Retirement 101: What Are Bonds?
Bonds can be a valuable part of your retirement savings. Before investing in bonds, it is important to understand what they are and how they work so that you can make informed decisions while planning for retirement. Below, we discuss what bonds are and the advantages of adding them to your retirement portfolio.
What Are Bonds?
When companies and governments need to borrow money, they can raise funds by issuing bonds to the public. Basically, a bond is a loan where you are the lender and the organization issuing the bond is the borrower. The issuer (the government for example) offers the lender (you) incentive by offering interest payments. These payments are set at a prearranged interest rate (or coupon) and are paid out on a predetermined schedule. The issuer has to repay the full loan amount on the maturity date.
Bonds are considered fixed-income securities because you know how much money you will be getting back when the bond has matured.
The difference between stocks and bonds is that bondholders act as a creditor instead of having part ownership. This means that in the case of bankruptcy, bondholders are paid before stockholders. However, when the company is doing well, bondholders do not share in the profits as stockholders do.
Different Types of Bonds
If you plan to invest in bonds in retirement, it is important that you diversify your portfolio by including different kinds of bonds. There are three main types of bonds:
1. Corporate Bonds
These are issued by private and public corporations and include investment-grade bonds, which have a higher credit rating, and high-yield bonds, which have a higher risk but offer higher interest rates.
2. Municipal Bonds
These are issued by states, cities, and counties. These bonds include general obligation bonds, which are not secured by assets, but rather backed by the full faith and credit of the issuer who can tax residents to pay bondholders. Revenue bonds are municipal bonds which are backed by revenues from a specific source, such as highway tolls. Another type is conduit bonds, which are issued by the government on behalf of private entities, such as hospitals or nonprofit universities.
3. U.S. Treasuries
U.S. Treasuries are a popular investment because they are issued by the U.S. Department of Treasury and carry the full faith and credit of the U.S. government. Types of U.S. treasury bonds include treasury bills, notes, bonds, and Treasury Inflation-Protection Securities (TIPS).
Pros and Cons of Bonds for Retirement
Bonds can make a great addition to your retirement portfolio. Though bonds may not offer the high returns of stock, they provide many advantages for retirees.
- Stability: Bonds are more stable than stocks, so including these in your portfolio along with your stocks can offer more stability when the stock market declines.
- Income: Bonds are a great way to create a steady stream of income because they regularly pay interest, typically twice a year.
- Security: U.S. Treasuries are the safest and most liquid investments next to cash. Bonds are a great way to invest money that you may need soon.
- Tax Savings: Some bonds offer income that is tax free. Though these bonds often pay lower yields than taxable bonds, they may offer higher income after tax for those who are in higher tax brackets.
Overall, bonds can be a great way to find a predictable income stream in retirement. If held to maturity, bonds also allow you to preserve your capital while you’re investing. If you cannot afford to take chances by exposing yourself to stock holdings that may be volatile, consider incorporating bonds into your retirement plan.
Find Out if Bonds Belong in Your Retirement Plan With a Retirement Calculator
A retirement calculator can be a good way to find out what you need to do for a more secure retirement. However, before making major investment decisions, you might want to work with a financial advisor.