Most bankers and brokers will tell you that bonds and bond funds are some of the safest investments that you can make as you begin to plan for retirement. This isn’t necessarily true, though.
The reason is simple: with interest rates that are near all-time lows, the risk of losing money is near all-time highs.
Let’s take a look at bonds and bonds funds and what they could mean for your retirement.
What are bonds and bond funds?
Bonds are classified as a loaner investment, meaning that they lend money to a company or a municipality with the promise of repayment plus interest. Bond funds are a single investment that have multiple bonds backed up into one fund. These are high grade bonds, which means the likelihood of defaulting is lower.
Why are bonds and bond funds so dangerous?
Bankers and brokers use the “Rule of 100.” In short, they tell you that you should have 60 percent of your money in bonds or bond funds at 60 years old. You should have 70 percent of your portfolio in bonds or bond funds when you are 70 years old. As interest rates are near all-time lows, it can be difficult to maintain your retirement while the majority of your portfolio could be earning next to nothing.
However, the bigger problem is interest rate risk.
Why should interest rate risk be a concern for you?
Interest rate risk is the amount of principal, or money that you lose when the interest rates rise. When interest rates rise, as they are expected too, the value of bonds and bond funds go down. Most retirees following the rule of 100 could be significantly affected by this type of risk.
Can you imagine taking a 15 percent hit on your safe money?
For example, in 2008, the average high yield bond fund lost around 26 percent when the market crashed.
The next thing many retirees hear after their safe money takes a hit is that they might have to make a lifestyle change. In 2008, many were forced to go back to work at banks, fast food establishments, and other forms of employment.
The bottom line is, bonds and bond funds should not be considered safe money. They can and will lose principal if rates go up. With interest rates near all-time lows it doesn’t make sense to put your safe money near all-time high risk.