Bonds and Bear Stock Market

The old saying that “in foxholes there are no atheists” has a counterpart in the world of stock investors: “When the market tanks, everyone believes in bonds.” If you consider investing a war or battle, I guess this makes some sense. Investors who have lived through bulls and bears understand that balancing your stock investments with some exposure in bonds is a prudent practice. Under most market conditions, bonds will perform well when stocks are in a slump. The problem for many investors is that when equities are hot it is too tempting to dump or downsize your bond holding to free more capital for stocks.

Not a Perfect World for Stock Investors

In a perfect world, the investor would see a slump in equities coming and restore her percentage of bonds. Of course, very few investors have this insight or the discipline to keep their portfolio balanced between stocks and bonds. The more normal reaction is holding on the falling stocks and hoping they’ll bounce back soon. Sometimes they do, but when stocks continue to fall it grows small losses into large losses. At some point on the downward slope, stock investors either bail out or they grit their teeth and ride out bear market. It can take years to recover your losses after some bear markets. Other investors with low thresholds for risk, perhaps, keep the percentage of their portfolio in bonds high.

Cautious Stock Investors

These cautious investors may give up some growth with stocks during a bull market in exchange for more security when the market drops. What is the correct percentage of bonds? When should you buy bonds? Since you will often be unsuccessful in timing the market, your best course of action is to find a balance between stocks and bonds and stick with it no matter what the market does. A good place to start in determining the best stocks to bonds ratio is to use the simple formula that moves more of your investments into bonds as you get older. Most consider 100 minus your age a good percentage for stocks in your portfolio. For example if you are 55, your ratio would be 100 - 55 = 45 percent in stocks and 55 percent in bonds.

Starting Point

This starting point will put a smaller percentage of your assets in bonds if you are young, while raising that percentage as you age. You can adjust these percentages based on your risk tolerance. If you are comfortable with more risk, you can increase the stock proportion, while a more conservative investor might feel comfortable with a higher bond percentage. Whatever you decide, the key is to fix that percentage and stick with the formula. Once or twice a year look at how gains or losses have changed the ratio and rebalance your portfolio. This means selling stocks if they have gained more than bonds and investing the proceeds in bonds to maintain the appropriate ratio.

This requires discipline and fighting the urge to chase hot investments, but you can do it.

Source: http://stocks.about.com/od/investingstrategies/a/111808Ratio.htm

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