Bonds take on a bigger role in retirement, as investors take chips off the table to protect their nest egg.
Unfortunately, it's easy to get tripped up — namely, by chasing returns and taking too much risk, according to financial advisors.
"Bonds are the single biggest mistake I see over and over and over again," according to Allan Roth, a certified financial planner and accountant at Wealth Logic, based in Colorado Springs, Colo.
"Bonds should be boring ... and allow you to sleep at night," he said.
Stocks are the growth engine of a retiree's portfolio, as they were during their working years. They help a portfolio keep pace with the cost of living, which may be substantial over a retirement of maybe 30 or more years.
But it's generally too risky for retirees to put all their money in stocks.
Perhaps half or more of their nest egg (depending on the investor) will likely be in bonds or bond funds, which serve as a general shock absorber when stocks tank; retirees may also use bonds as a source of cash to live on or to rebalance their portfolios when stocks fall, according to advisors.
"The main reason you hold bonds is to stabilize your portfolio," Christine Benz, the director of personal finance at Morningstar, said.
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This doesn't mean bonds are immune from losing money. In fact, 2021 was a rare year in which U.S. government bonds lost money. But bonds generally hold their ground or yield a slight gain when stocks fall, Benz said.
Which bonds to choose?
However, some bonds and bond funds are safer than others.
Retirees should aim to hold only high-quality bonds, advisors said. That means generally avoiding junk bonds and choosing those of investment-grade caliber, advisors said.
That's because junk bonds often move in tandem with stocks. They're issued by companies or governments at higher risk of defaulting on their debt — and incapable of repaying investors — during a recession or if the stock market tumbles, advisors said.
(They're often called "high yield" bonds because the issuer pays a higher return to compensate for that higher risk.)
Retirees who want exposure to junk bonds should use money earmarked for stocks and not bonds, Benz said.
One general approach to bond investing is to allocate a third of the bond portfolio to each of three categories: U.S. Treasury bonds, corporate bonds and mortgage-backed securities, according to Charles Fitzgerald, CFP and principal at Moisand Fitzgerald Tamayo.
Allocating to municipal bonds may also make sense, especially for high-income retirees with a taxable brokerage account, given their tax advantages, Fitzgerald said.
But retirees are better off buying investment-grade bonds, which are issued by entities with a high credit rating, he said. For example, Standard & Poor's investment-grade ratings include AAA, AA, A, and BBB.
Aside from bond type and credit quality, retirees should also consider duration when buying a bond fund, Fitzgerald said. That refers to the average time it takes for the fund's bond holdings to mature (i.e., come due).
Given recent high inflation, it makes most sense to buy funds that are short term (zero to three years) or intermediate term (about three to seven years), he said.
"Inflation can just destroy the money-making ability of a long-term bond," Fitzgerald said.
A simple approach
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However, there's a simpler approach for retirees who are less do-it-yourself oriented.
For one, they can buy a mutual fund or exchange-traded fund that tracks a broad, diversified bond benchmark, Roth said.
The Vanguard Total Bond Market Index Fund (VBTLX or BND) and iShares Core U.S. Aggregate Bond ETF (AGG) are the two most common funds the Wealth Logic financial planner uses with clients.
"It shouldn't be complicated," Roth said of retirees' approach to bonds.
They may also invest their nest egg in a low-cost "balanced fund," Fitzgerald said.
These funds are a one-stop shop that diversify across both stocks and bonds according to a pre-set allocation. (A retiree who wants a 50-50 stock-bond split would invest in a 50-50 balanced fund, which automatically rebalances holdings for investors.)
Target-date funds are similar; they pick a mix of stocks and bonds depending on an investor's envisioned retirement year. These funds generally change their asset allocation over time, becoming more conservative. Retirees should make sure the fund doesn't throttle back on stocks too much or deviate from their desired asset allocation throughout retirement if they use this approach.
FAQs
Retirees should generally avoid junk bonds in favor of investment-grade bonds issued by entities of high credit quality. A simple approach might be to buy a bond fund tracking a broad, diversified index of high-quality bonds.
Should a retired person invest in bonds? ›
Bonds can find a place in any diversified portfolio whether you're young or in retirement. Bonds can provide safety, income and help to reduce risk in an investment portfolio. Bonds can be mixed within a portfolio of equities or laddered to mature each year, providing access to cash when they mature.
