I know next to nothing about bonds, but I think I need to buy some for diversification.  Right now, I have 100% stocks.  I'd like to go to 90/10.  I have an aggressive risk strategy, and I'm looking to retire in 20 years.

What are some important things I need to know about bonds in general and bond funds?

The most important thing to know is the difference between a bond and a bond trader.

Eventually, a bond will mature.

I'm not trying to be a smart ass, but why do you "need to buy some [bonds] for diversification"?

Now there's diversification for diversification's sake, but ask yourself:  what are you trying to achieve with your investments and specifically by adding bonds to your portfolio?

Bonds are interesting in that they are at the same time, the safest investment available and one of the riskiest investments available.

Why and why?  First, and we're taking U.S. government bonds here, when you buy the bond, you are guaranteed two things:  you will get your coupon payment and you will, at the end of the term of the bond, get your principle back...one way or another.

Why are they risky?  Because bonds are extremely sensitive to interest rates and between the time you buy the bond and the time that the bond matures, interest rates may vary wildly and so will the price/value of your bond.  If the price of your bond goes down, you don't have to sell it, but it would be rather stupid to hold a bond paying say 1% interest when you could buy one that pays 6%.

As an example, the yield on the 30 year is about 2.5%.  Do you think that between now and 2046 interest rates will be such that the US30Y yield will never be (much) more than 2.5%.  Doubtful.  In other words, right now bonds are really only good for one thing:  putting your money where it is safe and fairly liquid...since you won't be earning any interest on them (as stated, you'll actually be paying the government to hold your money for you rather than the other way around).

The important thing to remember is that bond prices are inverse to interest rates:  interest rates go down, bond values go up; interest rates go up, bond values go down.

Now, with interest rates near 0% (and real interest rates negative), which way do you think interest rates are most likely to go, up or down?

So does now seem like a good time to be buying bonds?

Bottom line is if your investment horizon is 20 years (as stated) ride with equities.  If sometime between now and 2036 interest rates go up to an "acceptable" level, then buy bonds.

Besides, as you get closer to living off of your investments you should gradually transfer a greater and greater % from equities to bonds* so that you are assured of having something to live off of and avoid a catastrophic drawdown.

* That is unless your stocks have done well enough that you can live off of the dividends in which case there's no need to transfer to bonds unless, as stated, interest rates are "acceptable" (i.e. significantly more than you can get from dividends).

Nice!

OK, enough bond humor, I will try and be serious from now on.

Bond prices move opposite (what the cool kids call inverse), to bond yields.  This is your biggest danger now, since yields are near the lowest most of us have ever seen.  Eventually, they will rise.

So, if you buy long term bonds, (think 30 year treasury bonds, for example), you will lose as interest rates rise.  I don't know when rates start to rise, (and neither does any one else).  It will happen, however.

US gov't treasury bonds are considered the safest, but actually junk bonds are safer, provided you are well diversified.  This statement is not 100% accurate, but will prove to be 95% accurate 98% of the time.  (sorry, I can't be serious all of the time, what with being in the middle of the Brexageddon).

Individual treasury bonds might be acceptable for the retail investor, but I would still recommend a fund.  For anything else, junk, corporate, whatever, I definitely recommend the retail investor stick to funds.

No bond funds or bond ETFs for me.  Buy at auction.  Hold to maturity.  My $0.02.  YMMV.

No offense taken.  I'm glad you're challenging my assumptions.  I thought altering my asset allocation to add some bonds would add some stability to my portfolio.  This seems congruent with conventional wisdom (e.g. 110 - years of age).  Compared to target funds, I think even a 90/10 asset allocation seems too stock-heavy for someone 20 years from retirement.  To be clear, I don't want to buy bonds; it just seems that I probably should.

Interestingly enough, I took a Vanguard questionnaire on asset allocation after starting this thread, and they recommend 100% stocks for me.



I was considering starting this gradual transfer now.

Humor is welcome.  I need to read some more on Investopedia before understanding the rest of your post.



