bonds

Pros and Cons of Zero-Coupon Bonds

This isn't the investment for you if your retirement is years away.

I am 42 years old and interested in zero-coupon bonds to supplement my retirement savings. What are the pros and cons?

With retirement years away for you and today's low interest rates, we'd advise against buying zeros. These bonds don't make regular interest payments. Instead, they're sold at a big discount to face value; when they mature, you collect the full amount. Their big advantage is that you know how much you'll collect a certain number of years from now.

In mid June, for example, you could have bought a U.S. Treasury zero for $341 that matures in August 2027 at a face value of $1,000. That's an annualized return of 5.4%. But inflation, which has averaged about 3% over the past 20 years, will eat up a big part of that return. “Amounts due at maturity may not have the purchasing power you thought they would,” says Paul Winter of Five Seasons Financial Planning in Salt Lake City.

And if interest rates continue to rise, as they did in late spring, zeros, unlike regular bonds, don't give you the opportunity to reinvest your interest at higher yields. Moreover, if you hold zeros in a regular account, you'll have to pay taxes each year on so-called phantom income from interest you haven't yet received.

With 20 years or so to go before you retire, you'll almost certainly do better with a diversified portfolio of stocks, although they'll probably offer a bumpier ride along the way.

If the certainty of zeros still appeal to you, Winter suggests this strategy: Put some money in zeros that mature in 20 years. Five years from now, buy more zeros that mature 20 years from that point, and so on. If interest rates rise, you'll be able to invest at least some of your money at higher yields.

Most Popular

In What Order Should You Tap Your Retirement Funds?
retirement planning

In What Order Should You Tap Your Retirement Funds?

Should you go with your IRA first or your brokerage account? Pulling money haphazardly can have negative implications. Instead follow this road map fo…
June 28, 2022
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
An Easy Way to Find How Much You Will Spend in Retirement
retirement planning

An Easy Way to Find How Much You Will Spend in Retirement

One simple math equation can help you determine where to start building your retirement income plan, and whether your money should last.
June 27, 2022

Recommended

Is the Stock Market Closed for Juneteenth?
Markets

Is the Stock Market Closed for Juneteenth?

In 2021, Washington passed legislation turning Juneteenth into a federal holiday. As a result, investors will have the day off Monday.
June 17, 2022
8 Facts You Must Know About Bear Markets
investing

8 Facts You Must Know About Bear Markets

Bear markets can be terrifying, but they're normal, inevitable and – most importantly – don't last forever.
June 13, 2022
Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help
bonds

Bonds Are Having a Rough Year. Here Are 3 Actions That Can Help

Rising interest rates have hurt bond prices. But these three steps can benefit investors worried about their portfolios and their retirement income.
June 2, 2022
Is the Stock Market Closed on Memorial Day 2022?
Markets

Is the Stock Market Closed on Memorial Day 2022?

The stock market gets a full day off for Memorial Day. The bond market gets Monday off too, not to mention an early close ahead of the holiday weekend…
May 27, 2022