Bonds Archives

Should You Invest in Bonds Near Retirement?

Even though many consumers are putting off retirement further and further these days, the fact is that you should still be planning for the inevitable day that you can’t work any longer, whether by choice or not.

One thing to keep in mind, as retirement gets closer, is that the “investment horizon” you have gets smaller, meaning that you want to invest in things that are less risky. For this reason many financial advisors suggest that consumers in their 50s and even in the early 60s dedicate at least 50% of their portfolio to Bonds.

One of the best reasons to invest in bonds is that they offer many different choices and sectors, giving you the ability to diversify your portfolio quite nicely. Many bonds can only be purchased for a $5000 minimum investment however, meaning that you need to have significant assets in order to put together a portfolio that includes different issuers, different market sectors and different maturities of bonds.

For that reason, you might wish to consider bond funds, unit trusts or exchange traded funds. That will make it a bit more convenient to diversify your portfolio, and more affordable as well. One caveat however is that they don’t offer the same promise of a specific maturity date that a single bond will give you.

Depending on the tax bracket that you happen to be in, it might be more advantageous to purchase tax advantaged bonds that are issued by either federal, state and/or city governments. The reason is simple; any interest that is paid to you on US government securities will, in most cases, be exempt from both state and local income tax. If you live in a state where taxes are high, this can be crucial. Interest that you get on municipal bonds is exempt from federal income tax and, in many cases, exempt from state and city income tax also.

One excellent way to invest in bonds is called “laddering”, which along with diversification lowers your risk. An example is to purchase bonds with different maturities that are staggered over 1, 3, 5 and 10 years, reaching maturity at those times and making sure that, no matter what interest rates are in effect at the time, your bonds still deliver a good return. The reason is that, if interest rates are rising, your short-term bonds that are maturing will let you reinvest at a higher rate and, when rates are dropping, your longer-term bonds will still be paying you with their higher coupons.

If you have any questions about investing in bonds, or about personal finance in general, please let us know by commenting or dropping us an email, and we’ll get back to you with advice and answers ASAP.

If you’ve ever wondered what bonds actually are, how they work, and whether or not they’re a good investment choice for you, today’s blog will give you the Top 9 things you need to know so that you can make an educated choice. Enjoy.

#1) Bonds are issued by large companies and oftentimes the government

Large companies, the federal government and state governments issue bonds as a way to raise money to fund or finance a specific project. Basically what you’re doing is loaning them your money for a specific period of time and, in return, you get the loan back plus interest.

#2) In terms of performance, Bonds often outperform Stocks

Yes, during some periods of time in the last 150 years or so, stocks have done much better than bonds. On the whole however, returns on both have been about the same and, starting in 2003, the bond market has outpaced the stock market quite handily.

#3) A return on bonds is not guaranteed

Although the interest payments on bonds is fixed, their returns aren’t. If the company that issued the bonds goes bankrupt, you could lose your investment. Luckily this doesn’t happen very often.

#4) Bonds and interest rates usually move in opposite directions

Interestingly, bond prices usually rise when interest rates fall, and vice versa. These fluctuations don’t matter if you hold a bond to maturity however, as you will get back not only the original face value of the bond when you purchased it but the interest you expected as well.

#5) There’s a big difference between bonds and bond mutual funds

When you purchase a bond you’re guaranteed to get your principal and interest when it matures . (Assuming the company that issued the bond, or the government, doesn’t go bankrupt. See #3 above.)   The value of bond mutual fund fluctuates however, meaning that your return is uncertain.

#6) It’s unwise to invest all of your retirement money into bonds

Over time, the value of your bond’s fixed interest payments will be eroded by inflation. Even though stocks sometimes get hammered, in the long run they have a much better chance of outpacing inflation, thus younger and middle-aged people should put a good bit of their retirement money into stocks as well. As people are living longer lives these days, it’s even a good idea for retirees to own some stocks.

#7) Don’t forget to consider tax-exempt municipal bonds

Even though they might yield less than taxable bonds, tax-exempt municipal bonds can net you more income if you’re in the 28% federal tax bracket or higher.

#8) Yield is important, but still pay attention to total return

In the bond world, returns can be a little bit tricky. For example, if a broker sells you a bond that’s paying an interest rate of 6%, but interest rates rise and the price of the bond goes down by 2%, your total return for the year would only be 4% (6% and income minus 2% in capital loss).

