Bonds Come Up Short: Case Study February, 2016 In this real life example, a California couple ages 57 and 60 hoped to retire in 5 years. With an investment portfolio of more than $1,000,000 they expected to be able to live off the proceeds of their investment account, a rental property and social security. However, like most Americans they hadn’t taken a hard look at their spending or the impact inflation would have on their purchasing power. To help them understand the impact of inflation on their retirement, the retirement planner assigned to their case first showed them how their income and expenses would change over time due to inflation.
It was a wake up call. They would have to begin measurably drawing on their investment portfolio to supplement their income by the 5th year of retirement.
They wondered what would happen to their lifestyle if they had to depend on their investment accounts and the market crashed again.
To answer their question, their planner showed them what their income would look like if they invested in low risk or risk-less bonds to guarantee their retirement. That way they wouldn’t have to worry about a market crash. To compare, they also looked at a highly rated Fixed Index Annuity (“FIA”) which would guarantee their income like the bonds, but also give them a high probability their income would increase in the future.
To round it out, their planner also included one of the most popular types of dividend paying securities.
See the table below to see how well bonds and dividends worked.
Even though some of the bonds or dividend payers could have worked, there were three big problems.
First, if they hoped to increase their income, they would have to buy mostly shorter term or higher risk bonds and then hope interest rates were higher when the bonds matured and it was time to reinvest. In the low growth economic environment we are likely to continue to be stuck in for years or decades, it didn’t seem likely that bond opportunities would be much better 3, 5 or even 10 years from now.
Corporate, High Yield, and even Municipal Bonds are less risky than stocks, but they aren’t risk free like US Treasuries. Some analysts have predicted that nearly 50% of municipalities may face impairment in the next recession, perhaps even bankruptcy. Corporate bonds and High Yield are also subject to market cycles. So, they had to focus on US Treasuries, which brought them to their 3rd problem.
Using risk free bonds for retirement income took up the vast majority of their investment portfolio. There was little money left for unexpected or discretionary expenses in the future, and none left to leave a legacy their two boys.
Mortgage Backed Securities couldn’t protect their principal, even though the income was good.
But the Fixed Index Annuity had none of those problems. The FIA;
- Paid out enough income to guarantee their retirement using less than 1/3 of the investment required by risk free bonds.
- Gave them a strong likelihood of increasing income.
- Allowed them to leave their majority of their portfolio invested for the future, providing plenty of room for unexpected expenses and fun while providing a significant legacy for their boys.
- Protected their principal.
- Reduced the dollars they would have to take out of their IRA investments for Required Minimum Distributions, further padding the inheritance for their children.
Do you see why a Fixed Index Annuity fit this couple’s needs better than bonds or dividend securities?
If you’d like to see how bonds, dividend payers and fixed annuities stack up for you CLICK HERE.
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|Target Annual Income||$17,500||Portfolio $||$1,200,000||* bold = principal guaranteed|
|Instrument||Interest Rate||Inflation + ?||Principal Guaranteed?||Risk of Principal Loss||Income per $100k||Higher Income Possible?||Required Investment for Target Income||Time to Maturity||% of Portfolio||Notes|
|* 10 Year US Treasury||1.64%||No.||Yes.||No.||$1,640||Not until maturity / buy new issue||$1,067,070||10 years||68.80%||May get higher or lower rates in future.|
|*10 Year German Bond||0.24%||No.||No.||Very unlikely.||$240||Not until maturity / buy new issue||$7,291,667||10 years||540%||May get higher or lower rates in future.|
|* 10 Year Japanese Bond||-0.009||No.||Yes.||Negligible.||($90)||Not until maturity / buy new issue||N/A||10 years||N/A||May get higher or lower rates in future.|
|* Certificate of Deposit||1%||No.||Yes.||No.||$1,000||Not until maturity / buy new issue||$1,750,000||2 years||125%||May get higher or lower rates in future.|
|* Selected Fixed Index Annuity||5%+||Yes.||Yes.||No, unless pulled early.||$6,000||Yes, if markets have positive years.||$291,670||10 years.||21.50%||Highly probable income will increase almost every year.|
|Investment Grade Corporate Bonds||4%||Yes.||No.||Yes.||$4,000||Not until maturity / buy new issue||$437,500||rolling.||32.30%||May get higher or lower rates in future. Default risk rises in recession.|
|High Yield Corporate Bonds||6.25%||Yes.||No.||Yes.||$6,250||Not until maturity / buy new issue||$280,000||rolling.||20.70%||May get higher or lower rates in future. Default risk rises significantly in recession.|
|Mortgage Backed Securities||2.30%||Maybe.||No.||Yes.||$2,300||Not until maturity / buy new issue||$673,910||rolling.||56.20%||May get higher or lower rates in future. Default risk rises aggressively in recession.|
|Emerging Market Bonds||4.82%||Yes.||No.||Yes.||$4,820||Not until maturity / buy new issue||$321,580||rolling.||26.80%||May get higher or lower rates in future. Default risk rises aggressively in recession.|
|Municipal Bonds – A Rated||2.20%||Maybe.||No.||Minimal.||$2,200||Not until maturity / buy new issue||$795,455||10 years.||58.70%||May get higher or lower rates in future. Default risk rises in recession.|
Rates current as of June 2016
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