Using age to determine the proportion of bonds in your portfolio is never a good strategy to follow, said Ted Bovard, managing director and principal at Fort Pitt Capital Group in Pittsburgh.
"Higher paying dividend stocks, convertibles and high yield bonds may be the only way to get yield," he said. "Younger folks may have to employ a policy of total return -- dividends and stock value increases -- to generate the cash flow they will need in their retirement."
Increasing the percentage of bonds in your portfolio can help investors balance their risk and avoid the volatility from the stock market, experts say.
Bonds add value to a portfolio by preserving your capital, said Abigail Gunderson, a client relationship manager at Tanglewood Wealth Management, a Houston investment management firm.
"Bonds tend to be more conservative and they hedge your portfolio from the volatility of equities," she said. "They are the part of your portfolio that provides income."
While bonds are not the most prudent choice for a younger investor, they are a good fit for people who are very averse to risk.
"A bond mutual fund can be the best choice instead of picking individual ones because they are liquid and be sold anytime," Gunderson said.
Gen-Xers and Millennials should invest now in individual bonds with varying maturities, said Bill DeShurko, a portfolio manager on Covestor, the online marketplace for investing with offices in Boston and London."
"Now is the time to ladder individual bonds," he said. "This way if rates do rise, you will get your investment back as bonds mature allowing you to dollar cost average into the stock market. Timing is everything in investing. Assuming those under 40 like to make money, bonds should always be a consideration."
Bonds have demonstrated better returns than the stock market in the past, DeShurko said. In 2002, Barclay's aggregate bond index returned 10.26%, while the S&P 500 lost 22.10%. In 2008, Barclay's bond index returned 5.24% while the S&P 500 declined by 37%. Even in 2011, Barclay's bond index rose by 7.84% while the S&P 500 eked out only a gain of 2.11%.
"The greatest bull market in history was from 1981 to 2000," he said. "An investor that bought 30-year U. S. Treasuries in 1981 and constantly maintained a 30-year maturity would have outperformed the S&P 500."
Charles Sizemore, a portfolio manager on Covestor, said bonds "are priced to deliver competitive returns."
"This is clearly not the case in today's market, but recall the late 1990s when stocks were extremely expensive and bonds offered a high yield," he said. "Buying bonds in 1998 made all the sense in the world for an investor at any age based on valuations."
Bonds can anchor and balance a portfolio as well as provide income even if interest rates rise.
"You are using them as part of an active rebalancing strategy or as a way to lower your portfolio's volatility," Sizemore said. "This is a more valid rationale in the current yield environment, but cash could just as easily be used for the same purpose."
To maximize the effects of compounding, investors need to "limit large downward swings in the value of their portfolio," said Don Garman, founder and chief investment officer of Mirador Capital Partners in Pleasanton, Calif.
"Gen-Xers and Millennials have one of the biggest assets in investing time," he said. "Compound returns over time are a powerful driver of wealth creation and savings. Bonds should be viewed as an important, low volatility component of the portfolio, particularly when compared to the volatility of most equities."
Investing in individual bonds will give a consumer better returns and determine the type of credit risk they are engaging in, Garman said.
"We believe strongly that tactical allocation in individual bonds is preferable over bond funds," he said. "Bond investors should consider building a bond ladder consisting of individual bonds because that enables younger investors to know exactly what credit quality risk they are taking, when they will receive income (coupon) and return of principle (maturity). Investing in a bond fund carries more risk because the investor loses control over these important factors."
--Written by Ellen Chang for MainStreet