Buying a bond is like issuing a loan to a government or corporation. The bond is an agreement to pay you back a specific amount at a specific date and pay you interest (usually biannually) along the way.
If Bonds Are Guaranteed Money, Why Invest in Anything Else?
The interest paid back on bonds is modest at best, and most bonds aren’t adjusted for inflation. With a bond you generally know exactly what you’ll make for the life of the bond, but there’s an inherent opportunity cost for that safety.
Bonds are highly sought after for their reliability. They’re one of the lowest risk investments, but their predictable return often falls short of more risky and aggressive alternatives.
That doesn’t mean bonds are bad. For some people, bonds make a lot of sense.
Are There Inflation- Adjusted Bonds?
Yes–inflation-linked bonds, like Treasury Inflation-Protected Securities (TIPS) exist. Essentially, the principal of the bonds (the face value) increases when there’s inflation, and the interest payments are based on the face value.
That’s not always a good thing when there’s deflation. The deflation risk is serious enough that the U.S. Treasury Department sets a floor on TIPS valuation (par value). The par value reduces the risk of deflation, but purchasers could still end up losing money due to inflation-adjusted interest accruals being lower.
There are also some potential tax ramifications due to the way the valuation adjustments are calculated as income. If you have inflation-linked bonds and you have questions about how this “phantom income” can affect your taxes, you should speak with a financial planner or tax expert.
A retirement planning advisor can help you understand whether inflation-linked bonds are a good idea for your portfolio. Year-over-year inflation hit 7.9 percent in March 2022, a 40-year high. It’s the sharpest jump since the early ‘80s. This is why many investors are giving inflation-linked bonds a second look. Whether they’re right for you or there are more advantageous alternative inflation-absorbing options for your portfolio depends on your situation.
Are Bonds Good for Retirees and Soon-to-Be Retirees?
Bonds are one of the investments most frequently associated with risk-adverse investors. Many people nearing retirement, as well as those who are currently retired, studiously avoid risky investments. If that’s where you’re at in your life’s journey, you likely don’t want to jeopardize the value of your nest egg. The predictability of bonds makes them a safe option.
On the other hand, young people who are still in the early stages of retirement investing can afford to be risky. If you’re in your 20s or 30s, you likely won’t be withdrawing from your 401(k) or IRA for several decades. In that time there will likely be many ups and downs in the market, and you shouldn’t lose sleep over it because you won’t be relying on those dollars for many years to come. That’s why many young investors feel comfortable taking the riskier road with greater growth potential.
Bonds may still be part of a young retirement investor’s diverse portfolio, but they likely won’t be the largest part.
How to Invest in Bonds
Bonds are not traded on an exchange like equities or ETFs, but you can buy them through brokerage accounts. Investors can also buy U.S. Treasury bonds directly from the government.
Do take note that brokerage firms may charge a fee for facilitating bond purchases, and different brokers charge different prices. You may want to research your options before purchasing.
What Kind of Bonds Can an Investor Purchase?
Treasury bonds, or T-bonds, are one of the more popular types of bonds because they’re backed by the U.S. government and are often considered virtually risk-free by investors. They have the added benefit of being exempt from local and state taxes (but not federal taxes).
Investors can also purchase municipal bonds and bonds issued by companies. A company or a local government may issue bonds for a specific project, like building a new manufacturing facility or funding the construction of hospitals or schools.
The earned interest on corporate bonds is taxable, but those costs can be offset by higher yields.
There are two categories of municipal bonds: general obligation bonds and revenue bonds.
General obligation bonds are backed by the “full faith and credit” of the local government issuing the bond, similar to the way the U.S. government backs Treasury bonds.
Revenue bonds are paid back with the proceeds of the project. The simplest example is issuing a revenue bond to fund the construction of a toll road. The tolls collected would go back to bond purchasers.
Municipal bonds have a philanthropic component for some investors. They’re a good way to support community betterment while also saving money for the future.
Talk With a Fullerton Financial Planning Advisor About Bonds
Are you wondering if it’s time to begin safeguarding your nest egg by transferring your investments into bonds? The investment managers and retirement planners at Fullerton Financial Planning would be happy to discuss the pros and cons with you. Call us at (623) 974-0300 to get started.