AIn't nobody got time for that.  I like to buy and hold, which is why I am looking at funds.  If that doesn't work for bonds, I may never buy any.

EDV is one ETF I was looking at.  The performance doesn't seem horrible for a bond fund.

EDV is a good example of a fund that invests in long term treasury bonds.  

It will perform well in a declining interest rate environment.  It will also do very well on days like last Friday, when there is a rush to buy the "safe haven" kind of assets.

However, it will perform poorly in a rising rate environment.

Now, do rates go lower from here?  It is certainly possible, but no guarantees.

After WWII, rates rose until the early 80s, when they started declining.  So interest rates can trend in either direction for decades.

A mix of stocks & bonds will usually underperform an all stock portfolio, but will do so with much less volatility.

This is important to some people.  

Treasury bonds and the funds that invest in them have another advantage.  The interest they produce is only taxable at the federal level.  So, no state income tax.

Every little bit helps

There you go.

It depends on a couple of things, primarily your investment horizon (20 years in your case) and tolerance for risk.

It is also situationally dependent to a degree (i.e. where is the market and what are yields) but if you are not actually trying to live off of your fixed-income investments, there isn't a compelling reason for bonds, especially when (as stated) actual yields are negative.

Today you can invest in equities which easily have a 2-3% dividend yield and your only real risk in the long (20 year) term is that the company goes bankrupt.  Once bond yields are north of 5 or 6%, holding bonds starts to make sense but again, but would I buy 5% yield in a rising interest rate environment?  Granted, one can't tell where the tops and bottoms are, but with yields near zero I at least thought I knew where the bottom was; with the possibility (here and actuality in foreign bonds) of negative interest rates maybe we don't know where the bottom is.

But your theory is correct:  as you start to get closer to retirement/living off of your investments you should start increasing the % in bonds.  IMO with 20 years to go and rates near zero it's too soon to do so.

You may have heard the rule of thumb:  your age should be the % of bonds that you hold.  If you're 50, you should hold 50% bonds (and 50% equities) but as I've said, with yields near zero you'll be significantly reducing the overall return of your portfolio and while you still have 20 years to weather any significant drawdowns.

Most bond funds are going to buy and sell bonds inside the fund exposing you to the risk/opportunity of gain/loss on the principal.  If there is a fund or ETF out there that buys bonds at auction and holds them to maturity, I might be interested in that someday.

Check out Treasury Direct if you want to buy Treasuries direct from...wait for it...The Treasury at auction prices sans commissions .

Bond fund typically maintain a given maturity (1 yr, 5yrs, 10 yrs, etc.) by continuously replacing maturing bonds with bonds of like maturities.

One of the best strategies in a normal interest rate environment (which we are currently NOT in) is to get an "intermediate" (typically ~5 yrs) bond fund which will buy bonds at the "knee" (inflection point) of the yield curve, thus earning the highest yield with minimal risk.

The problem now is, the yield curve is essentially flat so that currently isn't a good strategy.

If you have to have bonds, go short term (or better yet an inverse.*) fund.



* Just kidding.  Inverse funds are not long term investments nor for inexperienced traders.

Thank you, gentlemen.  I'll hold off on buying for now.

Oh, yea:  did anyone mention this BRexit thing...which has hammered interest rates abroad and will probably result in no interest rate hikes here any time soon (some of the pundits are saying 2018)?

I like bond funds, I like the monthly divi,  I have intermediate Corp bond funds, high yield, and doubleline total return

Those are my best investments the past 2 years

Don't buy bonds. Interest rates are not going to give you the return you want given your situation. When you consider the time value of the money you invest in bonds, they will not perform as well as s blue chip stock paying a high dividend. Put your money in a low management fee, low expense ratio ETF or mutual fund, preferably an index fund. If you absolutely MUST add bonds to your portfolio, avoid the bond funds or ETFs. With these funds, there is no maturation. Do a little reading on bonds vs. bond funds. You will find what you are looking for.