up since you orginally purchased the bond, you will recieve less than face value of the bond from the buyer. You may also be holding a "callable" bond. With a callable bond, the issuing business has the ability to call, or cash out, your bond before it reaches its final maturity date. A company may want to do this if interest rates had fallen since the time they issued the bond. They could call their current bonds and then sell another bond that paid the lower prevailing market interest rate. So with bonds you know the cash flow, but with a stock it's much more uncertain. This is the basic reason that most people think stocks are riskier than bonds. With a stock, you can make significantly more money, and you can lose more money as well. But you will never see a bond to go up a factor of 10 in price, while holding stocks there is a good potential for large increases in price. Also, a stock may pay dividends for many years to come, while a bond has a final maturity date, after which it pays nothing. So holding bonds in a retirement portofolio can be a way to reduce the risk of your portfolio as you move into your retirement years. Building a "bond ladder", where you stagger the maturity date of the bonds that you are holding so that they mature in groups spaced over your retirment years is a great strategy to manage risk. There is one other significant thing to note. Many average investors won't hold individual bond issues in their investment portfolios. Most investors will tend to hold bond mutual funds for that part of their portfolio. It's critical to realize that bond funds act much differently than an individual bond will. The difference is great enough that if you are holding bond mutual funds you may find that the conventional wisdom that stocks are riskier than bonds may not be true... You can find out more about stocks vs bonds at http://fundztrader.com We also have tutorials about trading Fidelity mutual funds and other topics about mutual fund investing. |
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