Subscribe
Share
Share
Embed
Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire On Time, a show that answers your retirement questions. My name is Mike Decker. I'm a licensed financial advisor and fiduciary. And with me in the studio today is my colleague, David Franson, who will be reading your retirement questions. As always, you can submit those questions to (913) 363-1234.
Mike:Again, that's (913) 363-1234. David, what do we have for today?
David:Hey, Mike. I plan on living off of income from my bond portfolio. What's the risk with this income strategy,
Mike:and how do you plan around it? A bond portfolio is a very tried and tested strategy. It's boring, and boring is often very good.
David:K? What kind of bonds are these? Are these just a variety? That's a
Mike:good question. It's probably usually, when people say they got a bunch of bonds, they've got a bunch of bond funds.
David:Okay.
Mike:So we should probably differentiate the two.
David:So the fund has a lot of different bonds in it?
Mike:They're actively trading bonds. Oh. So, basically, bond funds can lose money. So if interest rates go up or down, the treasury, the ten year treasury, you'll like the market will affect bond funds. So bond funds aren't necessarily protected.
Mike:They're less volatile or less risky, but they have less growth potential. You equally have to appreciate the growth potential with the risk that you're taking. Bonds themselves are technically, quote, unquote, called fixed income, if you wanna be fancy. Okay. That's the fixed indexed part of the financial services space.
Mike:And, originally, the idea was you buy some bonds from some municipalities, some local governments, or treasuries from the federal government. Right?
David:K.
Mike:And you get your coupon rate that pays you your income, and all is well. And you might say, well, I've got a bunch of municipal bonds, so I'm getting tax free income. Life is good. There's a couple of risks associated with it. I'm not saying it's a bad strategy.
Mike:I'm saying, let's highlight the risks associated with it. And if you're okay with these risks, then great. If you're not okay with these risks, then maybe you maintain the strategy, but just blend in another or a secondary strategy to complement it.
David:Okay.
Mike:Now the two risks that I see are very high are, first off, inflation risk. So I know there are inflationary bonds out there. I'm not dumb. But the bonds that I see people buying aren't necessarily tied to inflation. They're tied to a fixed coupon rate.
David:So you're saying that there's a bond that would change its rates based on inflation?
Mike:Yeah. For example, like a zero coupon bond that's tied to inflation.
David:Oh, okay. So if inflation goes up, then the bond would pay more, is that what that means?
Mike:It matures at a better rate.
David:Oh, I see. Okay.
Mike:K. But most of bonds I'm seeing in portfolios, they aren't built around inflation. Uh-huh. They're built around, okay. Here's the debt that we want, and in exchange for you lending your money to us, because bonds are debt instruments, we're going to pay you a coupon rate, and then when it matures, you get your money back.
Mike:That's the idea.
David:So there could be like I don't know. The city of Prairie Village wants to expand their police department, whatever. They would get a bond for that?
Mike:Yeah. That'd be like a municipal bond. Okay. And those could be tax free. Now all markets are equally weighted based on the risk reward and benefits.
Mike:So a municipal bond will be priced in even though it may be tax free, but you're probably gonna get a lower rate than if you bought a bond that would create a taxable situation. So don't think that you're gonna have an apples to apples comparison of tax free municipal bonds than not.
David:Okay.
Mike:Also, it's important to note that according to the provisional income, which is how you calculate Social Security, municipal bonds and their, quote, unquote, tax free income actually count against you when it comes to your Social Security calculation. You can't get around that. It might be okay. It might not be okay. The reason why I say it might be okay, it might not be okay, is you might think, well, it's the government.
Mike:If something goes wrong, they'll just increase taxes, and the government's not gonna collapse. That's not always the case. Some municipal bonds can go belly up. Like, look at Puerto Rican bonds.
David:Okay.
Mike:So Puerto Rican bonds were going insolvent or at risk of insolvency, and so that kind of went sideways. So not all bonds are perfectly safe. They're backed as good as the municipality or so on. But let me go back real quick. Inflation risk.
Mike:If inflation gets out of hand, your bond doesn't necessarily keep up with inflation. So you might actually go backwards. K? Yeah. In addition to the inflationary risk, you've got reinvestment risk.
Mike:I don't see a lot of people buying a bond letter that goes out for thirty years. Usually, it's like five to seven years. So what happens once the bond matures? What is the coupon rate, or what are you gonna get at that point? No one knows.
Mike:What if bonds are gonna be, I don't know, 2%? Could you live off of that? If you've maintained your principal and you're living off whatever the coupon rate is or the income, quote unquote, rate is, could you live off that? And are you okay with the income risk because the coupon rate is or the reinvestment risk is kind of like your income risk in that situation? And you might say, well, you know, if that happens, I'll just sell part of the principal.
Mike:Well, if you sell part of the principal, then you're also cutting your legs out from underneath you. It's like the snake eating its tail. That's the right expression. Right? It can be an issue.
Mike:Then you've got another layer of issues, and that's the creditor. So how good is the creditor that backs it? So I'd say overall, government based bonds are probably safer than other bonds. That's a generalization. That's not always true.
Mike:But then you've got corporate bonds, and there's high quality corporate bonds, and there are low quality corporate bonds. And marketing is a very interesting thing, and that you've got high yield bonds, which are junk bonds. You're being compensated at a higher coupon rate for taking on more risk.
David:Sure. Okay.
Mike:So you're not gonna have a safe retirement based on fixed income when you're getting 9%, if that's even possible from these bond funds or not bond funds, but bonds themselves. So proceed with caution. It is a viable strategy when implemented correctly, but just understand that you may be taking on additional inflation risk, reinvestment risk, and credit risk in that strategy. There's no such thing as a riskless retirement, and there's no such thing as a perfect investment product or strategy, which means it is very, very important, in my opinion, to blend strategies and be prepared for whenever your strategy doesn't work, what's your backup plan. That's all the time we've got for the show today.
Mike:If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis.
Mike:Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.