Thinking About Buying Bonds Right Now? Here's What You Need to Know
If you're thinking about investing in bonds, it's important to understand how they work and the risks involved. At Sevey Wealth, we focus on creating a personalized strategy for your retirement, and bonds can be a big part of that plan. Below, we'll explain the basics of bonds, the risks involved, and how we use bonds in our retirement income strategy using something called the "buckets" approach—especially focusing on creating a cash flow schedule that isn’t affected by market ups and downs.
How Bonds Work
Bonds are a type of loan you give to governments, companies, or other organizations. In return, they pay you interest regularly, and at the end of the bond’s term, they return your original investment (called the "principal").
For retirement, bonds are a good choice because they provide steady income, which can help support your lifestyle without the need to sell stocks or worry about market changes.
The Primary Risks of Bond Investing
Credit Risk: This is the risk that the bond issuer might not be able to make their payments. Bonds issued by large, stable companies or governments, like U.S. Treasuries, are usually safe. However, bonds from smaller companies or municipalities may carry more risk.
Interest Rate Risk: Bond prices go up and down with interest rates. When interest rates rise, bond prices tend to fall, and vice versa. This can affect the value of your bonds if you need to sell them before they mature.
Duration Risk: This measures how much a bond’s price changes with interest rates. Bonds with longer terms (like 10+ years) are usually more sensitive to interest rate changes than shorter-term bonds.
Our Approach to Bonds and Retirement Income
At Sevey Wealth, we believe in building a solid, predictable foundation for your retirement income. One key strategy we use is the "buckets approach", which divides your money into different categories based on when you’ll need to use it. Bonds are an important part of this plan, especially for creating consistent income.
Bucket 1: Short-Term Income Needs (1-5 Years)
For people who are nearing retirement or are already retired, we focus on stability and making sure there’s enough cash flow for the first few years. In Bucket 1, we aim to make sure that the income you need for the next few years is not affected by market volatility. This means using investments that can provide steady cash flow, no matter what’s happening in the stock or bond markets.
To do this, we recommend individual bonds like U.S. Treasuries and CD ladders (a strategy where you invest in CDs with different maturity dates). These bonds provide reliable, predictable income with minimal risk. U.S. Treasuries are especially safe because they’re backed by the U.S. government, and CD ladders give you access to cash over time, with guaranteed returns.
The main advantage of this strategy is predictability—you know exactly how much you’ll earn, and your income isn’t affected by market changes. This is especially important when markets are going through periods of uncertainty, like we’re seeing now.
Bucket 2: Mid-Term Needs (5-10 Years)
For the next phase of your retirement, we focus on investments that still provide income but may offer a little more growth potential. In Bucket 2, we might use a mix of bond funds and balanced funds, which combine both bonds and conservative stocks to create a well-rounded portfolio. These funds provide diversification, helping to spread out risk, and can offer higher returns compared to just bonds.
Bond funds typically hold a variety of government, corporate, and municipal bonds. This gives you exposure to different types of bonds, including municipals, which offer tax advantages for high-income clients, as the interest is often exempt from federal taxes.
In addition to bond funds, we also use balanced funds in this bucket. These funds invest in both conservative stocks and bonds, giving you a mix of growth potential and income. The advantage of balanced funds is that they provide exposure to stock market growth while still focusing on the safety of bonds, which can help reduce overall portfolio risk.
By using a mix of bond funds and balanced funds, we can provide a diversified and steady source of income while allowing for some growth potential, all while managing risk appropriately.
Bucket 3: Long-Term Growth (10+ Years)
For long-term growth, we focus on more aggressive bond funds that can offer higher returns, but also come with more risk. In Bucket 3, we may use multi-sector bond funds or international bond funds. These funds invest in a wide variety of bond types, including corporate bonds, high-yield bonds, and bonds from other countries, offering greater diversification and growth potential.
We do not typically use individual corporate bonds in this bucket because of the added complexity and risk of managing those bonds on an individual basis. Instead, multi-sector and international bond funds give us the opportunity to access a broader set of bonds, which can help enhance returns over time, especially when interest rates and global economic conditions fluctuate.
