Question: I’m approaching retirement age and wondering how much of my investment portfolio should be in bonds. I know about the “100-minus-your-age” rule, but is that a universal rule that everyone should follow? Answer: Often applied to retirement investing, the rule of 100 subtracts your age from 100 to give you the percentage of your portfolio to invest in stocks. The remaining percentage should be in bonds and other low-risk fixed-income investments.
As an advisor, I’ve seen situations where the rule of thumb didn’t apply, although capital preservation generally takes precedence over growth as people age. High-quality corporate bonds and Treasuries generate reliable income for retirees. Bonds also tend to have a low correlation to stocks, meaning they hold value in equity market declines.
But that’s not always true.
You might recall that in 2022, both stocks and bonds declined. The Bloomberg U.S. Aggregate Bond Index dropped 13%, one of its worst performances in decades. Meanwhile, the S&P 500 fell 19.4%.
Those simultaneous declines soured some investors on the benefits of fixed income. However, in the bigger picture, high-quality bonds have generated steady income over time while reducing overall portfolio risk.
[Should Retirees Still Plan for 95?]
Traditional vs. Modern Bond Strategies
The 100-minus-your-age rule probably made more sense when life expectancies were shorter. Today, though, a 65-year-old man can expect to live another 17 years, on average. That number is 19.7 years on average for women.
That means investors need to balance growth with capital preservation.
For some retirees in their 70s, a 50% allocation to stocks may be suitable. That’s especially true for retirees with income sources beyond their investment portfolios and Social Security.
For example, in my experience, private-sector pensions are pretty rare, even for many boomers.
The number of private-sector workers with pensions has dropped drastically since the 1980s. Many retirees today rely on Social Security and their retirement accounts, with the pension being only a long-ago dream.
That’s a big shift, and it means more people have to rethink their asset allocation to ensure they don’t outlive their money.
However, I’ve had many clients who worked for state government, where pensions were, in the past, fairly generous. For those clients, taking more investment risk wasn’t a deal-breaker. Some could tilt more toward stocks in their investment accounts, with the idea of growing account value to pass on to their heirs.
Bond Ladders and Buckets
Some retirees use bond ladders. This investment strategy entails buying bonds with different maturity dates, such as one, three, five or 10 years. As each bond matures, you reinvest the money into new bonds. This provides steady income, reduces risk and helps manage interest rate changes.
Another retirement investment management strategy is to use the bucket system.
This means keeping a separate stash for your short-term cash needs. You might hold these funds in a money market account, which is easy to access and pays some interest but nothing to get too excited about. The main attractions here are safety and liquidity.
Bonds would go into the intermediate bucket, earmarked for funds you’ll need in a few years. They still serve the purpose of providing stability and income, and perhaps even some capital appreciation that would be higher than cash.
The long-term bucket would then be invested in higher-risk assets like stocks. This allows stocks to appreciate while giving some breathing room for market fluctuations.
The chief advantage of the bucket strategy is that you won’t be drawing down from riskier assets, or even your income-producing assets, to pay for that new roof you know you’ll need in a year or two.
[READ: How to Build a CD Ladder for Retirement]
Factors Influencing Your Bond Allocation
Here are a few points to consider when evaluating how much of your portfolio to put into bonds.
— Age and time horizon: The longer you expect to live, the more growth you may need from stocks. A January report from T. Rowe Price suggests that retirees in their 60s could hold as much as 65% in stocks to avoid outliving their assets.
— Risk tolerance: If stock market swings make you uneasy, a higher bond allocation can provide peace of mind. But there’s also a risk in being too conservative, as you don’t want to limit your long-term returns and purchasing power.
— Market conditions: Bond prices are sensitive to interest rate changes. In 2022, bond yields spiked, making newly issued bonds more attractive. Meanwhile, existing bonds lost their value. Understanding how different bonds react to interest rates and other market dynamics pays off.
— Taxes: Interest from bonds is typically taxed at ordinary income rates. Don’t make the mistake of underestimating how much you’ll be spending on taxes in retirement. If you’re in a high tax bracket, consider municipal bonds, whose interest is often exempt from federal taxes and, in some cases, state taxes.
More from U.S. News
How to Manage an Inherited IRA
Here’s How Much Money You Could Lose if Social Security Goes Bankrupt
Ask a Financial Pro: How Much of My Retirement Should Be In Bonds? originally appeared on usnews.com
