Retirement isn't what it used to be. Folks are living and working longer, putting off retirement sometimes well into their 70s or even 80s. As you get older, your tolerance for risk might decrease, because you have less time to recover from a mistake. That's why bonds and stocks both play an important role in a retiree's portfolio.
Bond Funds Produce Interest Income
Bonds are a source of interest income, which can be an essential part of your monthly budget. Different types of bonds involve different levels of risk and reward. You can buy U.S. Treasury bond funds that are completely safe from default but don't return as much as corporate bonds. High yield corporate, or "junk," bonds are riskier, but bond funds specializing in these securities can return 3 percent to 10 percent more than Treasury bond funds. Bond fund income might anchor your portfolio for as long as you live.
Stock Funds Produce Gains, Losses and Dividends
Stocks can be risky, as anyone who lived through the 2008 -- 2009 stock market can attest. Yet over the long run, stocks generate about double the return of Treasury bonds. New York University reports that for the period of 1928 through 2012, 10-year T-Bonds had an average annual return of 5.38 percent, compared with stock returns of 11.26 percent. In retirement, your planning horizon might be 20 or 30 years, allowing you to take some risks in order to stay ahead of inflation. However, you might find a portfolio containing only stock funds keeping you awake at nights. You can lower your risk and increase your income by including high-dividend stock funds in your portfolio, as they tend to have more stable prices and might provide a part of the income you need to pay your bills.
Modern portfolio theory shows that a diversified portfolio reduces the risk of a particular investment causing severe financial damage. Diversification suggests you allocate assets to stocks, bonds, money markets, tax-free municipal bonds, commodities, real estate and whatever else that interests you. While some of your investments can lose money, others might compensate by gaining value at the same time. For example, when the economy cools off, stock markets can fall while bond prices rise. You can invest in mutual funds and exchange-traded funds that specialize in a universe of different assets, providing you plenty of diversification.
According to the "New York Times," the Society of Actuaries estimates that at least one person in a married 65-year-old couple has a 45 percent chance of living until 90. The famous "4 percent rule," first put forward by Trinity University in 1998, has you withdrawing 1/25 of you investments each year. If you were to drain your bond funds first, your portfolio would be less diversified and at the mercy of short- to medium-term bear markets. If you sell off your stock funds first, you might find your bond fund income doesn't keep up with your needs or protect you from the ravages of inflation. You might consider withdrawing investments from your portfolio in a balanced manner, so that you maintain diversification for as long as possible.
Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.