Buying bonds can be an important part of an asset-allocation strategy that balances risk and reward. Asset allocation is all about diversification of investments, both within and among different asset classes. In short, it means not putting all of your eggs into one basket.
In putting together a diversified portfolio, you select a mix of stocks, bonds and cash so as to arrive at the risk-reward ratio that stands the best chance of reaching your investment objectives. In general, the longer you have to invest, the greater risk you can assume because you might have the opportunity to ride out short-term market losses in hopes of achieving greater long-term returns. But investing always involves some degree of risk—and risk comes in many flavors: inflation risk, liquidity risk, market risk and so forth. Remember that your risk analysis will always be unique to you. If you have limited assets or assets that you cannot or are not willing to lose, then you will want to think twice about the risks you take—especially risks that could result in your losing your principal or seeing the value of your investment eroded by inflation.
Here's an example of how portfolios might be allocated for investors who are willing to accept the risks of equities-based portfolios and who have differing investment horizons:
|20 – 30 years to retirement
|10 – 20 years to retirement
|5 years to retirement
|Retirement age and beyond
||30% or less
||40 – 80%
||20% or more
Generally speaking, the lower your tolerance for risk and the shorter your time horizon, the higher the percentage of your portfolio that you should keep in cash or short-term bonds. While bond values will fluctuate on the secondary market, in general (and with the exception of high-risk "junk" or emerging-market bonds) their upward and downward price swings will be narrower than those of stocks.
Of course, when you are planning to retire, how much income you'll need in retirement will be important in determining your asset mix, since the longer you plan to invest the money, the more risk you can afford to take. Here's a calculator that can help you determine your retirement income needs.
At least once a year, you should evaluate your portfolio with an eye to rebalancing your mix of stocks, bonds and cash to maintain the percentages you're comfortable with. For example, if bonds have dramatically outperformed stocks in recent years, you might want to rebalance your portfolio by moving some of your assets (or investing new money) into stocks.