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Bonds at Your Stage of Life

Your Stage of Life

Starting Out: Investing in Your 20s and 30s

  • Investment Goal at this Stage Maximize Capital
    (your most likely primary financial goal at this point)
  • Investment Horizon Very Long (30 - 40+ years)
    (how long until you need to access your money)
  • Risk Tolerance High
    (how much risk you feel comfortable taking)

At the beginning of your career you may have a hard time imagining life 15, 30 or 40 years from now. Chances are that you are more concerned about paying bills and saving money toward big-ticket items such as a car, a wedding, a house or having a baby.

Your ability to reach your goals and achieve financial security, however, depends in part on maximizing your current income through investments. You have the opportunity to create the important habits of saving and strategically investing now so you can enjoy its benefits in your later years. The work that you’re doing now is laying a foundation for future financial freedom. For example, having money withdrawn from your paycheck and automatically deposited into an employer-sponsored 401(k) retirement savings plan can provide you with a solid nest egg when you leave the workforce.

Since you have a longer horizon for investing (the amount of time between now and when you want/need to access your money), you are in a better position to consider investing in higher-yield, higher-risk instruments. There are higher-risk bonds that carry high coupons (interest rates) You may be interested in assuming that risk to potentially make significant interest on your investment.

Keep in mind, however, that even at this early stage of the investment game, you want to aim for a well-blended portfolio to balance risk and market volatility. While your higher-yield investments can appear more exciting (because of their potential to earn more interest), it’s important to round out your portfolio with some strategically chosen lower- and medium-risk investments as well, including bonds.

Depending on your circumstances bonds can help you:

  • Grow capital through high-yield returns There are high-risk/high-yield bonds that may be of interest to you as you look to grow financially. Remember that when you invest in higher-risk instruments you face a greater potential for loss due to interest rate risk and credit risk. Carefully research each bond offering and know a bond issue’s conditions and terms (including its’ rating, call features and whether or not it is insured) prior to investing. A financial advisor may be able to help you. Click here to learn more about “Selecting and Working with a Financial Professional.”
  • Preserve your savings for a big future purchase If you are saving money for a large future purchase—a car, a wedding, a house—you might consider investing that savings in a low-risk bond with a maturity date that matches the date you will need the money. For example, new issue U.S. Treasury bills, notes and bonds are available directly from the Federal Reserve in three-month, six-month, and two-year and three-year maturities in $1,000 increments starting at $1,000. You can also buy outstanding Treasury or corporate bonds with maturities timed to your needs in the secondary market through a bank or a broker. Prices and yields will vary.
  • Diversify your employer-sponsored retirement plan If your 401(k) or other employer-sponsored retirement plan offers a variety of mutual funds, you might want to allocate some portion of your assets toward bond funds to diversify your holdings and spread your risk. Because the stock and bond markets do not often move in the same direction, bond investments can stabilize and even enhance your overall returns. You might look into high-yield and long-term bond funds if you want to take more risk for the possibility of higher returns.
  • Supplement your income Maybe you’ve received an inheritance or other large sum of money. Investing it in bonds can help you preserve the principal for the future while generating interest income that you can spend now. Depending on how much you have to invest, you might want to consider constructing a bond portfolio yourself with the help of an advisor, or investing in another type of bond investment such as a unit trust or bond fund.
  • Develop discipline with dollar-cost averaging One of the common myths about investing is that you have to have a lot of money to do it. That’s a good reason to consider dollar-cost averaging. If you can only invest a small amount at a time, or if you are uncomfortable investing large chunks of money at once, dollar cost averaging can be a way to invest in bonds automatically on a regular schedule. First, consider working with a financial advisor to determine what types of bond investments are appropriate for your portfolio. Next, select a regularly scheduled date to have a pre-determined amount of money automatically withdrawn from an account of your choice and have it deposited into your brokerage account to purchase (or earmark toward purchase) the bonds you have chosen. Making small deposits over time will add up to consistent investments which can reap significant dividends over the long term. Think you don’t have enough money to invest? Consider the dollar-cost averaging approach to purchase bonds for your portfolio.

