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Do Young Investors Need a Bond Allocation?

Although stocks should play the leading role, some allocation to bonds can be beneficial

Karen Wallace 25 July, 2016 | 0:08
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Q: If you have a very long time horizon, and won't need the money for 40 years, is there any point in diversifying into bonds or any other asset class that traditionally earns far less than equities? Is diversifying among different types of equities enough?

A: If you don't need the money for several decades, you are correct that you don't need to have a large allocation to fixed income. Because stocks, despite their volatility, are likely to outperform bonds over extended periods, the longer one's time horizon, the greater one's allocation to stocks should be.

But even if you have four decades until you retire, it never feels good to lose money. As Morningstar's director of personal finance Christine Benz explains, your risk capacity--how much risk you can tolerate given your time horizon--is often very different from your risk tolerance--essentially, your comfort level with short-term volatility. That's why a sliver of fixed income can be helpful, as just a tiny allocation to bonds can help tamp equity volatility in a portfolio without giving up too much upside.

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About Author

Karen Wallace  Karen Wallace, CFP® is Morningstar’s director of investor education.

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