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

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
The 12 Best Tech Stocks to Buy for 2022
tech stocks

The 12 Best Tech Stocks to Buy for 2022

The best tech-sector picks for the year to come include plays on some of the most exciting emergent technologies, as well as several old-guard mega-ca…
January 3, 2022
The 10 Best Closed-End Funds (CEFs) for 2022
CEFs

The 10 Best Closed-End Funds (CEFs) for 2022

These high-yielding CEFs won't just significantly boost your portfolio income. They'll also allow you to buy their underlying stocks and bonds at a di…
January 12, 2022

Recommended

Is the Stock Market Closed on MLK Day?
Markets

Is the Stock Market Closed on MLK Day?

Both the stock markets and bond markets will have Monday off as the nation honors civil rights leader Martin Luther King Jr.
January 15, 2022
Stock Market Holidays in 2022
Markets

Stock Market Holidays in 2022

Is the stock market open today? Take a look at which days the NYSE, Nasdaq and bond markets take off in 2022.
January 14, 2022
4 Tips on How to Build a Better Bond Position
bonds

4 Tips on How to Build a Better Bond Position

In a world where stock markets keep setting records, bonds look quite dull in comparison. But don’t give up on them! Polish up your bond portfolio usi…
January 12, 2022
The 7 Best Bond Funds for Retirement Savers in 2022
bonds

The 7 Best Bond Funds for Retirement Savers in 2022

Fixed-income investors face a difficult path in 2022, but these seven bond funds can help minimize the impact of rising rates and inflation.
December 17, 2021