investing

The Best Bond Alternative No One Is Talking About

Fixed indexed annuities may provide the steady income and stability that bonds aren't providing these days.

What is the job of a bond in your portfolio? When you think about it, bonds have two primary roles in a well-balanced portfolio.

Role #1 is to provide steady income. Role #2 is to provide stability for a portion of your principal to offset some of the volatility of market positions. How are bonds doing in fulfilling those roles in today's environment?

When it comes to steady income, bonds are currently grading out at a D. Due to low interest rates, you are receiving almost no income from your bond positions, unless you venture into high-yield bonds, which are a euphemism for junk. Investment-grade bonds are paying very little.

In regards to providing stability to your portfolio, bond prices are at all-time highs. Bond prices move inversely with interest rates. What will happen to the value of your bonds when interest rates rise in the future? They will decline. Buying bonds today is the equivalent of buying high so you can later sell low. Not a great idea.

What else can you do?

Imagine for a moment that you could go out on the market today and buy a 10-year investment-grade bond with the principal insured paying a coupon rate of 4%. Would you buy that bond? If you are like most people, you would jump all over it and hold it for the next 10 years happily.

That hypothetical bond would fulfill both roles of a bond admirably. Unfortunately, no such bond exists. However, something very similar does exist if you broaden your horizons.

If you are willing to expand your thinking just a bit, you will find that insurance companies have a few fixed indexed annuities that actually work similarly to our hypothetical 10-year 4% bond.

For many of you, you simply need to get over the word "annuity."

Warning: Very Few Qualify

Please be aware that out of the thousands of fixed indexed annuities very few will actually produce a 4% return over the next 10 years.

One fixed indexed annuity approach that we are currently using as a bond alternative: As of this writing, two highly rated companies have a 10-year fixed indexed annuity that pays interest equal to 35% of Standard & Poor's 500-stock index when it is up for the year, and pays 0% when that index is down for the year.

In other words, if the market is up, you get 35% of the upside. If it is down, you get 0% for that year. Each year during the 10 years is evaluated separately when calculating interest.

If you do any kind of research, you will find that this approach will very likely net you between 3% to 6% annual returns in almost any 10-year period. Your principal is insured, and you receive returns closer to what you want your bonds to pay.

Of course, fixed indexed annuities come with disadvantages. The two biggest are that you will pay surrender charges if you exit out of the annuity completely during the contract period, and the earnings are not guaranteed.

If you cannot stomach an annuity, you can also look into the world of limited partnerships, as there are options for alternative income. But buyer beware: These can look very good on the surface, but the liquidity is often very limited.

Don't be afraid to think outside the box in today's low interest rate environment. You need to evaluate new solutions to today's new problems.

Michael Reese, CFP®, CLU, ChFC, CTS is the founder and principal of Centennial Wealth Advisory, LLC with offices in Austin, Texas and Traverse City, Michigan. His focus is to help retirees enjoy financial security in any economy.

About the Author

Michael Reese, CFP®

Founder and Principal, Centennial Advisors LLC

Michael Reese, CFP, CLU, ChFC, CTS is the founder and principal of Centennial Advisors LLC, with offices in Austin, Texas, and Traverse City, Mich. Michael's vision is to help American retirees "re-think" how they manage their financial portfolios during their retirement years. His focus is to help retirees enjoy financial security in any economy, something that he believes is sorely lacking in today's financial world.

Most Popular

The Inflation Reduction Act and Taxes: What You Should Know
Tax Breaks

The Inflation Reduction Act and Taxes: What You Should Know

The U.S. Senate has passed the Inflation Reduction Act of 2022—a climate, energy, healthcare, and tax bill that would increase IRS funding, and change…
August 8, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
‘I Can’t Retire – I Need Health Insurance’
health insurance

‘I Can’t Retire – I Need Health Insurance’

Health insurance is seen as a huge hurdle for early retirees, but the answer to finding affordable coverage could be simpler than you think.
August 7, 2022

Recommended

10 Facts You Must Know About Recessions
Markets

10 Facts You Must Know About Recessions

Fears of an economic downturn are once again on the rise, but what is a recession, exactly? We tackle this and other questions here.
August 7, 2022
Taxable or Tax-Deferred Account: How to Pick
Investing for Income

Taxable or Tax-Deferred Account: How to Pick

Use our guide to decide which assets belong in a taxable account and which go into a tax-advantaged account.
August 2, 2022
How to Invest for a Recession
investing

How to Invest for a Recession

During a recession, dividends are especially important because they give you a cushion even if the stock price falls.
August 1, 2022
Are We in a Recession? Here's What the Experts Say
investing

Are We in a Recession? Here's What the Experts Say

The U.S. economy contracted for a second straight quarter in Q2 according to the latest GDP data, sparking plenty of recession chatter around Wall Str…
July 28, 2022