Bonds are debt securities that pay periodic interest and return principal at maturity. They provide portfolio stability and predictable income, often performing well when stocks decline. For retirees, bonds serve as the shock absorber that prevents forced selling of equities during market downturns.
Bonds (also called fixed income) are loans made by investors to governments or corporations. The issuer pays regular interest (the coupon) and returns the face value at maturity. In retirement portfolios, bonds play the essential role of reducing volatility, providing predictable income, and acting as a stabilizing counterweight to equities.
How It Works
Bond returns come from two sources:
- Coupon payments: Regular interest payments, typically semi-annual
- Price changes: Bond prices move inversely to interest rates — when rates rise, existing bond prices fall, and vice versa
Historical performance (U.S. investment-grade aggregate):
| Metric | Value |
|---|---|
| Average nominal return | ~5% |
| Average real return | ~2% |
| Standard deviation | ~6% |
| Worst single year | -13% (2022) |
| Best single year | +33% (1982) |
Key properties relevant to retirement:
- Low correlation with stocks: Bonds often rise when stocks fall, providing portfolio-level risk reduction
- Lower volatility: Roughly one-third the volatility of stocks
- Lower expected returns: Typically 3–5 percentage points below equities
- Income generation: Regular coupon payments can fund withdrawals without selling shares
Why It Matters for Retirement Planning
Bonds serve three critical functions in a retirement portfolio:
-
Volatility reduction: A 60/40 stock/bond portfolio has roughly 40% less volatility than a 100% stock portfolio, dramatically reducing drawdowns and sequence-of-returns risk
-
Withdrawal funding: During stock market downturns, retirees can take withdrawals from the bond allocation instead of selling equities at depressed prices — the core principle behind the bucket strategy
-
Psychological stability: A portfolio that drops 20% is much easier to hold than one that drops 40%, helping retirees avoid panic selling at the worst possible time
The trade-off is lower growth. An all-bond portfolio often fails to keep pace with inflation after accounting for withdrawals, leading to slow portfolio depletion over a long retirement. The right bond allocation balances stability against the need for growth.
A Practical Example
A retiree with $1,000,000 experiences a 2008-style stock market crash in the first year of retirement:
| Allocation | Stocks Return (-37%) | Bonds Return (+5%) | Portfolio Return | Portfolio After | $ Lost |
|---|---|---|---|---|---|
| 80/20 | -29.6% + 1.0% | = -28.6% | $714,000 | $286,000 | |
| 60/40 | -22.2% + 2.0% | = -20.2% | $798,000 | $202,000 | |
| 40/60 | -14.8% + 3.0% | = -11.8% | $882,000 | $118,000 |
The 60/40 retiree loses $84,000 less than the 80/20 retiree. After withdrawing $40,000 for living expenses, the 60/40 portfolio needs a 35% recovery to break even — achievable in 2–3 good years. The 80/20 portfolio needs a 48% recovery — a much steeper climb.
Frequently Asked Questions
- Why should retirees hold bonds if they have lower returns than stocks?
- Bonds reduce portfolio volatility and provide stability during stock market downturns. When stocks drop 30-40%, bonds typically hold steady or even gain value. This matters enormously for retirees making regular withdrawals — bonds prevent the need to sell stocks at depressed prices, reducing sequence-of-returns risk.
- How much of a retirement portfolio should be in bonds?
- A common guideline is 'your age minus 20' in bonds (e.g., 45% bonds at age 65). Most retirement portfolios hold 30-60% bonds depending on risk tolerance, other income sources, and retirement duration. Shorter retirements may benefit from higher bond allocations; longer retirements need more equity for growth.
- Do bonds lose money?
- Yes — bond prices fall when interest rates rise, and bond funds can experience negative returns in rising-rate environments (as seen in 2022 with -13% for aggregate bonds). However, individual bonds held to maturity return their face value. For retirement portfolios, bond funds provide better diversification and liquidity despite short-term price fluctuations.