Most retirement financial planning advisers will advise you to invest your pension money in a varied selection of shares, because over a long period of time, this kind of portfolio could possibly outperform a varied collection of bonds. That could be great guidance, if you have time and energy to ride out stock exchange volatility. But in the event that you don't have 40, twenty, or perhaps even 10 years until retirement?
If you're in your fifties, sixties or perhaps seventies, and you're worried about your retirement financial planning, the traditional wisdom may not apply and you might be able to estimate retirement income that's sufficient from high-yield bonds.
Before you need the regular income, keep bonds in a tax-deferred retirement account, including an Individual Retirement Arrangement (IRA) or 401(k) program as part of your retirement financial planning. It is usually best to have bonds in your IRA, rather than shares, because of the different way stocks and bonds are taxed.
Shares of common stock, by their nature, have built-in tax deferral. You only pay tax on the gain when you sell. Moreover, even when the stock pays dividends, it is most likely these dividends are taxed at a preferred rate, not more than 15%. Therefore, in case you have bonds and stocks as part of your portfolio, bonds ought to remain tax-sheltered inside a pension program or IRA. By benefiting from that tax arbitrage, you will have greater after-tax income.
Most 401(k) plans don't provide a high-yield bond investment option but you are able to own them in your IRA. The important thing is not to own individual high yield bonds but instead, own shares in a high yield bond fund. When you estimate retirement risk, the knowledge that a fund will diversify among 200 to 300 bonds reduces risk to very acceptable levels.
Why high-yield bonds rather than other kinds of bonds? Because they offer possibly greater earnings and might not be as volatile as stocks and shares or even other bonds. Sure, there was an unparalleled wave of liquidations and defaults following the 2001 economic downturn but anyone who held onto their funds did well. And yes, high-yield bonds usually have lower credit-ratings from agencies such as Standard & Poor's and Moody's Investor Services. However that shouldn't automatically scare you away when you estimate retirement options for income or when you think about your retirement financial planning. Along with risk may come possibly greater returns and the diversification of a fund helps reduce the risk.
Fitch, a bond rating service, reports that in 2009 a total of 151 issuers defaulted on their high yield bond obligations, up from 63 in 2008 and just 15 in 2007. The default rate swung from an all time low of 0.5 percent in 2007, to 6.8 percent in 2008, to 13.7 percent in 2009. However, the large bond funds had minuscule defaults because the fund managers are able to screen bonds carefully and avoid those with the highest risk profile. Consequently we recommend investors to use bond funds when investing in high yield bonds but to avoid bond funds when investing in high quality bonds.
Keep in mind that some safety measures apply to owning any sort of bond fund. When interest rates go up, the price of the shares will drop. Do not panic or make quick changes. Interest rates rise and fall continuously so just go with the flow. Whenever you calculate retirement earnings options or when you are thinking about your retirement financial planning, there are few alternatives that can provide a greater monthly income than high yield bond funds.
John@ stocks paying high dividends says
I still think bonds and bond fund needed to be treated like any other instrument. Unless you are holding the bond to maturity, the price of the bond/bond fund will fluctuate with the market and you could still wind up losing money if you had to sell.
Nick@ high yield bonds says
Great insights. I agree that high yield bonds have a better risk/reward ratio than stocks and other securities, something that's often overlooked.