In the Middle: Investing in Your 30s and 40s

  • Investment Goal Capital Growth
    (your most likely primary financial goal for your principal at this point)
  • Investment Horizon Long (20—30+ years)
    (how long until you need to access your money)
  • Risk Tolerance Moderate
    (how much risk you feel comfortable taking)

The middle years—mid-30s to late 40s—are crucial to accumulating and wisely investing toward your retirement and long-term financial goals. Even if you didn’t, or couldn’t, start saving and investing earlier you need to begin making up for lost time.

If you’re between 35 and 55, you are probably earning enough to live more comfortably now than when you were younger, but are increasingly concerned about funding your retirement and paying for your children’s education. While you still have time in your investment horizon to be able to recover from a market downturn, you don’t want to have your portfolio so heavily loaded in high-risk investments that you could lose the bulk of your money if the stock market or your individual stocks decline significantly.

Because your investment horizon is somewhat shorter than when you were first starting out in your twenties, you should rebalance your portfolio to make sure that you have allocated your assets appropriately. Financial advisers usually recommend that at this point in your investment life it would be prudent to shift your investments to focus more on medium-risk and low-risk instruments, while still maintaining a healthy, but smaller, percentage of investments in higher-risk instruments. Remember that the key is spreading, or allocating, your assets across investments of varying degrees of risk to blend the risk you’re taking and to maximize your interest-earning potential. Consult a financial advisor for investment recommendations and assistance.

Bonds should represent a larger portion of your asset allocation than they did when you were younger. Bonds provide a stable backbone and more predictable income generation than equities.

Following are some bond strategies to consider at this stage in your investment life. As always, it’s a good idea to consult a financial advisor before making any investment decisions.

  • Zero Coupon bonds for specific goals Zero coupon bonds are sold at a steep discount from their face value. When the bond matures, the face value reflects both the principal and the interest accumulated. Buying a zero coupon now with a maturity that coincides with the year your child starts college or the year you would like to retire can be a cost-effective way to increase the likelihood that you will have the money you need when you need it. Zero coupon bonds work best in a qualified, tax-deferred retirement or college savings account because the interest is taxable when it is credited to the bond, even though you can’t spend it until maturity.
  • Tax-advantaged bond investing If you’re in a high tax bracket, tax-advantaged municipal bonds issued by state and city governments may be more attractive than corporate bonds that pay taxable interest income. Interest paid on most U.S. government securities is exempt from state and local income tax, which can be important if you live in a high-tax state. Municipal bonds pay interest that is exempt from federal income tax, and, depending on the issuer, possibly from state and city income tax as well. To see how much you would have to earn on a fully taxable investment to match the return of a tax-exempt investment you’re considering, use the Taxable Equivalent Yield calculator. You can earn tax-exempt interest on bonds and bond funds that qualify. In most cases, you don’t want to put this kind of investment in a tax-deferred retirement or college savings account, however, so you don’t waste the tax exemption feature.
  • Increasing your allocation to bonds If you have not yet started investing a portion of your assets in bonds, now may be a good time to start. If you are willing to take a little more risk for the possibility of higher returns, consider high-yield or longer-term bonds or bond funds.

Nearing Retirement: Investing in Your 50s and 60s

  • Investment Goal Conserve capital
    (your most likely primary financial goal at this point)
  • Investment Horizon Moderate (5 - 15 years)
    (how long until you will need to access your money)
  • Risk Tolerance Low
    (how much risk you feel comfortable taking)

Hopefully by this point the hard work and discipline of saving and investing is creating a solid portfolio that enables you to look forward to financial freedom in your retirement.

As retirement approaches, your investment horizon shrinks. In other words, the closer you are to retirement, the less chance you want to take that you could lose a sizable portion of your investments. You want to more aggressively protect your assets from the stock market’s volatility. Many advisors suggest that people at this point begin increasing the bond portion of their portfolio to 50% or more to lower their overall investment risk.

