There is a financial theory that states the percentage of bonds in your portfolio should correlate to your age. For example, if you are 66 years old, 66% of your portfolio should be invested in bonds.
We do not believe investors should follow this rule. A 66-year-old investor could easily live to 90 years old. This provides plenty of time for your investments to grow. Our general rule is to plan for liquidity needs no longer than 10 years out. If you need the money within 10 years, it should be in bonds. Any money not needed in the next 10 years should be invested in equities, providing time for the money to grow.
If a client needed money in five years, we would not buy anything more than a five-year bond. When investors move money into bonds beyond 10 years, they take on additional interest rate risk. For example, an investor needs the money in five years, but opts to buy a 30-year bond paying a better interest rate. The investor then plans to sell the bond in five years, before it matures. However, if interest rates rise, the value of the bond decreases. The investor may have to sell the bond for less than he paid for it.
With interest rates at historic lows, it is the worst time to be buying bonds. We generally try to wait for interest rates to rise before buying a bond. But recently, it has been difficult to find a 10-year bond paying the interest rates we seek. We often buy a short-term security with 10-year money to wait out a period of low interest rates. Short maturity bonds are not as likely to experience price deflation in rising rate environments as are longer term maturity bonds.
We suggest investors look at tax free bonds. In Georgia, if you buy a Georgia municipal bond, you do not pay any federal or state income tax on the bond cash flows. This can be even more beneficial in states where there are city and county taxes. Many tax exempt bonds are yielding the same as federal government bonds for the same quality rating after taxes.
Additionally, we prefer individual bonds to bond funds. If an investor were to buy a $1,000 10-year Treasury bond, in 10 years, he will get his $1,000 from the federal government. However in a bond fund, in 10 years, if interest rates were significantly higher, the value of the bonds in the bond fund decline, and the investor would likely lose principal. Bond funds also have management fees and often carry lower quality bonds in their portfolio.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
