Retirees Can Do an All-Bond Portfolio for Income and Portfolio Preservation
© Shane Flait (2012)

 

Are you of modest means and worry about how to invest your money in these tough times? If you really can't afford to risk any of your money to market downturns, then perhaps you should try an all-bond portfolio.

By this, I mean pack your portfolio with solid bonds – i.e. Treasury and Treasury inflation-protected security type bonds, U.S. agency bonds and high-grade municipal bonds. But don’t forget to maintain 3 to 6 months of money in short term Treasuries or a money market for emergencies.

Don’t maintain the usual equity portion of your portfolio and stay away from bond funds since they can lose unrecoverable value, too.  You’ll just buy and hold your bonds to their maturities. By doing this, you’re looking for steady income for your living expenses or building your portfolio. And you’re eliminating any chance of loss of your principal since you’re holding your bonds to maturity – and buying bonds that won’t default.

By foregoing equity investments you’re ignoring Roger G. Ibbotson of Yale University in New Haven, Conn. His classic findings show that, historically, stocks have returned about 10% and bonds 5%. But this apparent advantage of higher equity returns is undermined by several considerations:

• You must pay federal, state and sometimes local income taxes on equity gains.
• Fees and expenses associated with fund holdings are not taken into account, and
• Your bad timing when buying and selling your equity funds can seriously undermine your expected return.

The historical return that individual investors received after taking these three considerations into account brings the expected stock returns down closer to the return of bonds.

Buying newly issued bonds and holding them to maturity eliminates capital gains tax – i.e. you buy them for what you eventually receive as principal; there are only minimum fees that apply, and there’s no bad timing. So after risk-adjusting stocks, bonds (when bought and sold as recommended here) are a more assured investment in tough times.

What about inflation’s effect on your bond income?

Buying equity is presumably the way to combat inflation. But stocks produce risks that bonds simply don’t have. Stocks have taken enormous hits in the past. Even under the high inflation of the 1970s, stocks crashed in 1973-1974. In 1973 stocks lost 14.6% and in 1974 stocks lost an additional 26.5%. Moreover, between 1966 and 1981 stocks essentially provided no positive return.

Clearly, you must hold equity through the very long term to offset possible losses that the markets can produce. As a retiree you can’t afford a long recovery time with limited resources.

For your all-bond portfolio, rising inflation means rising interest rates which you can take advantage of by laddering your bonds. That way you can reinvest the interest earned and principal that comes due each year in brand new higher-yielding bonds.

I’d still try to put about 4 or 5% of your portfolio in a hard asset such as gold in case inflation shows up with a vengeance.

 

 

 

 

Shane Flait is a writer and educator. See more at www.EasyRetirementKnowHow.com