What is the downside to buying Treasury bonds? ›
These are U.S. government bonds that offer a unique combination of safety and steady income. But while they are lauded for their security and reliability, potential drawbacks such as interest rate risk, low returns and inflation risk must be carefully considered.
What are the disadvantages of bonds? ›
Historically, bonds have provided lower long-term returns than stocks. Bond prices fall when interest rates go up. Long-term bonds, especially, suffer from price fluctuations as interest rates rise and fall.
Can you lose money on bonds if held to maturity? ›
Holding bonds vs. trading bonds
However, you can also buy and sell bonds on the secondary market. After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
How much money should retirees keep in cash? ›
It may be reasonable to hold cash to cover one to two years of living expenses.
Does Suze Orman recommend bonds? ›
The benefits of investing in I bonds
Suze Orman has long been a fan of these unique savings bonds because they offer so many benefits over other types of investments. For starters, they offer a guaranteed return on your investment, unlike stocks or mutual funds, which may go up or down over time.
How much is a $100 savings bond worth after 30 years? ›
How to get the most value from your savings bonds
| Face Value | Purchase Amount | 30-Year Value (Purchased May 1990) |
|---|
| $50 Bond | $100 | $207.36 |
| $100 Bond | $200 | $414.72 |
| $500 Bond | $400 | $1,036.80 |
| $1,000 Bond | $800 | $2,073.60 |
Both Treasury bonds and Treasury bills are low-risk debt securities issued by the federal government. T-bonds are designed for long-term investing, while T-bills have much shorter maturity periods. Both can help diversify your investment portfolio while shielding you from state and local taxes.
What is better CD or Treasury bond? ›
Taxes: Treasuries can offer tax benefits that CDs do not.
If investing in a tax-sheltered account, like an individual retirement account (IRA) or a 401(k), the tax benefits that Treasuries provide disappear, because earnings in these types of accounts are not subject to income taxes.
Holding bond funds for shorter periods than that opens you to the risk of further, short-term gyrations in your fund's value, without sufficient time for recovery. And if you buy longer-term individual bonds and have to sell them, you risk the kinds of losses that investors have been experiencing lately.
What is the problem with bonds? ›
All bonds carry some degree of "credit risk," or the risk that the bond issuer may default on one or more payments before the bond reaches maturity. In the event of a default, you may lose some or all of the income you were entitled to, and even some or all of principal amount invested.
What is the average annual return on bonds? ›
For example, the broad U.S. stock market delivered a 10.0% average annual return over the past 30 years through the end of 2018, while the average annual return for bonds was 6.1%.
What happens to bonds when stock market crashes? ›
Even if the stock market crashes, you aren't likely to see your bond investments take large hits. However, businesses that have been hard hit by the crash may have a difficult time repaying their bonds.
What happens if bond market crashes? ›
So, if the bond market declines or crashes, your investment account will likely feel it in some way. This can be especially concerning for investors with portfolios heavily weighted toward bonds, such as those in or near retirement.
Why are my bond funds losing money? ›
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
What type of bonds should retirees own? ›
However, some bonds and bond funds are safer than others. Retirees should aim to hold only high-quality bonds, advisors said. That means generally avoiding junk bonds and choosing those of investment-grade caliber, advisors said. That's because junk bonds often move in tandem with stocks.
How much should a retiree have in bonds? ›
Designed for a retirement that's expected to last more than 25 years, this is for investors with a high capacity for risk: Cash: 8% of assets are kept in cash for years 1 and 2 of retirement. Bonds: 32% of assets are kept in bonds for years 3-10 of retirement.
Where is the safest place to put your retirement money? ›
The safest place to put your retirement funds is in low-risk investments and savings options with guaranteed growth. Low-risk investments and savings options include fixed annuities, savings accounts, CDs, treasury securities, and money market accounts. Of these, fixed annuities usually provide the best interest rates.
Should a 70 year old be in the stock market? ›
If you're 70, you'd look at sticking to 40% stocks. Of course, there's wiggle room with this formula, and it's really just a way to get started. And for many older investors, a 50-50 split of stocks and bonds is what's preferred throughout retirement, and that's fine, too.
