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Two of the loudest voices in money just gave you opposite advice about bonds.
On a recent episode of “Mad Money,” Jim Cramer said, “Only in your 40s do I want to introduce bonds to your portfolio.” (1) Earlier this month, Dave Ramsey went further, telling retirees that “conventional wisdom isn’t wise” when it comes to holding bonds at all. (2)
Ramsey’s case rests on inflation. “If you don’t make 4.2% on your money, the inflation rate, you are going backward in real purchasing power,” he said. (3) But the latest government numbers put inflation at 3.4%, not 4.2%. (4) And the core rate (without food and energy) is even lower: 2.4% for August.
Meanwhile, the 10-year Treasury now yields more than 5%. (5)
I know bonds from the inside. I was a Wall Street investment advisor in the early 80s and sold them for a living, back when a Treasury bond paid about 15% and the prime rate peaked at 21.5%.
I’ve spent roughly 45 years investing my own money since.
So who’s right? Both, as it turns out, but only for certain people. And if you’re over 55, following the wrong one could cost you plenty.
1. Cramer is mostly right about young savers
If you’re 30, a stock market crash is a sale, not a catastrophe. You’ve got decades of paychecks ahead to keep buying and wait out the recovery.
Cramer’s point is that you need growth, and lots of it. He even wants people under 30 to take “tons of risk, maybe more than you think you can handle.” (1) I’d tone down the “tons,” but the direction is right.
His long-term-care argument is sound too: owning bonds for 20 extra years can leave you short when a big bill finally arrives. (1) Growth early is what pays for care late.
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2. Ramsey’s inflation math doesn’t add up
The Bureau of Labor Statistics says consumer prices rose 3.4% over the 12 months ending in August. (4) Strip out food and energy, and it’s 2.4%. (4) Neither figure is 4.2%.
Ramsey also said taxpayers need “a little over 6% just to break even.” (3) Let’s check that. Say you’re in the 22% federal bracket. To keep 3.4% after tax, you need to earn about 4.4%, not 6%.
That matters, because a bond paying 5% clears that bar with room to spare.
3. Retirees can’t wait out a crash the way a 30-year-old can
Here’s where Ramsey’s advice gets dangerous. When you’re living off your investments, the order of your returns matters as much as the average. Planners call it sequence-of-returns risk. (6)
The problem is simple. If stocks drop right as you retire and you have to sell them to pay the bills, those losses become permanent. The shares you sold never get to bounce back. (6)
I was a stockbroker during the 1987 crash, and I watched people panic-sell at the bottom. Retirees who had no choice but to sell had it worst.
Look at 2008. The S&P 500 lost 38.5% that year. (7) It didn’t close above its 2007 record until March 2013. (8) Imagine selling stocks to cover groceries for five straight years of that.
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4. How I think about it: a bucket, not a bet
Ramsey is right that you need stocks in retirement. A 65-year-old could easily live another 25 years, and bonds alone won’t keep pace over that stretch.
But you also need money so you’ll never be forced to sell at a loss. That’s the idea behind the bucket approach. (6)
The first bucket holds a few years of withdrawals in cash, CDs or short-term bonds. Kiplinger suggests at least one to two years of cash. (6) The rest stays invested for growth.
When stocks fall, you spend from the safe bucket and leave your stocks alone. When they recover, you refill it. That’s insurance.
5. Bonds finally pay you again
When I sold bonds, 15% Treasuries were real. For most of the last 15 years, yields were so low that holding bonds felt like a slow leak.
That’s changed. The 10-year Treasury yielded 5.18% on Sept. 24. (5) Inflation-protected Treasuries were recently paying a real yield of about 2.43% above inflation. (2)
In other words, the safe part of your money can now actually beat inflation. Dumping bonds entirely means walking away from that.
6. Bonds aren’t your only source of steady income
If you’re like me and own mostly stocks, it’s still worth thinking about income that doesn’t depend on share prices. Dividends are one route. Rental income is another.
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7. Don’t make this call based on a TV clip
Cramer and Ramsey are talking to millions of people at once. Your mix of stocks, bonds and cash depends on your age, your income, your taxes and how much you’ll need to withdraw.
That’s why a second set of expert eyes comes in handy, especially as you approach retirement. Consider talking to a fiduciary financial advisor. SmartAsset, for example, matches you, free, with up to three fiduciary advisors who are legally required to put your interests first. Have $100K+ in investments? Get matched free in minutes.
The bottom line
Cramer’s advice fits the young. If retirement is decades away, lean into stocks and don’t lose sleep over a crash.
Ramsey’s advice is backward for the people he’s aiming it at. Retirees don’t lose money because they own a few bonds. They lose it because a crash forces them to sell stocks at the worst possible time.
I sold bonds when they paid 15%, and I’ve owned stocks through every kind of market since. The lesson hasn’t changed: the money you’ll need soon shouldn’t be riding on the market’s mood.
Stocks are for the years you can wait. Bonds and cash are for the years you can’t.
Sources: 1. 24/7 Wall St.; 2. 24/7 Wall St.; 3. 24/7 Wall St.; 4. Bureau of Labor Statistics; 5. Federal Reserve Bank of St. Louis (FRED); 6. Kiplinger; 7. Bloomberg; 8. NPR
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