For years, bonds have been an investment cornerstone for retirees because of their perceived stability, security, and ability to provide a reliable source of income. Below, we review some of the reasons you might want to make bonds part of your retirement portfolio and also highlight a few pitfalls you should be aware of.
Why Bonds for Retirement?
Compared to equities (or stocks), bonds have a reputation as a relatively conservative investment. While bonds come with some risks, the income they generate is predictable. That’s why they’re known as fixed-income investments. Plus, you’ll get your principal back when the bond reaches maturity, assuming all goes well and the bond issuer doesn’t default. That predictability is appealing to many retirees who are looking for the confidence that they’ll have the money they need to meet all their expenses after they stop working.
Bonds can also offer tax advantages, which may be especially appealing to retirees. Since you won’t pay federal income tax (and in some cases, state and local tax) on income from municipal bonds, including some of these investments in your retirement portfolio may be a way to generate much-needed income while also keeping your tax burden as low as possible.
Most people who invest end up with some of their portfolio n bonds, since they are a good way to provide diversification. If you are including bonds in your retirement portfolio, you will likely want to diversify your holdings, just as you would with stocks. Treasuries and highly rated corporate and municipal bonds may help generate income without taking on too much risk. Lower-rated bonds can generate more income, but there’s a greater chance of default.
Bonds: How much?
Given the perceived advantages of bonds – predictable income, less risk of steep losses, and tax perks – you may be wondering not if you should invest in bonds, but rather how much of your retirement portfolio should be made up of bonds. That’s a tough question. Traditionally, financial experts have urged people to focus on investing in equities when they are younger to earn as high a return as possible while they are able to take on more risk. Once people get closer to retirement, the conventional advice is to move to more bond-heavy portfolios for all the reasons discussed above. But recently, some have challenged this conventional wisdom.
One problem with bonds is that they tend to have less-impressive returns than stocks. In some ways, that’s good for retirees who tend to be looking for stability, not growth. But it can present a hidden hazard especially when interest rates are low, as they are now (and have been for some time.) Low interest rates mean that retirees aren’t earning much on their bond investments. And when you combine low earnings with creeping inflation, you may actually end up losing money. In turn, that can cause you to draw down your retirement portfolio faster than expected, creating a risk that you’ll run out of money.
Another problem with the relatively low yields on bonds? Because people are living longer, they often need a plan to make their portfolio last for there or four decades after they retire. Some retirees may still need to generate significant returns form their investments if they are anticipating retiring at 65 and living to age 95 or 100.
So what’s the solution? There’s no easy answer. Retirees need to strike a balance between preserving the wealth they’ve earned so they can live well for decades with the need to generate enough income to sustain their lifestyles. Please call if you’d like to discuss this in more detail.
Copyright © Integrated Concepts 2015. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.