| Bonds Online |
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| 5/10/2013Market Performance |
| Municipal Bonds |
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S&P National Bond Index
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3.00% |
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S&P California Bond Index
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2.96% |
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S&P New York Bond Index
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3.13% |
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S&P National 0-5 Year Municipal Bond Index
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0.70% |
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| S&P/BGCantor US Treasury Bond |
400.09 |
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| Income Equities: |
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| Preferred Stocks |
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S&P U.S. Preferred Stock Index
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848.03 |
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S&P U.S. Preferred Stock Index (CAD)
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636.26 |
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S&P U.S. Preferred Stock Index (TR)
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1,701.05 |
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S&P U.S. Preferred Stock Index (TR) (CAD)
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1,276.26 |
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| REITs |
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S&P REIT Index
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174.07 |
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S&P REIT Index (TR)
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425.30 |
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| MLPs |
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S&P MLP Index
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2,469.58 |
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S&P MLP Index (TR)
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5,428.50 |
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See Data
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Bond Funds Are Bad For Retirement |
Forbes.com - May 7, 2010 - by Stephen J. Huxley
Buying individual bonds is the best way to structure retirement income while minimizing exposure to capital losses.
The top concern that advisors hear from retired clients is that they will outlive their money. The challenge for the advisor is to ease those fears with a portfolio strategy that creates stable retirement income without any dramatic change in the client's lifestyle.
This is the fundamental advantage that the unheralded world of individual bonds can bring to the table. Unlike more widely used bond funds, individual bonds offer predictability when managed properly. Bond funds can experience falling net asset values as interest rates rise (they are predicted to rise this year), which can have a substantial negative impact on the portfolio if clients need to make withdrawals. But holding individual bonds to maturity can immunize the portfolio against rising rates. In fact, holding U.S. Treasuries, agencies, CDs and TIPS to maturity provides the closest thing to perfect predictability that exists when it comes to future cash flows. It represents one of the few exceptions to the rule that it is impossible to forecast the future (death and taxes also come to mind).
This predictability means that individual bonds can be used to create peace of mind for retirees worried about what will happen to their long-term chances of success if the market happens to be down just when they have to sell to get cash for living expenses. Individual bonds, if their maturities are managed properly, can supply perfectly timed cash flows year after year, without missing a beat.
The idea is to build what college finance books call a "dedicated bond portfolio." This requires synchronizing the bond maturities and coupon payments to match the cash flow stream the client needs, then holding the bonds until they are redeemed.
For example, consider a couple just entering retirement with a $1 million portfolio. Assume their advisor has recommended a 60/40 stock/bond allocation (probably the most common retirement portfolio) with an initial withdrawal rate of 5% increasing each year with inflation. That means the couple would withdraw $50,000 the first year. If inflation during that first year turned out to be 3%, they could withdraw $51,500 the next year, and so on.
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To generate and protect these cash flows regardless of market performance the planner could buy individual bonds with that $400,000 and hold them to maturity. Each bond would supply income in two ways: the coupon interest it produces each year plus its redemption value when it matures. These cash flows would remain constant, regardless of what happens to interest rates--they have been immunized.
The trick is to buy the bonds in just the right amounts and maturities so that the total cash flows match the withdrawals needed for each year. At current yields on U.S. Treasuries or AAA corporate bonds, $400,000 would buy about eight years of income starting at $50,000 and growing at 3% per year. Because safety is paramount, only the safest bonds are used (governments or AAA rated munis or corporates).
Once the dedicated bond portfolio is in place, it provides the cash flow for the withdrawals in just the right amount at just the right times. Furthermore, the eight-year income stream is protected from market fluctuations. The value of the portfolio itself is not protected against rising interest rates, but the cash flow stream is protected because the bonds are held to maturity and not traded. Risk is nullified where it counts. As each year passes, the same eight-year time horizon of protection can be maintained for as long as needed by adding a new bond with an eight-year maturity if desired. Doing it every year over a lifetime would be the equivalent of self-annuitizing.
There is nothing sacred about eight years. Other horizons can be used (5 to 10 years are common for retirees). At today's yields, each year of cash flow takes about a 5% allocation to fixed-income, assuming the initial withdrawal rate itself is at or below 5%. For instance, if the couple had wanted a 30% allocation to fixed income, they could have secured about six years of income; a 50% allocation would buy about 10 years of income. Most retirement portfolios' fixed-income allocations fall into a 30% to 50% range, with 40% being the most popular.
By following this simple dedicated portfolio strategy, advisors can give their retired clients several advantages unique to individual bonds. They can insulate clients from volatile markets. They can provide an intuitive explanation for the client's bond asset allocation. And, especially important in today's competitive times, they can focus on the other non-investment issues that advisors need to manage in providing comprehensive wealth management services to their clients.
Stephen J. Huxley, Ph.D. is chief investment strategist at Asset Dedication, LLC.
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