The Risk of Bonds for Near Retirees

Over the past 10 years, we have seen historically low-interest rates which lead to lower returns with fixed income assets.  This can create unique challenges as one approaches retirement and portfolios turn a bit more conservative as to not risk those retirement funds in the broad markets.

Burdened by this fact, many people find themselves hoping that the interest rates will rise, but in today’s COVID-19 environment, the Federal government has already said they currently have no plans to raise the Federal interest rate from its’ current .25%, and many experts predict it will stay at this rate throughout the rest of 2021.

What is a bond?  A bond is a contractual obligation to make a specific payment on specific dates to the bond owner, typically once or twice a year.  If you hold that bond for the stated duration, you will have all of your principal returned to you, plus all the interest payments received over the duration of that bond.  What if you don’t want to own that bond for the duration?  Enter the secondary market.

The secondary market is where issued bonds are traded.  The rules of supply and demand dictate if a particular bond will increase or decrease in value.  For example, when the stock market crashes and investors want to “flee to safety”, many want to sell their stocks and buy “safer” bonds.  This triggers the high demand for bonds and drives up their price on the secondary market – selling at a premium.  The same works in reverse when investors all want to be in the stock market and the value of bonds drop – selling at a discount.

Now that we know what a bond is and we know that interest rates are at historically low levels, what is one to do with this dilemma as it relates to low-risk investments?  You can buy a longer duration bond that may offer higher yields, but if you do not hold them until their maturity date, you most likely will experience some loss in value when interest rates increase in the future.  Then why not simply buy a short-duration bond?  These bonds might not see a decrease in value when interest rates increase, but you will have to accept the lower yield that shorter-duration bonds have compared to their longer-duration counterparts.

Being that we have such low-interest rates throughout today’s bond markets, this creates a problem for those nearing retirement.  As interest rates will start to increase, once the world beats the COVID-19 pandemic, the existing bonds that people have in their portfolios will start to lose some value.  How much?  It depends on how fast interest rates go up.  So once again, here’s another dilemma for those nearing retirement – trying to keep their nest egg safe while earning interest at a rate higher than inflation.  Is there another “safe” option that can yield more than the .86% (5-year bonds) or 2.31% (30-year bond) that is available from the government?

Fixed annuities can be a great option for short-term, “safe” growth as one closes in on retirement or is actually retired.  A fixed annuity is a contract between an individual/couple and an insurance company that can provide growth with a guaranteed interest rate on a tax-deferred basis.  Currently, the market is seeing guaranteed interest rates of up to 2.25% for a 3-year product, 2.75% for a 5-year product, and 3.35% for a 10-year product.  All of this growth is guaranteed and done without exposure to market volatility. So, when interest rates start to go higher, your safe investment will not lose value like a typical bond might.  Because of this, as stated by Wade Pfau, PhD and professor of Retirement Income at the American College for Financial Services in Bryn Mawr, PA, “A fixed annuity may potentially outperform other fixed income strategies in a rising interest rate environment and support growth at a specific interest rate without exposure to price fluctuations and potential losses as interest rates change”.

Of course, there are always pros and cons with any investment and these should be discussed with a financial professional before jumping right into a fixed annuity to enjoy the higher returns they offer compared to today’s low-yielding bonds.  If you would like to discuss the idea of adding a fixed annuity to your portfolio to add a little more horsepower to your “safe” money investments, like your bank or credit union account funds, be sure to go and talk to a Financial Advisor.

This blog is created and authored by Chuck Henrich (Content Creator) and is published and provided for informational and entertainment purposes only. The information in the Blog constitutes the Content Creators own opinions and it should not be regarded as a description of services provided by Southwest Michigan Financial, LLC. The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.  It is only intended to provide education about the financial industry.  The views reflected in the commentary are subject to change at any time without notice.

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