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Should Retirees Buy Bonds With Low Coupon Rates Now?

Should retirees be buying bonds when interest rates are low? Typically I’d say that depends but now the risks of owning a long term bond paying a low coupon are much larger than before.

As I write this (October 26, 2010), Yahoo Finance is reporting that the government sold 2 year treasury notes with a yield of 0.40% (notice the “ZERO POINT” in front of the 4) and that TIPS were selling for negative yields! Can anyone retire on that? And seeing that CD rates closely mirror government bond rates of similar maturities (though 2 year CD’s are currently paying over 1% according to bankrate.com – woo hoo!), should people be putting their money in a CD or government bond?

Let’s examine two situations – one is someone who wants to park their emergency fund” money somewhere, and the other situation is where one is looking for income.

For an emergency fund, I recommend people keep the money absolutely safe- that yield is secondary to principal safety. Therefore, a bank account or CD is not bad if you’re thinking along the same lines. For those with a larger pile of money, and a larger emergency fund, you could consider some currency diversification or laddering/diversifying to get higher yields.

Those who are more moderate in their wealth, should not get so fancy. Though this doesn’t affect what I think about owning precious metals (see Why Our Clients Own Gold).

For retirement income, this yield is atrocious. I am almost embarrassed to admit how much writing I wasted blasting our Federal Reserve Chairman, Ben Bernanke, for keeping rates low and impoverishing savers. I won’t get into that here but just know I am upset.

Will Your Retirement Be This Happy?

The Risks

I have met people – who 3 years ago were earning 4-5% on their CD’s, and for a $100,000 balance, it was enough to cover their Medford, MA property taxes – who now earn less than 1% and are POOR because of the low rates.

These people have been “forced” to buy junk bonds and other investments with higher yields in order to offset the income loss. Basically, Bernanke is forcing grandma to speculate when she should be in the bank. This is one of the major risks faced by the interest rate environment fostered by the Fed.

One way to combat this risk is to consider annuity strategies at this point, as insurance companies are one of the few places offering a guarantee* and a decent yield. Retirees and those close to retirement both here in my hometown of Medford, Massachusetts and across the nation need to be prudent about income investing.

A second major risk is interest rate risk – buying a long-term, low-coupon bond, there is short to medium term principal risk. Of course principal is returned at maturity but if someone buys a longer term maturity bond to get the higher yield (2 years at 0.40%, 30 year bonds at around 3.5%), then the principal could fall in the interim and the bondholder will be stuck holding to maturity.

There are few ways to combat this risk other than buying shorter maturities or investing in something else, like dividend paying stocks.

Whatever one does, it will be helpful to work from a comprehensive financial plan and think through decisions before making rash choices. And with the risk of inflation, which is all around us (how’s your grocery bill lately?), what some people consider safe (government bonds or the bank for example) could be risky as inflation makes stagnant dollars worth less over time.

*guarantees backed by the insurance company and not guaranteed by any government agency

If you are interested in more reading on retirement income, try these other articles:

Individuals Must Create Their Own Pensions, But How?

Convert Your Bond Portfolio to a Baseline Pension

And don’t forget to check out our Financial 101 Section!

And if you don’t want to miss out on great articles that can help you make smart choices about your money, and you want to be kept in the loop about free upcoming financial education workshops, then join my Insiders Club. Learn more HERE.

Please see my disclaimer page about tax advice on this site – thanks!

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