"If the client has 10 years in the future before they need the money, then a 60/35/5 (percent) mix of stocks, bonds and cash is the preferred portfolio," said Mark S. Ballard, president of BankChampaign, a wealth management firm in Champaign, Illinois.
But investors with shorter deadlines may find that reliance on stocks too risky. Meanwhile, cash in federally insured bank savings is the other extreme: It is safe, but it is earning so little these days, the investor loses out to inflation.
Individual bonds are the classic alternative. Interest earnings are better than bank savings, and the investor can choose bonds that will mature the year funds will be needed. "For investors who need a specific amount of money on a set date, individual bonds are generally the go-to investment," said David Twibell, president of Englewood, Colorado-based Custom Portfolio Group. "They provide a high degree of certainty, particularly if you hold them to maturity and limit your exposure to issuers with strong credit quality."
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Some investing experts are now looking to a relatively new and, to many investors, unfamiliar product: the target-maturity bond ETF. It combines the diversification, liquidity and tax efficiency of a fund with an individual bond's fixed maturity, when the investor is sure of getting back the bond's face value.
Individual bonds can be troublesome for many investors who do not come from a sophisticated financial background.
"Individual bonds often trade at wide bid/ask spreads, which means you could end up overpaying for the bond if you're not careful," Twibell said. Many investors are not comfortable figuring that out or gauging credit quality and interest-rate risk — the danger that a bond will fall from favor and lose value when newer ones offer higher yields. That risk diminishes when a bond approaches maturity, because investors know they'll get back the bond's face amount.
"You can invest in individual bonds to eliminate interest-rate risk by selecting bonds with appropriate maturities, but investors may find it difficult to diversify because of the typical high minimum (purchase requirements) on individual bonds, or they simply find it too complicated to manage a portfolio of many individual bonds," said Matt Hylland of Hylland Capital Management in Virginia Beach, Virginia.