Does a 40% Bond Allocation Make Sense in Today’s Portfolios?

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Whether you’re the kind of investor who meets regularly with an adviser or the set-it-and-forget-it type who rarely looks at your 401(k), there’s a good chance your portfolio is set up with something close to a 60/40 mix of stocks and bonds.

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That asset allocation — with approximately 60% of an investor’s money in stocks and 40% in bonds — has been the traditional model for decades. It’s based on the conventional wisdom that the “safer” bond allocation will offset the risk of investing in equities, allowing investors to maintain a reasonably healthy balance in their portfolio whether the stock market is flourishing or floundering. Bonds have long been viewed as a good alternative for moderate and conservative investors who like the stability and income potential they offer.

But in recent years, the 60/40 model hasn’t held up so well for many. That’s partly because the stock market is changing, and more overall diversification in a global economy has become a must for investors. But it’s also because the interest rates on bonds — especially government-backed bonds — have been sitting at such extremely low levels. (As I’m writing this, the rate for a 10-year U.S. Treasury bond is an abysmal 0.69%.)

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And if interest rates go up? Well, that might be a good thing for future bond purchases. But if new bonds are paying a higher interest rate than the fixed rate on the bonds you’re holding, those older bonds could drop significantly in value.

So, if the bonds in your portfolio are earning next to nothing with low interest rates, and they could lose value if interest rates go up, does it make sense to have such a high allocation to bonds anymore?

For a lot of folks, the simple answer is no — and it’s probably time to take that allocation down a notch. OK … a few notches. There can still be a place for bonds in some portfolios to hedge against market loss, but the reliance on bonds to exclusively protect investors from downside risk may not be the smartest approach. It’s the high percentage so many investors have allocated to bonds — the 40% that’s supposed to make everything OK — that needs another look.

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Consider target date funds. Many do-it-yourself investors casually select an investment based on a retirement year. Here is the formula: The sooner the target date, the higher the bond allocation. For young investors starting out, target date funds can be a fine way to begin investing. But for more mature investors, there are often better ways.

What other options are there? Where can you allocate a portion of your money for the potential for reasonable growth?

There are a number of insurance and investment vehicles out there that might make sense for your portfolio, including:

Fixed or index annuities

Annuities are insurance products designed to participate in market growth while simultaneously protecting against market downturns. They are the only option here not subject to the whims of the markets.

Fixed annuities: This type of annuity pays a stated, guaranteed fixed interest rate, which is declared by the insurance company at issue.
Fixed index annuities: This type of annuity comes with higher growth potential. These products offer interest potential based on external market indices without ever being invested in the market itself. Each year, the insurance company calculates interest based on the movement of the index. If the index is up, you can earn interest tied to it, subject to limits established by the company. But if the index goes down, your money is protected against loss. By protecting the downside in bear markets and allowing for growth in bull markets, fixed index annuities can provide an opportunity for long-term growth and stability.

One thing to keep in mind with annuities is they can have restrictions on the amount available to withdraw each year (typically 10% of the account value or less per year), so they are more appropriate for long-term goals. These types of annuities can also help retirees create a steady flow of income — something that’s becoming increasingly valuable as more employers abandon their defined benefit plans.

Preferred stocks

Preferred stocks are traded on exchanges like common stocks, but they provide reliable income payments that are more like bonds. (Bonds make regular interest payments, while preferred stocks pay fixed dividends.) Preferreds typically carry more risk than bonds when the market goes down, but they’re generally considered less vulnerable to volatility than common stocks. And preferreds tend to have a higher yield than bonds.

If you haven’t heard of them, it’s likely because they aren’t as well promoted as common stocks and bonds, but they’re a worthy option to consider.

Convertible Bonds

Convertible bonds are technically a bond, but they can also increase further in value with the stock market because they can be converted into stock. Their risk profile falls between a stock and a bond, and their value can be influenced by both the stock and the bond market. So, if bond values are falling due to rising interest rates, convertibles can be supported by a rising stock market. If stocks are falling, the bond component can provide a potential buffer against loss to the convertible bond.

Precious metals

A lot of people are talking about gold these days, because gold tends to do well in low interest rate environments and when economic conditions worsen. Recently, both stocks and gold have been increasing simultaneously, but gold also tends to increase when the economy is in downturn, and thus stocks are declining. Due to this inverse relationship, gold can be a good tool to buffer against stock market declines. (On the flip side, when the stock market is doing well, gold may underperform.)

Furthermore, with the government printing so much money these days, adding to the country’s overall debt burden, gold has become more valuable due to the increased money supply. With gold’s supply relatively constant, but with an ever-increasing number of dollars in circulation, gold has the potential to increase in value based on the increasing supply of dollars. And it doesn’t look as though we can anticipate government spending to diminish anytime soon, in my opinion.

But gold has its downsides, too — including that it doesn’t pay out any interest or dividends.

As with any financial decision, it helps to do your research and to talk to a financial adviser who has a fiduciary duty and is legally obligated to put a client’s best interests ahead of their own. If you already have an adviser, and that person is a big fan of the old-school 60/40 portfolio, ask why that mix is right specifically for you and your goals. If you can’t get a good answer, it may be time for a second opinion — and an updated financial plan.

Kim Franke-Folstad contributed to this article.

Disclaimer

Appearances on Kiplinger.com were obtained through a paid PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

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Disclaimer

The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Kurt Fillmore is founder and president of Wealth Trac Financial, an independent financial services firm based in Bingham Farms, Michigan, specializing in customized wealth management and retirement planning. He is an Investment Adviser Representative and licensed insurance professional.