In the next 20 years, an astounding $84 trillion is expected to change hands as older Americans pass wealth down to younger generations.
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At 36 years old, inheriting $500,000 could be a game-changer for your financial future. The Federal Reserve puts median retirement savings among American households of those ages 35 to 44 at just $45,000.
A sum that large could serve as the foundation for your nest egg, allowing you to allocate your paycheck to other goals, like saving for a home.
But if you’re going to invest your $500,000 windfall, it’s important to choose the right asset allocation — and given recent stock market volatility, you may be inclined to put all of that money into bonds.
However, there are pros and cons to this particular strategy. Let’s dive in so you can understand both sides.
Putting your windfall into bonds
One benefit of going all in on bonds is that you won’t have to lose sleep over your portfolio.
The stock market has a tendency to swing wildly, as evidenced by recent fluctuations. But bonds, which may be issued by governments or companies, are a less risky investment. Bond values tend to be more stable over time than stocks, and you are promised interest payments at regular intervals and your principal repaid to you at maturity.
Bonds are contractually obligated to pay interest. Companies that pay dividends, by contrast, are not required to share the wealth with stockholders — many just choose to do so.
But with bonds, there’s an actual obligation, so that income is guaranteed barring a default. If you choose bonds with strong credit ratings, a default is less likely to occur.
Because bond values tend to be fairly stable, they’re also a good option for preserving your money. Let’s say you’ve decided that you can retire comfortably on $500,000. If you want to avoid a scenario where you risk losing some of that money, you might choose to put all of it into bonds, as opposed to a mix of stocks and bonds.
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The drawbacks of putting all of your money into bonds
There’s a real danger when you invest all of your money in bonds at 36 — you could end up seriously stunting your portfolio’s growth. You should be thinking of investing with a long-term mindset if you want to build a nest egg. Even though the stock market is seeing a lot of volatility right now, historically it has always recovered and posted new highs.
The average annual return for the S&P 500 over the last century is around 10%, while long-term government bonds returned between 5% and 6%, according to Morningstar data cited by CNN.
If you invest all of your money in bonds, your portfolio may not grow as much as you want it to. Your money might also grow at a pace that doesn’t keep up with inflation, thereby leaving you with less buying power later in life.
Remember, $500,000 might seem like a large sum of money now. It’s hard to say how much buying power it will give you in 30 years.
Meanwhile, let’s say you invest $500,000 in an S&P 500 ETF at 36 and retire in 30 years. Let’s also be conservative and say your portfolio gives you an 8% yearly return, not 10%. In that case, you’re looking at retiring with about $5 million.
But if your portfolio only generates a 5% yearly return during that time because you’re sticking with bonds, you’re looking at more like $2.1 million in 30 years. That could make a huge difference in your retirement.
It’s also generally not a good idea to invest your entire portfolio in a single asset class. So while it’s OK to keep some of your money in bonds, a split between stocks and bonds may be more ideal.
To be clear, this would apply even if you were older and closer to retirement. A popular rule of thumb says to subtract your age from 110 to know how much of your portfolio should be in equities. So at your age you should have around 70% in stocks and sticking to just bonds could mean missing out on a world of returns.
If you’re particularly risk-averse, as a compromise, you may want to put 50% of your portfolio into stocks and 50% into bonds so that you’re benefiting from share price growth while also generating a nice amount of income from the bond portion.
Then, as you get closer to retirement, you can increase your bond allocation and decrease your stock holdings.
You may also want to talk to a financial advisor if a fear of losing money is driving you to go heavy on bonds at such a young age. They may be able to create the perfect asset allocation for your risk appetite, investing horizon and long-term goals. Talking to an expert may also make you feel more comfortable putting more of your assets into the stock market.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
