I’m under 40 and avoiding bonds – am I missing out on a key investment strategy for my future?

There is a Wall Street saying that stocks are for people chasing wealth while bonds are for people trying to hold onto wealth. The types of risk involved and the structure of these different asset classes are a prime reason for the basis for this maxim.  

There is also a stereotype that holds that the young are prone to take more risks, whether it be due to naivete or hormones. Conversely, the notion that more risk averse and conservative investors are inevitably older is also a stereotype. Both stereotypes can be considered true in a majority of cases, but both have numerous exceptions. 

Bonds As A Safe Haven Alternative

Bonds are a facorite source of income for many retirees, but investors of all ages can appreciate the lower volatility and principal protection aspects of bonds when stock market volatility whipsaws them.

A young investor posted on Reddit asking why people other than pending retirees should be interested in investing in bonds. Unsurprisingly, he shares the same stereotyped concept about bonds, which is primarily for older people. However, some understanding of investing history might shed some light on the scope of bonds.

Bonds are, in essence, IOUs from the issuer, whether it be a sovereign government, a municipality, or a corporate entity. The coupon payments, which represent the yield on the debt, are in return for the bondholder taking the measured risk that the issuer will not default. As bonds are priced relative to interest rate benchmarks, such as the US 10 or 30-year bond, the level of volatility is considerably lower than that of the stock market. 

Bond holders also have a much higher position on recoupment than shareholders in the event a corporate issuer goes belly up.  While the odds of seeing significant capital gains on a bond are relatively small, the odds of losing a sizable portion of one’s initial investment is commensurately small. 

That said, bonds are not solely an older person’s game, despite persistent perceptions to the contrary. 

When Michael Milken revolutionized the leveraged buyout market by trading junk bonds at Drexel Burnham Lambert, he was just 30 years old. Among the companies that benefited from Milken’s strategies were:

• RJR Nabisco
• Revlon
• Mellon Bank
• Calvin Klein
• MCI Telecommunications
• Caesars World
• Bally’s Manufacturing
• Duracell

…. And many others. 

Not coincidentally, many FIRE (Financial Independence Retire Early) adherents who also have pensions might overlook a critical fact: on average, over 21% of pension funds are invested in bonds. While 45% is in equities for growth, pension funds invest a combined equivalent amount in bonds and real estate for both principal safety and reliable income. 

Some People Are Just Wired Differently

Young investors burned by stock market volatility may have fewer sleepless nights with even a small 10-20% bond allocation of their portfolio.

Respondents to the poster pointed out, practically unanimously, that the decision to allocate any aspect of a portfolio to bonds was almost entirely predicated on personal risk tolerance. For example:

• One respondent noted that quite a few young investors who were 100% in stocks had become paranoid of the recent market volatility, and their anxiety risked pulling the trigger on panic selling and locking in losses. 
• An observer mentioned that younger investors who were too young to experience or never read about the 1987 Black Monday market crash – where some investors lost over 50% of their wealth within hours – have been so accustomed to a bull market that even a larger than average correction gave them the jitters. 
• A somewhat older respondent referenced how those who took big losses in the stock market due to the dotcom bubble burst in the late 1990s took 7-8 years to get their money back – only to take another hit in the 2008 subprime mortgage banking meltdown.
• Citing how the S&P 500 had historically always outperformed the bond market in terms of Return On Investment for over the past decade and a half, the case for allocating 10-20% of a portfolio in bonds was focused more on emotionally preserving peace of mind and minimizing sleepless nights than on mathematical evidence of numerical superiority. 

Overall, the realization that not everyone can invest fearlessly and that risk tolerance is not necessarily quantified by age, but more on subjective psychology is where the case for bonds is made. Young people who prefer not to take the extreme risks of their peers have other options, and bonds can be a viable alternative, even on a partial basis, without a need to become a portfolio preponderance.