If you’re thinking when you retire you can live off some kind of fixed income portfolio, forget about it.
That’s a myth now.
Sure, there was a time when you could, but that’s gone the way of the dodo bird and free markets.
With the Federal Reserve manipulating interest rates “lower for longer” for decades and lately driving them down to near zero, or maybe busting another myth and turning them negative some time in our future, there’s no way anyone can retire comfortably, or retire at all, on a fixed income portfolio.
Not only isn’t there enough yield to be had, unless you load up of the riskiest bonds out there and good luck with that, you’re at increasing risk of losing money on your fixed income dreams in more ways than you know.
Here’s why and how traditional fixed income investing for your retirement is a bad idea and what to do instead.
The bond market’s a complicated beast. It’s also where we get “fixed income” bills, notes, bonds, and other yield-based products from.
Fixed income means you pay what it costs for a bond (we’ll use the generic term “bond” for all fixed income investments), and you get a fixed amount of income, called interest or yield, from your investment.
The Truth About the Bond Market
The biggest complication with the bond market and your bond investment is while the yield, or fixed amount of income you get, doesn’t change, the price of the bond itself is always changing.
If you don’t ever sell your bond, or bonds, meaning you hold them to maturity, price doesn’t really matter to you. You collect your interest based on your yield and when the bonds mature you get the principal or “par” amount of the bonds back.
The principal or par value of a bond isn’t necessarily the same amount as what you paid for the bond.
A bond is essentially a loan, it’s called a bond because there’s a bond between the borrower and the creditor. If you borrow $100 from someone and offer to pay 5% interest a year for two years to whomever lends you the $100, you may have a written agreement that records the transaction and covenants that define your relationship, or you may offer your word as your bond that you’ll pay the interest and the lender’s principal ($100) back in two years.
In this example the par amount or the principal amount is $100, and the lender would lend you $100.
That’s basically how it works across all bond markets, with minor and major complications, of course.
But suppose the lender wants to get their money back sooner than two years. That’s when price matters.
In the real-world marketplace for bonds, price matters.
Suppose you bought a 10-year U.S. Treasury bond and paid $100 and suppose the yield or interest rate is 5%. If you want or need to sell that bond before it matures the price you get probably won’t be $100
If interest rates rise a year after you bought the bond, and new 10-year Treasuries are yielding 6%, no one would pay you $100 for your bond that only yields 5% when they can buy a new 10-year bond that yields 6%.
The good and bad news is there’s a mathematical way of calculating what your bond is worth to someone.
Since your bond only pays 5% a year, the price you get would be lower by an amount that makes both yields about equal. In other words, for your bond to yield 6% (what investors want to get now) the price would have to come down. At some price, maybe $90, the buyer who is only investing $90 to collect 5% is getting the same yield as an investor paying $100 to get 6%.
The reciprocal of that is, if interest rates go down, your 5% yielding bond would be priced higher because your bond yields more than what new bonds with the same maturity are yielding.
With interest rates moving all over the place all the time, you can see now that price matters, if you’re going to sell your bonds before they mature.
Retiring on Bonds: Nothing More than Fanciful Folklore
The problem for fixed income investors now is the Fed has lowered rates so much, which has been good for bondholders who own higher yielding bonds because the price of their bonds has gone up, that most of the “price appreciation” is already baked in.
Unless the Fed lowers rates more, or turns them negative, there’s not much price appreciation left in bonds. However, if interest rates start rising, bondholders who are buying bonds with exceptionally low yields won’t only get stuck collecting miniscule amounts of interest, the price of the bonds they own will start falling.
That’s what retirees are faced with now.
Moving into fixed income bonds and products now, with rates so low, not only locks in miniscule interest payments, it exposes investors to huge losses if they have to sell their bonds before they mature.
The U.S. Treasury 10-year bond yields about 0.80%, that means you get eight tenths of one percent interest on your “loan” to the government every year for ten long years. That’s nothing!
You can’t retire on anything like that.
And if you buy bond funds or bond ETFs that have higher yields because they’re investing in riskier bonds, sure you may get more yield but you’re taking more risk with your retirement money than you need to or would want to. Bond funds and bond ETFs are just as exposed to interest rate fluctuations as individual bondholders.
Two Much Better Ways to Invest to Retire
There are better ways to invest for income.
Option one:
Earlier this year, my publisher introduced me to a man who would quickly become one of my team’s greatest assets: Andrew Keene.
Andrew’s trading strategy is intense, fast, and proven. Even in the worst conditions, I’m talking about March lows of course, Andrew was leading folks to four- and five-digit payout opportunities.
Every morning at 9:30, he walks his subscribers through several trade recommendations, play-by-play, and they’ve had fantastic results. Bob Dunn was up $34,000 while the markets were crashing, Raymond C. made $74,000 in one play, and Robert Norton made $19,255 in one week, then used that to make another $51,422.
It’s simple, it’s fast, it’s proven, and it could hand you the profits you need to retire.
Another option:
The dividend yield on the stock market today, as measured by the S&P 500 is about 1.81%. It’s about 2.15% on the Dow Jones Industrials Average.
You can buy SPY or DIA, two ETFs that track the S&P 500 and the Dow and collect interest on your investment in the stock market.
You will be at risk if the market falls. But, if it does and you have a long-term perspective (meaning you won’t need to sell your investment) for maybe 10 years, the same as the 10-year maturity bond you could have bought, the stock market will more than likely rise again, maybe keep rising, and you’ll still be getting your interest while your stock market investment appreciates.
Interest rates aren’t going a lot lower. They could turn negative, but that’s not likely and if it happens, they may not go negative for too long. Besides, why would anyone lend the government money and get back less than you lend, because that’s what happens when rates are negative.
If you’ve got a 5- to 10-year investment horizon, and longer would be better, you’re infinitely better off buying the stock market and collecting interest on stocks, because of their dividends, than you are investing for your retirement in fixed income…anything.
And, even better, you can buy good, safe high yielding, dividend paying stocks and earn good fixed income from them.
I’ll recommend a bunch of those stocks right here, next time.
Until then,
— Shah
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Source: Total Wealth