As investors near retirement, their advisors often recommend that they move a larger part of their portfolios from stocks and mutual funds to bonds and other fixed-return investments.

To some extent, this is an understandable retirement investing strategy, since bonds provide steady income and a guarantee to repay the principal at maturity.

Bonds will lower the long-term returns that are key to successful retirement investing

Bond prices will likely fall over the next few years as interest rates inevitably rise again. Big government budget deficits could spur inflation and push up rates, for example.

That’s why we continue to recommend that you invest only a small part of your portfolio in bonds and fixed-income investments. Instead, you should aim for a diversified portfolio of well-established companies with long histories of dividends, or mutual funds that hold these stocks. We recommend a number of stocks and funds appropriate for retirement investing in our Canadian Wealth Advisor newsletter.

We recommend this retirement investing strategy 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, everybody who 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.

Bonds and other fixed-return investments can add stability

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.

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 Canadian T-bills with maturities of around three months.