Retirees often include bonds in their retirement portfolio because of their perceived safety and the consistent income they provide. However, while bonds play a valuable role in a retiree’s portfolio, understand how they work before getting involved.

Holding bonds may reduce potential growth

If your goal is to leave an inheritance to your children when you pass away, bonds could significantly reduce the amount you will be able to leave. Since 1926, bonds have earned an average return of 5.4% a year, compared to the average return of 10.1% for the stock market. Naturally, past performance is no guarantee of future returns.

Bonds do play a valuable role in retirement portfolios, but overloading on bonds can lessen your portfolio’s overall performance. Keeping some of your money in stocks may increase your returns, and allow for greater overall growth (and risk).

What role can bonds play in a retirement portfolio?

One of the biggest risks that retirees face is sequence of returns risk, which means that if they suffer a few bad losses in the beginning of their retirement, they might not be able to make it up. A significant drop in the value of your investments in the few years post-retirement can irreparably harm your plans as you draw down your portfolio while the value of your investments bottoms out. In the worst scenarios, you may have to lower your lifestyle, return to work, or run out of money.

Increasing your bond holdings as you approach retirement and in the few years after you retire can reduce the sequence of returns risk that you face since bonds tend to be more steady than stocks.

Bonds can also provide a steady income in retirement. You can generally rely on their regular and predictable payments to pay your expenses while hoping the stock portion of your portfolio will produce growth. How you allocate your funds will depend on your income needs and goals.

To help decide if bonds are right for your retirement portfolio, read my blog piece on the topic here.