“Stocks and bonds” are always mentioned together, much like salt and pepper. But while most people know how stocks work, not everyone is as familiar with the bond market and the opportunities that it provides for savvy investors.
As an asset class, bonds historically have less risk than stocks and are an excellent choice for those looking for safer investments for retirement. In the current volatile financial environment, they’re seeing impressive (and somewhat surprising) growth.
Let’s take a closer look at the return of this market and why bonds should be incorporated into your portfolio as soon as possible.
Building a Framework
Simply put, bonds are promissory notes from governments, municipalities, or corporations which guarantee a specific interest rate, as well as the repayment of the principal over a certain length of time. The history of this kind of transferable loan with a repayment plan offering interest goes back to ancient Mesopotamia.
The bond market is two-pronged. The primary market, sometimes called the “new issues” market, is where transactions happen directly between the issuer and the buyer, and typically involve larger sums.
The secondary market is where investors buy previously sold bonds via a broker or intermediary, and these may be packaged as a component of a life insurance policy or mutual fund. This is where most investors get the chance to participate, and it’s heating up as you read this.
There are many different types of these investment instruments, with varying durations, payment timelines, and rates of return. The five most common are Treasury, savings, agency, municipal, and corporate.
Uncertainty — and Good News
Treasury bonds are considered the safest because they’re guaranteed by the government, and they’re used to set the rates for every other fixed-rate long-term bond.
As the Federal Reserve raises interest rates to stem inflation, bond returns are on the rise as well. Another ¾% increase is expected in November when the Treasury performs its bi-annual coupon re-pricing.
A year ago, many financial pundits said this market was facing historic losses, as returns hovered at a paltry 1-2%. Many people gave up too soon and sold their bonds, and demand sank.
Successful investing is a long-term game. If you have the cash, it pays to invest in bonds now. Shorter-term (13-month) Treasury notes are currently paying over 4%, and the two-year offering has the highest government rate in the bond market, 4.3% as of mid-October.
As uncertainty about the future swirls, it stokes fear of even higher inflation (it’s teetering at 8.26% at the moment). But the good news is that the bond market shows clarity on returns and can serve as a hedge against this, specifically Series I Savings bonds. These have an annual fixed interest rate and a semiannual variable rate based on inflation — the most recently issued ones have a return of 9.62%!
Things to Consider
While the bond market can provide investors with many benefits in the current economic climate, there are a few details you should discuss with an experienced financial advisor.
Regarding government I-bonds, you can only purchase $10K, per year, per Social Security number. However, there are a few strategies for stretching that limit.
You can get up to an additional $5K in paper Series I bonds as a tax refund by filing an IRS Form 8888. Investors may also purchase bonds in trust for their children, and small business owners can buy them on behalf of their company.
The bond market isn’t a turn-and-burn investment. It’s critical to get in now and hang on to them as long as you can. I-bonds are issued as five-year bonds, and you may not cash those out for one year. If you cash it out before the five years are up, the government claims your last three months of interest. On the other hand, you can hold an I-bond for more than five years if you choose.
It’s also smart to invest in bonds via your IRA, as that income is tax-deferred, and only taxed upon withdrawal. Outside of an IRA account coupons are taxed in the year received and any capital gains in the year the bond is sold. The bond market is a complex animal. Before you invest, consult with an expert.
The Bottom Line
It makes good sense to take advantage of the return of the bond market and invest your extra funds now. As part of your long-term financial strategy and retirement plan, they’re a safe tool that can provide you with a nice chunk of guaranteed income in the future.
With the vast array of investment options available today, it can feel overwhelming to find just the right ones for your specific goals.
Partnering with a highly skilled and experienced advisor helps you navigate the complexities of financial planning and create an individualized strategy for maximizing your assets. If you’re ready to learn more, schedule a consultation today!