Investors who are nearing or already in retirement have long been urged to shift the bulk of their investment savings from equities to bonds.
The idea is simple (and you’ve likely heard this advice many times):
You buy stocks when you’re willing — or can tolerate — exposure to volatility in exchange for a potentially higher reward.
You buy bonds when you’re seeking safety and reliability in your portfolio.
The balance between these two investments is often adjusted through the years to reflect how much risk an investor is willing to take. One popular rule of thumb, for instance, suggests the percentage of bonds in your mix should be a close match to your age. So a 70-year-old investor who is retiring or retired might choose a 30/70 portfolio split (with 30% in stocks and 70% in bonds) to better protect his or her nest egg.
Here’s the Rub
The problem, of course, is that we’re currently in an inflationary environment with rising interest rates, which means investors actually could be losing money on their “reliable” bonds in two ways.
- Rising Prices. Rising prices can reduce the purchasing power of each interest payment a bond makes. If you hold your bond to its maturity, inflation could be nibbling away at your money for five years, 10 years or more. When you’re dealing with inflation, duration matters. And a nibble can become a serious bite.
- Rising Interest Rates. As interest rates rise, bond prices tend to fall. When new bonds start paying higher interest rates, existing bonds with lower rates become less appealing to buyers. If you decide to sell your bonds, you may have to discount the price to make up for the smaller yield.
Because the media and most investors tend to pay more attention to the ups and downs of the Dow, Nasdaq and S&P 500, it’s easy to let the bonds in your portfolio just do their thing. But with inflation sitting at 8.3% in August, it can be dangerous to think of bonds as “set-it-and-forget-it” investments.
Just How Bad Are Your Bonds?
Do yourself a favor: When you look at how your holdings are performing, separate your bonds from your stocks. You may be surprised by how poorly your so-called safe securities have been doing. For example, Aggregate Bond ETF (AGG) is down 15.7% YTD as of Oct. 12. And you might want to rethink your mix – especially if you’re depending on bonds to provide a large chunk of your retirement income.
The good news is there are alternatives to bonds that still can provide you with safety and growth.
Some Alternatives to Bonds
Although you may not be as familiar with options like buffer ETFs, multi-year guaranteed annuities and indexing strategies within indexed annuities as you are with bonds, these products are not new, untested or especially complex. And with each, you can enjoy upside potential while benefiting from some downside protection.
Buffer ETFs (exchange-traded funds) are called that because they provide investors a buffer against market losses. In exchange, though, the investor is accepting a cap on market gains. Here is an example of how that works: You can create an ETF with a 30% buffer based on the S&P 500. In this scenario, the market would need to drop more than 30% for the accounts to decrease. There is no limit on how far the ETF can drop. There is a 25% buffer for loss, and clients are responsible for the first 5.85% and protected up to 25% after that. Of course, as mentioned, there is a cap on what you can gain and, as of September, the buffers were 25%, and the cap was 16.98%.
- A multi-year guaranteed annuity (MYGA) offers a guaranteed fixed interest rate for a specific period of years. As an example, at the time I am writing this, a five-year MYGA with Nationwide pays 4.95% compounded, and Barclays’ five-year CD rate is sitting at 3.65% as of Oct. 12.
- Indexing strategies inside a fixed-indexed annuity can be another good option. These annuities are tied to indices, such as the S&P 500. The annual return for a fixed-indexed annuity also has a cap, such as 8%. If the market performs well, you benefit up to that cap, but if the market goes down or even crashes, you don’t lose any money.
Of course, just like bonds, each of these options has its pros and cons. (Sadly, there’s no such thing as a perfect investment.) So, it’s a good idea to speak with a Certified Financial Fiduciary® who is legally bound to look out for your best interests – about these and other bond alternatives.
There are multiple solutions available, and this is definitely the right time to check out all the possibilities. Just because you want to protect yourself in retirement doesn’t mean you have to settle for poor bond performance.
Kim Franke-Folstad contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
Adam Bruno is the founder and president of Evolution Retirement Services in Fort Myers, Florida. A former teacher, his goal is to provide a one-stop shop where individuals can receive education and holistic guidance in all aspects of financial planning. Adam is a regular contributor to Fox 4 News in Fort Myers, host of the Retirement Evolved podcast, and author of They Lied: The Real Cost of Your Retirement. Adam is married and has four children.
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