Are Bonds A Safe Way To Invest?

We often hear the question at Bertram Financial. When determining whether bonds are a safe way to invest, conventional wisdom tells us that the closer we get to retirement, the more we should reduce the amount of risk in our portfolios and move away from stocks and into bonds. 

 

You may have heard about the 60-40 portfolio set up. (Read about rebalancing and the 60/40 portfolio here) That refers to a portfolio made up of 60% stocks 40% bonds, which can be especially important as you’re moving towards retirement.

 

One of the most common investment vehicles, especially with retirement planning, is target-date funds. Target-date funds move you away from equities and more towards bonds as you approach your retirement date & beyond. 

 

Should I buy bonds?

 

So, with all of that conventional wisdom, are bonds a good place to invest? We have some individuals who had quite a few bonds during this last market correction or craziness as I like to say. During this past spring, bonds were hit well as the equity market. While bonds can be a great place to invest, the truth is that the bond market is inefficient. 

 

Most people that are investing in bonds are investing in bond funds. These bond funds become inefficient for multiple reasons.

 

First, because of their size and how large they are, bonds need to be bought in bulk. Investors might see a great opportunity come up in bonds but because there might be only a million dollars worth and they need more for their bond fund they can’t even touch it because they’re too big to get into some of the opportunities. Plus, they end-up paying the people selling bonds, whether you’re buying individual bonds or they’re going to the bond funds, sometimes they’re marking them up and you’re paying a premium because you’re paying the people that are selling the bonds. Therefore, the bonds are being marked up by 4% before you even get them. 

It doesn’t matter if you sell or somebody else sells, they have to sell. 

 

Lastly, I just recently saw a bond statement and talked about the yield. The yield was saying yield to maturity, however, if we take a closer look at the individual bond we find that it was callable in a couple of years. That means if interest rates are low then more than likely that bond is going to get called. This means that the interest rate it was showing would only yield them about ⅓ of what they would actually receive. 

 

How do I work to reduce risk in my portfolio as I move towards retirement?

 

With the bond market being so inefficient, the question becomes, what can we do about it?

 

As is with everything at Bertram Financial, we always look to find specialists and experts in different areas to help. We are excited to have some bond experts on our money management team. They have all the experience of working in the bond industry for years, but because of their size and structure, they’re able to do things that the bond managers cannot do.

 

If there is a great opportunity that comes up, they can buy at the institutional prices, they don’t have to pay the markup, and they can buy smaller portions that fit each client’s individual needs versus having to do it for a fund. 

 

I look at it this way, think of bond funds as a big bus. If you have this big bus and you have to park that bus, I want you to think about parking this big bus in Downtown Madison. Can you imagine how hard it is to find a parking spot for this huge bus in Downtown Madison? It’s not very convenient, right? Yes, you can get on and off whenever you need to, but if you have to park the bus, it is going to be a while. There might be great parking spots right by where you have to go, but if you have to park the bus there you’re not going to be able to. 

 

That’s how the bond funds work. With our management team, it is kind of more like getting an Uber driver. They know the best spots to go and they can fit into smaller parking spots. If you’re going to go to bonds we want to make sure that we have a specialist work with you because you may end up in a very inefficient situation. 

 

Are FIAs (Fixed Index Annuities) good?

 

A Chief Investment Office at Zebra Capital and Yale professor by the name of Roger Ibbotson just released a white paper on Fixed Index Annuities (FIA) as an asset class. An FIA is a retirement vehicle that allows you to participate in some of the upsides of the market while not taking any of the downside losses.

 

In this white paper, which you can download, it will talk about what they’ve done over time. Roger talks about the ability to use FIAs as an alternative to bonds in your portfolio for multiple reasons. He says it is very prudent to reduce risk as your closer to retirement, but you do have to be cautious about your strategy to approaching the bond market.

 

He strongly recommends looking at FIAs as a bond alternative inside your portfolio. Roger also advises that you speak to an advisor to make sure that this move fits in your overall plan. 

 

So far he has seen great results with this method. Don’t forget to download that white paper, or better yet, if you want to talk about a strategy to reduce risk as you move into retirement or using our experts and my management team to be more efficient in the bond market, give us a call. We will connect you with one of our specialists on the team to answer any questions that you may have.