Retirees often make one big mistake with bonds. Here’s what to avoid
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As investors leave chips on the table in order to preserve their nest eggs, bonds play a greater role than ever before.
Unfortunately, it’s easy to get tripped up — namely, by chasing returns and taking too much risk, according to financial advisors.
Allan Roth is a Certified Financial Planner and Accountant at Wealth Logic. He lives in Colorado Springs.
He stated, “Bonds ought to be boring… so you can sleep at night.”
The growth engine that a portfolio can grow is the stock market. Stocks were a major part of their work life. A portfolio’s cost-of-living increases can be offset by stocks, helping it to keep up with inflation.
However, it is too risky to invest all of your retirement money in stocks.
Advisors say that bonds and bond funds could make up half of a retiree’s nest egg. These bonds can be used to provide cash for living expenses or to balance their portfolios in the event of stock market declines.
Christine Benz of Morningstar Personal Finance said that “the main reason why you hold bonds it to stabilize the portfolio.”
Bonds can still lose money, however. Unfortunately, U.S. government bonds were not issued in 2021. lost money. Benz stated that bonds are generally stable or can yield a small gain when stocks drop.
How do you decide which bonds?
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Some bonds or bond funds, however, are more secure than others.
Advisors advise that retirees aim to only hold high-quality bonds. This means that you should avoid “junk” bonds, and choose high-quality bonds of investment grade caliber.
This is because junk bonds are often paired with stocks. They’re issued by companies or governments at higher risk of defaulting on their debt — and incapable of repaying investors — during a recession or if the stock market tumbles, advisors said.
These bonds are sometimes called “high-yield” bonds. This is because they offer a higher return in order to cover the higher risk.
Benz stated that retirees looking for exposure to junk bonds should make use of money that is earmarked specifically for stocks, and not bonds.
Charles Fitzgerald CFP principal of Moisand Fitzgerald Tamayo is recommending that you allocate 1/3 of your bond portfolio to U.S. Treasury, corporate, or mortgage-backed securities.
Fitzgerald suggested that allocating municipal bonds could also be a good idea, particularly for wealthy retirees having a tax-efficient brokerage account.
Fitzgerald stated that retirees should purchase investment-grade bonds. These bonds are issued by companies with high credit ratings. For example, Standard & Poor’s investment-grade ratings include AAA, AA, A, and BBB.
Fitzgerald stated that, aside from credit quality and bond type, retirementists need to consider “duration” in buying bond funds. It is the time taken for bond holdings in the fund to mature, i.e. come due.
Fitzgerald said that because of recent high inflation it’s best to purchase funds that are either short-term (0-3 years) or intermediate (3 to 7 years).
Fitzgerald stated that inflation can destroy long-term bonds’ money-making potential.
Simple approach
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For retirees that are not as DIY-oriented, however, there is an easier way.
Roth stated that they have two options: one is to buy an exchange-traded or mutual fund that tracks broad bond benchmarks.
Vanguard Total Bond Market Index FundVBTLXOder BND) and iShares Core U.S. Aggregate bond ETFAGGThese are his most frequent words with clients.
Roth stated, “It shouldn’t be complicated,” when referring to the retirement approach to bond investing.
Fitzgerald suggested that they could also put their nest eggs in a “balanced” fund, which is low-cost and can be used to invest the money.
They are an all-in-one solution for diversifying across stocks and bonds based on a pre-set allocation. A 50-50 balance fund would be an option for a retiree looking to split 50-50 between stock and bonds. This automatically rebalances investors’ holdings.
The target-date fund is similar to other funds. They pick stocks and bonds based on the investor’s retirement years. The fund’s asset allocation changes over time and becomes more conservative. If they choose this method, retirees need to ensure that the fund does not throttle back stocks or divert from their preferred asset allocation during retirement.
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