#9) For steady income it’s best to purchase short and medium-term bonds

Your best bet for steady income from bonds is to invest in what the experts call a “laddered portfolio” of both short and intermediate term bonds.  If you aren’t sure what that is, talk to your financial expert to find out, or Google “laddered portfolios”.

It’s well-known among investors that US equity markets have gotten off to a pretty rough start here in 2014. Because of that being the case, there is much higher interest in fixed income securities resurfacing this year. Almost all bond ETF’s struggled in 2013  to keep up with the quick pace of the equity market and, by the end of the year, many funds were in the red. Now that the Federal Reserve has begun to taper their massive bond buying purchases however, a lot of investors are beginning to return to this once coveted asset class.

Fixed Income makes a Return

Long heralded as key diversification agents, the income securities are also excellent source of current income. Investors hungry for more yield however were forced to turn to other corners of the market after the central bank started implementing a number of stimulus policies that ended up keeping interest rates close to zero. These included REITs, MLPs and dividend paying stocks.

Investors have been drawn back to what is considered a safe haven asset class in 2014 due to a combination of the aforementioned tapering by the feds as well as a recent spike in volatility. Because of this, there are a number of bond ETF’s net have, so far, seen impressive inflows so far this year. (The data below is as of 2/14/14)

  • 1-3 Year Treasury Bond ETF (SHY, A)
  • 3-7 Year Treasury Bond ETF (IEI, A-)
  • Ultra 7-10 Year Treasury ETF (UST, B+)you will
  • Total Bond Market ETF (BND, A)
  • 1-3 Year Credit Bond ETF (CSJ, A-)
  • 20+ Year Treasury Bond ETF (TLT, B)

Some of the best  inflows so far in 2014 had been seen by treasury bond funds. Vanguards Total Bond Market ETF is also quite popular.  All bond funds aren’t doing as well as these of course and one of the most popular, the iBoxx $ High Yield Corporate Bond ETF (HYG, A), will actually see 1.83M of outflows.

What’s the Bottom Line

What the year-to-date flow data shows so far this year is that investors have had a crucial shift in their mentality from 2013. As investors begin to return to this “safe haven” asset class due to monetary policy changes and recent market volatility, Bond ETFs are becoming more attractive once again. Tapering from the Feds is expected to continue to the year, meaning that we might still see fixed income securities gaining more traction sometime in the near future.

 

In 2013 we saw moderate economic growth while the Federal Reserve maintained their quantitative easing program.  This was something that kept short-term interest rates low but still the Fed’s general attitude was something that made most investors a bit nervous and inevitably hurt many bond portfolios due to the rise in long-term rates.

What this showed many investors is that forecasting the market is as much about investor sentiment as it is about data analysis. Indeed, as they continued to be active with their QE program last year it became clear that what the Fed was saying was nearly as important as what they were doing, a theme that will more than likely be quite significant in 2014

Which leads to the question of what’s likely going to happen with the bond market in 2014. In all likelihood we’ll see the same slow growth as the markets continue to be policy driven. 5+ year bonds will more than likely see their rates go higher as the federal government’s bond buying program is tapered down. Most experts are predicting that the Funds rate will remain zero in 2014, something that should help anchor short-term fixed income yields. Volatility will more than likely be a theme again in 2014 and, in most likelihood, inflation should maintain its historically low course.

All of which leads to three strategies for bond investors in the next 12 months.

  1. Shorten the duration of your fixed income portfolio. In 2013 one of the best strategies was duration rotation, whereby investors who anticipated a rise in rates shortened the duration of their portfolios in response. The fact is that Treasury rates, based on current growth levels and inflation, are rapidly approaching their fair value. Unless either inflation or growth have a large spike in the coming year the rate increase in 2014 will be a bit more modest than it was last year.
  2. Invest in short duration bonds rather than cash. Right now investors are getting a negative real return on their cash investments (after they factor in inflation) because of near zero short-term interest rates. Even though cash is definitely the safest investment, bonds of short duration are relatively low risk but offer the opportunity of a much higher yield overall than cash. You can expect that short duration ETF’s will be used by many investors this year as they continue to get their feet wet in the market again.
  3. Consider investing (with caution) in municipal bonds. On a tax adjusted basis municipal bonds are still very attractive, especially in a market where finding yield is becoming more and more difficult. Keep in mind however that they are highly rate sensitive.

Of course before you choose any type of fixed income strategy you should always consider the exact role that bonds will be playing in your portfolio. Consider whether you are seeking yield, stability or diversification and keep those objectives in mind with all of your bond investments. If you do that, 2014 should prove to be a very good year.

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