As investors near retirement, their advisors often recommend that they move a larger part of their investments from stocks to bonds and other fixed-return investments.
To some extent, this is an understandable strategy, since bonds provide steady income and a guarantee to repay the principal at maturity.
Stocks are bound to be more profitable for retirement investing than bonds
Bond prices will likely fall over the next few years as interest rates inevitably rise again. For example, governments injecting money into their economies could spur inflation. Higher inflation would likely prompt governments to raise rates.
That’s why we continue to recommend that you invest only a small part of your portfolio in bonds and fixed-income investments. Instead, focus your retirement investing on building a diversified portfolio of well-established companies with long histories of dividends. We recommend a number of these types of stocks in our Canadian Wealth Advisor newsletter.
We recommend this retirement investing approach because equities are bound to be more profitable than fixed-return investments over long periods. That’s because equity returns are related to business profits, while returns on fixed-return investments are related to business interest costs.
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A business’s profits must be higher than its interest costs in the long run. Otherwise, every business that owes money would go broke, and that’s not likely to happen. That’s why most investors should hold a large part of their money in stocks most of the time.
Returns on your stocks are sure to be more volatile than what you earn on fixed-return investments (that includes short-term bonds). That’s because returns on stocks are related to the part of gross profit that’s left over after a company pays its interest costs.
Bonds can provide stability — and a place to park your cash
Though fixed-return investments are less profitable than equity investments, they can help stabilize your portfolio’s value. They serve as reserves you can use to buy more stocks when prices are down. For that matter, when stock prices are down, you can use your reserves for personal spending to avoid having to sell at a low.
In the end, the right equities/fixed return split depends on your financial circumstances and your temperament. If you are older and planning your retirement investing strategy, you may want to hold some fixed-income investments. But with interest rates at current low levels, stick with government bonds that have terms of, say, two years or less.
Click above, or call 1-888-292-0296 to schedule your FREE consultation. *Past performance is no guarantee of future returns.
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