Why Bonds Should Be Part of Your Retirement Portfolio
Michael Baum, CFP® RICP®
Vice President & Associate Financial Advisor
We have good news for investors: Bonds are finally offering attractive interest rates and can play an important role in most retirement portfolios. The 10-year Treasury yield has risen to a respectable 4.25%, a notable rebound from its shockingly low level of 0.55% in 2020. The 10-year Treasury yield hasn’t been this high since the onset of the Great Financial Crisis in 2008!
The Treasury bond is typically the benchmark off of which other bond interest rates are set. As a result, the entire universe of bonds is offering higher yields than were available just a few years ago. Corporate bonds can have interest rates that range from 5.5% to 7.5%, depending on their credit quality, and municipal bonds can yield north of 4%.
MAKE CASH WORK
What does this mean for investment portfolios? First, cash is no longer trash. Cash can be invested in money market funds or short-term CDs at interest rates north of 4% or 5%. Anyone with lots of cash sitting in a bank account earning almost no interest is missing out on an opportunity to earn interest income with very little risk.
THINK LONG TERM
It may be tempting to put a portfolio’s entire fixed income allocation into money market funds or short-term bonds because they’re offering higher yields than five- and 10-year Treasury bonds. Doing so may pay off today, but it may backfire in the next year or so.
Interest rates tend to move in cycles. When the economy is strong and inflation is a risk, the Federal Reserve raises interest rates and that’s what has occurred since March 2022. The Fed has raised its interest rate range from 0%-0.25% to 5.25%-5.50%. Historically, high interest rates slow economic growth, and sometimes recessions ensue. When the economy slows, the Federal Reserve responds by lowering interest rates to encourage economic activity.
Going forward, the Federal Reserve is expected to start slowly cutting interest rates. If that occurs, money market funds boasting a 5% yield today, will quickly adjust, and start paying out much less interest. Short-term CD rates would likely fall as well. Meanwhile, anyone who bought a 10-year Treasury bond yielding 4.5% would enjoy many more years of clipping attractive coupons.
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A STABILIZING INFLUENCE
Over the long term, stocks have been the surest way to grow an investment portfolio and beat the corrosive effect of inflation. But bonds can play an important role, too. Besides providing interest income, bonds offer diversification and act as a shock absorber in investment portfolios.
Every so often, investors get overly optimistic about stocks, prices rise too far too fast, something spooks the market and shares tumble. A 10% decline is called a correction and drop of 20% or more is colorfully called a bear market. The last bear market bit in 2022, when the S&P 500 fell by 24.5%.
Holding onto stocks while they are falling is never any fun. But a portfolio that includes a mix of stocks and bonds may not fall as sharply as a portfolio that only owns stocks. Ironically, bonds didn’t play that stabilizing role in 2022, when interest rates were close to 0% and inflation was rising, causing bonds to fall in value. Today, however, interest rates are much higher, inflation has fallen from much higher levels and bonds look ready to resume their traditional role of appreciating if stocks fall.
Bonds also provide interest income that investors can use instead of selling stocks that may be depressed after a correction. Alternatively, the interest income can be used to buy those depressed shares. Because, fortunately, stock market downdrafts have always been followed by rallies. For example, the 2022 bear market was followed by the current bull market, during which the S&P 500 has climbed more than 50% as of June 2024.
BE TAX EFFICIENT
Because bonds throw off interest income, typically twice a year, investors should think about how to minimize the resulting tax bill. The interest paid by investment-grade corporate bonds gets taxed at the local, state and federal level so they should be held in tax-advantaged accounts, like 401Ks or IRAs, where the income will remain tax-deferred. Treasurys interest payments are subject to federal income tax, but exempt from state and local taxes. So, depending on your tax bracket, you may want to hold those in tax-advantaged accounts as well. Conversely, the interest paid by municipal bonds often isn’t taxable at the federal level and may or may not be taxable at the local and state levels. Munis are often held in taxable investment accounts.
Our team of financial advisors at WHZ can help you determine how bonds can enhance your investment portfolio. At WHZ, our strategic Plan Well. Invest Well. Live Well.™ financial planning process looks at your full financial life when constructing a portfolio that will help you achieve your goals. Contact us for a complimentary consultation or call us at (860) 928-2341 if you're seeking a knowledgeable partner to help craft a hyper-personalized financial plan to provide Absolute Confidence. Unwavering Partnership. For Life.
Authored by Vice President, Associate Financial Advisor, Michael Baum, CFP® RICP®. Securities and advisory services are offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084. 860-928-2341. www.whzwealth.com.
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