Rethinking Bonds

"He behaved like an ostrich and put his head in the sand thereby exposing his thinking parts." - George Carman

Plenty of investors have portfolios with a large allocation to bonds.  It is the part of the portfolio that is considered safe and the base for creating a sustainable retirement.  With rates at historic lows the main issue with a bond portfolio is reinvestment risk.  This is the risk that some of your longer dated higher coupon bonds are maturing.  The proceeds, if they are reinvested into similar longer term bonds, yield next to nothing.  The reinvested dollars yield a very low amount creating havoc with a retiree's income.

In the modern world where financial companies are constantly trying to show the world that retirement is easy, millions of people are pouring billions of dollars into target dated funds,  The idea is a nice one (and I use nice in its true sense meaning a fair idea with limited merit) but the problem is that it automatically shifts the needle on allocations more heavily into bonds as you age.  This is creating a lower overall portfolio return and is not producing the desired returns impacting the ability to retire.

Rather than blindly following the herd pull your head out of the sand and survey the investment scene.  First thing to do in a low interest environment is to look for places where there is yield.  When you find it make sure that you are not accepting too much risk for the return.  As most high yielding (and I am thinking in the neighborhood of 6% and higher here) investments are fraught with danger there are limited opportunities in this market to find the safe haven required by your retirement funds.

Assuming that you are unable to find a safe investment yielding anything of significance the next thing to do is to invest in shorter term bonds.  I would not look out much further than two or three years.  I know that you will be giving up some yield as short term rates are lower than long term rates but the difference is marginal.  One or two percent difference will have a powerful impact on your portfolio over the long run due to the power of compounding however if rates start to rise then the drop in value of the long term bond would mean you are either stuck in that low interest investment or you have to take a far larger hit to your portfolio by selling the bond at a large loss.  This to me means that you should rather earn a lower rate for the short run in order to participate in a larger rate of return later in the cycle.

The last thing you can do is reduce your allocation to bonds and focus on other parts of the market that can provide the boost your portfolio needs.  One place to look is the stock market and this is touted by the "experts" as the only place to look but finding high yielding stocks is not easy and most of these stocks come with a double dose of risk; possibly cutting the dividend in poor times and/or falling precipitously from their current highs.  To me this risk is the same as the higher yielding high risk bond investments.  So you will have to look further afield to find returns and yields that match the requirements of your portfolio.  One of these places is the property market where there are some parts of the country that can produce relatively high returns on investment with the safety of a free and clear property.  Outside of this keeping this part of your portfolio secure while mitigating risk is becoming ever more difficult but one thing is for sure you will need to take some responsibility and control of your investments as we all know what happens when the blind lead the blind!