Should Your Bonds Allocation Match Your Age?

Bond AllocationThis is a topic and a saying I have ignored in my investment strategy. It’s obvious when you look at my holdings that bonds are not matching my age. It’s very far from it. The only bonds I have are through an income mutual funds purchase in my defined contribution plan. It’s one of the 4 mutual funds I have in my defined contribution plan where I follow index investing. My ratio is mostly about stocks too with 70% in stocks between US and Canada. No international exposure as I rely on my conglomerates to give me international exposure. I don’t understand the social economic outside of North America to even bother.

Related: International Diversification Through Conglomerates

Should Your Bonds Allocation Match Your Age?

Many financial writers, book writers, and advisors recommend having an amount of bonds in your portfolio that matches your age. For example, if you are 25 years old, they say you should have 25% in bonds. If your age is 50, then you should have 50% in bonds. Unfortunately, in these days and age, I don’t believe in it. I respected it and believed it made sense but I never applied it and I am almost 40. It’s time I seriously decide what I am going to do about it. I just plainly feel that it’s too conservative and geared towards a portfolio that you plan to withdraw from. My dividend strategy is about not touching my principal portfolio and to rely on the income my portfolio generates. Stay with me while I go over my thoughts on the bonds and age matching topic.

Related: Dividend Investing Strategy

Just like My Own Advisor is rethinking his bond allocation, I too am defining what my bond allocation should be. There are a couple of reasons that I want to highlight for not following the bond saying.

  • First, I believe it is too conservative. The purpose of the strategy is to protect your portfolio from the major market swing when you are getting ready to need the money. It might just be the markets that we are in but I much prefer the performance of my conglomerate stocks from a yield perspective. The value might swing but the yields remained unchanged for the most part.
  • Second, life expectancy is much higher than when the saying was established. Actuaries screwed up estimating how long we will live for and admitted it. The life expectancy has not been adjusted properly over the past years and has caused major issues with pension funds as many are now underfunded.

What I like about the saying and portfolio rebalancing is that it provides a very easy way to buy low and sell high. To that extent, I believe you need to have a bond allocation so that you can shift money from one side to the other. After compound growth, I believe that portfolio rebalancing is the second most powerful investing concept as it allows you to simply sell high and buy low without being a stock picker. Don’t shift your bond allocation target because of how the markets are performing, you need to stick to your strategy as Couch Potato explains.

The New Bond Ratio Thought

Here is where I am at in terms of beliefs in the bonds matching your age strategy.

  • Do I believe in holding bonds? Yes
  • Do I believe in having an allocation matching your age? No
  • Do I believe in diversification? Yes
  • Do I believe in rebalancing? Yes

As you can see the age ratio is the only issue I have. I feel that I just lose too much in performance. It’s not like the other part of my portfolio is in high-risk stocks either. It’s actually quite conservative and boring (almost like watching paint dry).

  • Imagine you are 20, does holding 20% of your relatively small portfolio in bonds make sense? You have 30 to 50 years of compound growth ahead of you. I think your holding in bonds should be either 0% or 5%. Again, it doesn’t mean you should hold high-risk stock. You want a good diversification across sector and across equities (REITs, Common Stocks, Preferred Stocks, …).
  • Imagine you are 30, what should your bond allocation be? You still have 20 to 40 years now. That’s a very long time. You might be paying for a mortgage and kids so your hard earned money should work for you. I would say that maybe 10 or 15% in bonds is appropriate.

Bonds Ratio

There is no right or wrong bonds ratio in my opinion. As such, I have created a few scenarios above to help anyone with their decision. In my next reader portfolio review, I will be going over a portfolio of a couple in their 70’s retired since the early 30’s and their portfolio is much closer to the income bonds ratio than anything else.

Define Your Plan

What’s your strategy?

What is important is that you assess how bonds fits in your plan. Will you be earning a pension from a pension plan? Will you withdraw the money at a 4% rate? How will you retire is the big question. It’s pretty daunting when you are in your 20’s trying to assess. Usually, you can look at our parents and relative to get insight into their retirement cost and revenue stream. It’s really important that you do that to get some point of reference. Robb @ Boomer & Echo has a pension plan but because of uncertainties in the underfunded pension plans, he is planning on saving on top of his pension plan.

Related: How To Define Your Retirement Cost

Stick To Your Plan

It’s fine to make adjustments to your plan and refine it but don’t drastically flip it over. Just like I recommend doing a partial trade and sell (add to your positions slowly when appropriate and take profits when appropriate), you should only be doing small adjustments at a time. The plan and the ratios are what allows you to make objective non-emotional decisions.

My Bonds Strategy

My plan is to follow the income allocation strategy. It’s true that bonds can help you during a market crisis as it softens the blows. On the other hand, my dividend investing strategy to generate income has many indicators unique to dividends that I can rely on to see if my portfolio is affected negatively for income. Since I don’t plan to withdraw from my portfolio but rather use the income, the fluctuation in the value of the portfolio is not as much a risk compared with a reduction in income. It means I can ignore the market and focus on the income as I have been doing if you follow my Dividend Income.

  • No dividend increase – are the fundamentals affected by the company?
  • Dividend reduction – definitely an adjustment. I usually sell.
  • Dividend cut – probably overdue and the market condition force their hand. I usually sell.

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