Some issues to consider when evaluating bonds for your portfolio:

  • Bonds or Bond Funds? The bond markets offer investors many choices and sectors, each with a slightly different risk and return profile. As with all investments, diversification is important in your bond investments too. Because many kinds of bonds can only be bought in minimum increments of $5,000, creating a bond portfolio that includes different issuers, market sectors, maturities and credit qualities can require a significant amount of assets. Bond funds, unit trusts or exchange-traded funds may be a better choice for more convenient and affordable diversification, although they don’t offer the comfort of a single bond’s promise that your principal will be returned on the maturity date.
  • Tax-advantaged bond investing If you’re in a high tax bracket, tax-advantaged bonds issued by federal, state and city governments may be more attractive than corporate bonds paying taxable interest income. Interest paid on most U.S. government securities is exempt from state and local income tax, which can be important if you live in a high-tax state. Municipal bonds pay interest that is exempt from federal income tax, and, depending on the issuer, possibly from state and city income tax as well. To see how much you would have to earn on a fully taxable investment to match the return of a tax-exempt investment you’re considering, use the Taxable Equivalent Yield calculator. You can earn tax-exempt interest on bonds and bond funds that qualify. In most cases, you don’t want to put this kind of investment in a tax-deferred retirement or college savings account, however, as that would be wasting the tax exemption.
  • Managing interest rate risk The rule of thumb is that when interest rates rise, bond prices fall and vice versa. If you buy a bond with a 5% coupon and interest rates on the same maturity rise to 6%, not only will your bond be worth less if you want to sell it before maturity, but you will also be missing the opportunity to earn higher interest. One way to manage this risk is with laddering. Creating a portfolio of bonds with maturities staggered over one, three, five and ten years, for example, helps you do well in any interest rate environment. When rates are rising, you will have short-term bonds maturing that allow you to reinvest the principal at higher rates. When rates are falling, you will still have the longer-term bonds paying higher coupons.

Retirement: Investing in Your 60s

  • Investment Goal Preserve Capital
    (your most likely primary financial goal at this point)
  • Investment Horizon Short (Immediate Access to Funds)
    (how long until you need to access your cash)
  • Risk Tolerance Very Low
    (how much risk you feel comfortable taking)

During retirement your main investment focus is ensuring your financial security. Most financial advisors say you'll need about 70 percent of your pre-retirement earnings to comfortably maintain your pre-retirement standard of living. If you have average earnings, your Social Security retirement benefits will replace only about 40 percent. Your investments and your employer’s plan, if you have one, will have to make up the rest. Bonds can generate an important source of retirement income while preserving your principal.

When thinking about bonds, think about:

  • Maximizing your lifetime income The right kind of bond investments for you will depend on your life expectancy, your tax bracket, and the amount of risk you can afford to take. High yield and longer-term bonds may have higher coupons, but they also can put your principal at risk if you need to sell the bond before it matures and the issuer’s credit quality has declined or interest rates have risen. Consider a balanced bond fund where you can supplement your regular income with a percentage of your earnings while still maintaining enough capital in the fund to outpace inflation. If you’re in a higher tax bracket you may benefit from the federal (as well as possibly state and local) tax-exempt interest from municipal bonds.
  • Guarding against inflation Retirees living on a “fixed income” can lose purchasing power if inflation increases. To help guard against this risk, you might consider including Treasury Inflation Protection Securities (TIPS) or Treasury Inflation Indexed Securities in your investment portfolio. TIPS have a fixed coupon rate, but their principal amount is adjusted every six months according to changes in the Consumer Price Index. As a result, the amount of your income that should stay represents equivalent purchasing power. At maturity, you get the higher of the original face value or the inflation-adjusted amount. Another way to guard against inflation is to keep a small percentage of your portfolio invested in stocks for their greater growth potential.
  • Spend from taxable income first Remember that if you’re in a position where your cash assets won’t cover ongoing or one-time expenses you will want to dip into your taxable investment accounts first. Taking money from a tax-advantaged retirement plan, such as a 401(k) or IRA, can have tax implications and early withdrawal penalties. Keep an eye on CD maturity and bond maturity rates in your portfolio and consider cashing those out and retaining a portion before rolling the sum into another vehicle when they mature.
  • Leaving a legacy If you want to preserve your assets so they can be passed on to future generations or your favorite charity according to your wishes, you may want to establish an estate plan using investments held in trusts. Bonds often play a vital role in the investment strategy for an estate plan, but be sure to consult an attorney and accountant so you understand all the legal and tax implications.