Some 10,000 Baby Boomers turn 65 each day. As Boomers approach retirement, they might consider shifting their investment focus from stocks to bonds.
Why? While stocks provide the best potential for long-term growth, they also pose a substantial risk of steep short-term declines. Historically bonds have offered less growth—5.4 percent annualized since 1926, compared to 9.9 percent for stocks1—but bonds have been less likely to post large, sudden losses. Another plus is that bonds can provide regular, predictable income payments.
These factors make bonds an attractive investment for those looking to potentially reduce portfolio risk. "Bonds are particularly appropriate for people headed for retirement," says Annette Thau, author of The Bond Book.
What is a bond?
A bond is a debt issued by a company or other institution. By purchasing one, the buyer is making a loan to the issuer. The issuer promises to pay back the bond's face value at its maturity date, but in the meantime, pays the purchaser interest.
These are common terms associated with bonds:
- Maturity date — The date the issuer promises to pay back investors.
- Face value — The amount the bond will pay when it reaches its maturity date.
- Interest rate — The percentage of the bond's face value that it pays in interest each year.
- Term — The amount of time until the bond reaches maturity.
Investing in bonds
Bonds can be purchased individually or as shares of a bond mutual fund. Many investors prefer mutual funds because they offer professional management and convenient, low-cost diversification.
Although bonds are generally more stable than stocks, they do carry certain risks:
- Interest rate risk. When the overall level of interest rates rises, the rates offered by new bonds rise too. Existing bonds' rates don't change, so they become less appealing to buyers, and their prices decline as a result. Interest rate risk tends to affect the value of bonds with longer terms more than those with shorter terms.
- Credit risk is the possibility that an issuer won't make payments on time. Different bonds pose different levels of this risk. For example, U.S. Treasury bonds have virtually no credit risk, while high-yield bonds issued by entities with poor credit ratings have relatively high credit risk. Bonds with greater credit risk generally offer higher interest rates.
A diverse portfolio with a variety of bond types and other investments may help manage these risks.