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Do you own too many bonds?
If you are retired, or near retirement, the question probably sounds crazy. After all, aren't you supposed to have most of your money in bonds? Aren't they the "safe" investment for those who can't take on too much risk?
Such is the conventional wisdom, after all. One popular rule of thumb says you should have the same percentage of your portfolio in bonds as your age -- 60 percent at 60, and so on. Many portfolio advisers follow variations of this. So do so-called target-date funds, which automatically shift your portfolio toward bonds as you grow older.
Investors -- including tens of millions of baby boomers now slouching toward their golden years -- have taken the advice to heart. Over the past four years, they've poured more than $800 billion into mutual funds that invest in bonds, according to the Investment Company Institute, while yanking more than $250 billion from those that invest in stocks. And they've done well, especially recently, as bonds have boomed.
But is the conventional wisdom right? My concerns stem from two sources. The first is a point already well-established: Anyone buying bonds at recent prices is getting what looks like a pretty lousy deal, thanks to piddling interest rates. The yield on 10-year Treasury bonds recently fell below 2 percent. Corporate-bond yields have also collapsed.
And overall, these "own more bonds" rules of thumb seem to ignore the price you pay for investments. Bond prices right now are extremely high, and any sustained uptick in inflation will crush them; this is exactly what happened in the 1970s. Today, even inflation-protected Treasury bonds -- once among my favorite investments, especially for retirees -- look dangerous: The long-term bonds offer meager returns, by historical standards, while the short-term bonds effectively guarantee a loss of purchasing power.
But there is another problem with bonds that concerns me. To put it simply, if you are like most people, you already own a ton of bonds -- or bond-like investments, at least -- that you don't even think about.
Those investments? Social Security and your home. Many people, when they retire, put these mentally to one side, ignoring them as they focus on how much extra income they want.
Okay. Fair enough. But Social Security will pay you a guaranteed inflation-adjusted income stream for life, after you retire. That's the equivalent of owning an inflation-adjusted immediate annuity or, if you like, a huge portfolio of inflation-adjusted bonds. After all, if you didn't have that income stream, you'd have to buy an annuity, or pile up bonds, to replicate it.
How much is it worth? The average Social Security payment is about $14,000 a year. I asked New York Life how much someone age 66 would have to pay for an immediate annuity that would pay that much per year, plus an annual inflation bump (the insurer offers annual increases of up to 3 percent). The answer: About $280,000. That's roughly 20 times the annual payment -- a useful formula in the current interest-rate environment (since interest rates affect the amount annuities pay).
And then there's your home. If you own it and you've paid off the mortgage, that's the equivalent of holding an ultrasafe annuity that pays your rent each year. How much is that worth? Forget the market value of your property; the economic value to you is how much you would have to hold in bonds, or an annuity, to provide the same benefit.
That's quite a sum. Let's say that if you had to rent your home, it would cost you $20,000 a year to live there. And let's say that right now it's only costing you $8,000 a year, in taxes, maintenance, insurance, fees and so forth. The difference, $12,000 a year, is the economic benefit you enjoy by owning your home instead of renting it.
Someone in his mid-60s would have to own bonds or an annuity of about 20 times that figure, or around $240,000, to produce the same income. (And that may be understating the matter. Your annuity would have to cover the tax on any income as well as your rent.)
Bottom line? Many retirees, and most middle-class ones, already hold the equivalent of hundreds of thousands of dollars of their portfolio in investments akin to ultrasafe bonds. They just don't realize it. And then they are rushing to put 60 to 70 percent of everything else they own in bonds as well.
A number of portfolio advisers told me that they have to do things this way. Aunt Sally just can't handle stock market volatility. Alas, bonds may be offering Sally a false sense of security. I wonder how many bond investors are chasing performance. And how many realize that bonds are like seesaws: If the yields go up, the prices will come back down.
Finally, consider this: Today many blue-chip stocks offer higher yields than you'd get on good-quality bonds. But if you are afraid to own stocks and really want to focus on bonds, at least make sure you look at your entire portfolio, including your hidden bond holdings, first.
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