Until recently, investors enjoyed one of the longest bull markets of all time. However, rising volatility in stocks have sent many portfolios through sudden ups and downs, and created uncertainty about the future.
Fixed-income investments can help stabilize your portfolio and provide more predictability instead of uncertainty. Products like bonds may help hedge against the market’s dramatic swings, as they are less likely to feel the impact of volatility. This kind of investment may also help generate steady returns you may rely on to cover expenses such as healthcare, while preserving the assets you’ve built for retirement.
“If you’re entering or already in retirement, volatility in the markets can have a material impact on your portfolio if you withdraw funds on a regular basis,” said Matt Sadowsky, director of retirement and annuities at TD Ameritrade. “By having fixed income, you’re dampening volatility.” Essentially, a downturn in the stock market won’t necessarily hurt your fixed-income holdings the same way it hurts an equity portfolio.
Let’s take a deeper dive into four aspects of fixed income.
1. Goals of Fixed-Income Products
Fixed-income investments may have several purposes for those nearing retirement or already retired:
- Preserve wealth. Although prices may fluctuate and return of principal is not guaranteed, the end goal of fixed-income investments is to receive the full face value amount when your investment matures.
- Generate income. Investments may provide a steady stream of income to help supplement your other income or help fund your retirement.
- Diversify your portfolio. Diversifying your investments across asset classes may reduce the risk exposure for your overall portfolio. However, diversification and asset allocation do not guarantee against investment loss.
- Manage interest rate risk. Although the risks of not receiving interest rate payments—or worse, never getting your money back—are quite real, the most everyday risk with these securities is potential loss of value from interest rate changes. A bond ladder (see below) with staggered maturities, is one way you can try to manage interest rate risk in both rising and falling environments and limit exposure to interest rate volatility.
2. Potential Advantage of Bonds over Dividend Stocks
Over the last few years, as the stock market boomed, many investors began looking to dividend-paying stocks instead of bonds for their income. This isn’t necessarily a bad idea, but it typically exposes investors to higher potential risk. Companies can cut stock dividends or even cancel them entirely, meaning there’s no guarantee of income. A bond, especially a U.S. government bond, is much more likely to pay you the income that’s promised when you purchase it.
In addition, relying on dividends from stock holdings means exposing yourself to more of the stock market’s turbulence. Although retirees may feel they need stock market investments to help protect against inflation and provide growth opportunities, it’s worth questioning whether this is the best place to go for income. Keep in mind that bonds typically do not share in the same gains that the stock market sees.
3. Rates Factor in Risk of Default
Bonds do carry risks, including the possibility that the bond issuer might default. The more risky the bond, generally the higher the coupon rate, meaning you get a higher yield on your investment. Less risky bonds, including U.S. Treasury bonds, tend to pay far lower yields than some types of corporate or municipal bonds. The 10-year U.S. Treasury bond was paying investors a yield of about 2.7% as of mid-January 2019, while the average corporate bond paid 4.49% as of December 2018.
When considering a bond, remember to do your research. Check what the ratings agencies have to say about it and know the risks, including that of default. Bond prices tend to have an inverse relationship to interest rates. So one of the risks of holding a bond is that, if interest rates rise, the value of your bond would likely decrease. If you hold the bond until maturity, you’ll still receive the full principal and the full coupon rate, but if you have to sell the bond before maturity, you could lose money.
4. Creating Bond Ladders
Retirees don’t necessarily need to let interest rate fears stand in the way. One approach that may help protect against rising rates (which typically accompany falling bond prices) is to diversify your bond portfolio by building a bond ladder of short- and long-term bonds. By holding longer-term bonds, you may be able to benefit from higher interest rates. Shorter-term bonds mature sooner, which could give you flexibility to reinvest if rates rise in the future. Thus, a bond ladder is designed to diversify across time horizons to provide a balance of flexibility and yield.
The Bottom Line
As volatility continues to rattle the markets, making your nest egg last a lifetime may become more of a challenge.
Many investors still need to grow assets through other investments, such as stocks, but you might want to double-check your portfolio allocation. The optimal mix depends on a lot of factors, including your age, your other assets, and your spending needs, all of which you should consider discussing with a financial professional.
There’s no such thing as an investment without risk. But fixed-income investments have the potential to help those in retirement generate income over the long term and minimize the risk that comes with market volatility.