As they come closer to retirement, some investors decide that they are too old to assume any investment risk. That attitude is often abetted by advisors who 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.

On the other hand, bond prices will likely fall over the next few years as interest rates inevitably rise again. For example, governments have injected a lot of money into their economies and this 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 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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Bonds can play useful role in stabilizing portfolio’s value

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.

Though fixed-return investments are less profitable than equity investments, short-term issues (with maturities below two years, say) 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 your shares at a low price.

In the end, the right split between equities and fixed returns 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.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

What is your approach to bonds and other fixed-income investments in this era of low interest rates? Has your attitude changed from the time when rates were higher? Let us know what you think.