Many retirees may see bonds as a safe track for increasing income during their golden years, but bonds do carry some risks.
The bond market is known as a safe haven to escape the volatility of stocks and other investments, and recent events have sent many investors fleeing to them.
But even if you are keen on bonds, Ken Fisher, founder and executive chairman of Fisher Investments, explains why a bond-heavy portfolio may not be the best retirement investment strategy in a recent article on USA Today. Fisher likes certain aspects of bonds, like their transparency and definable risks and proportioned reactions to those risks, but he suggests using them in a broader, blended portfolio with other assets.
Here are five risks involving bonds, according to Fisher:
1. Interest Rate Risk of Bonds
Bond prices and interest rates move oppositely. When interest rates rise, bond prices fall. Rates will probably increase little in 2019, but when they do, selling before maturity (to meet an expense, perhaps) locks in losses.
2. Credit Risk of Bonds
Otherwise called default risk – the potential that a bond issuer reneges on the contract. When the issuer can’t make interest or principal payments, they default. Depending where you sit in a bankruptcy pecking order, you may not get your money back. When Greece defaulted in 2012, bondholders suffered huge losses. Higher credit risk bonds carry high-interest rates – alluring – but that simply balances the higher likelihood of loss.
3. Liquidity Risk of Bonds
With individual bonds rather than a bond fund, you can hit trouble when it’s selling time. Many bonds – particularly corporate and municipal issues – don’t trade much. That can make them tricky to price and find buyers for. Most bonds aren’t like stocks, which trade daily on public exchanges. Selling can be more slippery than a politician’s pretty promises. You can’t sell in a flash near prices found online. Selling a “thinly” traded bond with few buyers can leave you forced to sell at steep discounts – particularly if there are no buyers and you need the proceeds fast for unexpected reasons.
4. Reinvestment Risk of Bonds
Owning high-interest bonds from low-risk issuers – and planning to hold them until they mature – may seem fool-proof. Yet even here, risks lurk. Many corporate bonds are “callable” – meaning the issuer can redeem them at will. Companies often do this when interest rates fall. Why keep paying the higher rate when they can call the bond at below market prices and float a cheaper new one? Good for them. Bad for you.
Even if your bond isn’t called, trouble can loom when it matures and you must replace that income stream. What if you can’t find something with a high enough yield? A 30-year U.S. Treasury bond from 30 years ago paid over 8% a year. Good luck finding that with low default risk now! America’s current 30-year yield is below 3%. You can’t even get near to 8% in Greece! Its 25-year debt pays just 4.3%. You’d need a 30-year Mexican or Brazilian bond, skyrocketing credit risk.
5. Inflation Risk of Bonds
Few bonds have inflation-linked interest rates. Normally, interest is the same each year. When the bond matures, you get the exact face value back. Over time, even low inflation erodes the interest income’s purchasing power. Ditto for your principal. With a 10-year bond maturing now, the $1,000 you receive buys far less today than it did when issued in 2009. To maintain purchase power, your money must grow.