As retirees get older, it’s common to shift a greater percentage of investment funds from stocks to bonds. This has been traditional wisdom for decades.
Traditional wisdom may not be the best option right now.
The last several decades have seen a bull market for bonds. They have been an effective safe haven when the stock market has gotten volatile and risky. But one thing has changed… the direction of interest rates.
Bonds and interest rates run inversely to each other. This means that as interest rates fall, bond values increase. The last several decades have been a narrative of falling interest rates.
Although we are NOW entering into a future in which interest rates risen and may continue to rise. This is bad for bond values.
Fortunately, if you hold individual bonds, you can simply hold them to maturity and get your money back.
Unfortunately, most investors today hold bonds in the form of bond mutual funds. The advantage of bond mutual funds is diversification… the default of any bond holding inside the portfolio won’t hurt you much. The disadvantage of bond mutual funds in a rising interest rate environment is that the bond mutual fund manager cannot control the maturity of the bonds and when they are sold. This is because the investors who see their bond values falling and sell shares of the bond mutual fund will require that the mutual fund manager sell enough shares of the fund to honor the liquidation request. This will lock in the losses of the bonds inside the bond mutual fund.
If you see interest rates spike and bond mutual fund values fall, you can be assured that investors will panic and sell. Who gets hurt? The ones still in the fund.
I read a recent article by Roger Ibbotson, Professor Emeritus of Finance at Yale School of Management and major thought leader (whose research and wisdom has formed what is considered traditional investment wisdom) who believes there may be a better asset class to replace bonds for an uncertain interest rate future.
That asset class is fixed indexed annuities.
In his white paper, “Fixed Indexed Annuities: Consider the Alternative” he thoroughly outlines his position in a convincing manner. Click on the following link to read it:
Whether or not you agree with Ibbotson, finding an alternative in the coming years to traditional bond mutual funds as a safe haven as you get closer to retirement will be imperative.
If you have any questions about the use of bonds in your investment accounts and for retirement, please contact me.