While these funds carry more risk and are more sensitive to interest rate changes or global economic shifts, the key advantage is that they offer the potential for higher returns and are designed to grow over the long term. With Bucket 3, we can afford to take on more risk since the goal is to focus on growth for the future, not immediate income needs.
The Importance of a Predictable Cash Flow Schedule
Right now, with the stock and bond markets being volatile, having a predictable cash flow schedule is more important than ever. You don’t want to rely on investments that could lose value when you need the money the most. By using our buckets approach, we make sure that your short-term cash flow—the money you need in the next few years—isn't affected by market volatility.
Without a predictable cash flow, retirees could struggle during market downturns. For example, when interest rates rise or when stock markets drop, bond prices may fall, affecting the value of your investments. If you need to sell bonds to generate income, this could cause unnecessary stress.
By keeping Bucket 1 focused on safe, stable investments like Treasuries and CD ladders, we ensure that your immediate income needs are met no matter what’s going on in the market. This allows you to focus on long-term growth in Buckets 2 and 3, where we can take on more risk with bond funds, balanced funds, and aggressive bond funds.
Tax Considerations
One important aspect to consider when investing in bonds is the tax impact. Certain types of bonds come with tax advantages. For example, municipal bonds offer income that is generally exempt from federal income taxes and, in some cases, state taxes. This can be especially beneficial for high-income earners looking to minimize their tax liability.
However, it’s important to be mindful of how bond income could affect other areas of your tax situation. For example, interest from taxable bonds could impact your Modified Adjusted Gross Income (MAGI), which can have a direct effect on costs like IRMAA (Income-Related Monthly Adjustment Amount) charges for Medicare premiums. If your income increases due to bond interest, it could push you into a higher Medicare premium bracket, increasing your overall healthcare costs.
Individual Bonds vs. Bond Funds: Which Is Right for You?
Individual Bonds:
Predictable Income: With individual bonds, you know exactly how much you’ll earn as long as you hold the bond to maturity. This makes them a great choice for creating steady, reliable income.
Risk Control: You can choose bonds based on the issuer’s credit rating and your risk tolerance, giving you more control over the risk you’re taking.
More Control: Owning individual bonds lets you decide exactly which bonds you want to invest in.
Bond Funds:
Diversification: Bond funds hold a variety of bonds, helping to spread out risk. This is great for people who want a broader approach to investing in bonds.
Liquidity: Bond funds are easy to buy and sell, making them a flexible option if you need access to cash.
Professional Management: Bond funds are managed by experts who decide which bonds to buy and sell, making it a good choice for those who prefer a hands-off approach.
Balanced Funds:
Growth Potential with Income: Balanced funds offer a mix of bonds and conservative stocks, providing both income and the potential for growth. They can be an excellent choice for people who want to balance stability with some upside.
Diversification: Since balanced funds invest in both stocks and bonds, they provide built-in diversification, which can help manage risk.
Aggressive Bond Funds (Bucket 3):
Higher Growth Potential: Multi-sector and international bond funds offer exposure to a wider variety of bonds, including riskier assets that have higher growth potential over time.
Diversification: These funds help spread out risk by investing in multiple types of bonds from different sectors and regions, making them ideal for long-term growth.
Conclusion
At Sevey Wealth, we believe there is no "one size fits all" when it comes to bonds. Every investor has different goals, and that’s why we use a wide range of bond structures based on what’s best for each portfolio. Whether it’s individual bonds like U.S. Treasuries and CD ladders, bond funds, balanced funds, or more aggressive bond funds like multi-sector and international bonds, we tailor the approach to fit your unique retirement goals and risk tolerance.
Our buckets approach ensures that your portfolio is built to create a predictable cash flow while allowing for the growth potential you need in the long term. We manage the risk by choosing the right mix of bonds for the different phases of your retirement. Before making any investment decisions, it’s important to evaluate your goals and how much risk you’re comfortable with.
At Sevey Wealth, we are committed to helping you build the right strategy that aligns with your long-term objectives. Bonds can provide stability and income, but it’s essential to structure them in a way that supports your financial future. Let us help guide you in choosing the right bond strategy for your retirement.
