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Choose bonds very carefully

By Jennie L. Phipps · Bankrate.com
Thursday, January 16, 2014
Posted: 4 pm ET

Seventy-six percent of people saving for retirement in 401(k)s and other workplace plans told retirement planning firm State Street Global Advisors that their plan is in the same or better shape than it was five years ago, before the economic meltdown, and 79 percent said they were able to continue to contribute the same amount or even increase their contribution levels during these economically tough years.

But there has been one fairly dramatic change -- 49 percent said they are investing more conservatively than they did five years ago. In many cases, they are doing so by preferring fixed-income investments over equities. About one-third of the respondents told State Street that they were choosing bonds because they believed bonds would protect their portfolios from inflation. That's a mistake. Actually, inflation reduces the value of future interest and principal payments that bonds offer.

Investment adviser Benjamin Sullivan, a Certified Financial Planner for Palisades Hudson Financial Group, is warning against jumping willy-nilly into bonds as a hedge against the possibility that the value of equities will decline. He points out that if interest rates were to rise 4 percent, the value of a 10-year bond would fall 40 percent. Instead of buying intermediate or long-term bonds, Sullivan suggests that nervous savers choose short-term bonds. While the yields are modest, short-term bonds reduce volatility, preserve cash when you think you'll need it in the short term, and offer long-term savers money to invest aggressively when the equity market turns down and prices fall.

Sullivan also warns investors away from foreign and junk bonds. "Bonds are for protecting your wealth, not for risking it," he says.

In particular, he's looking favorably at money market funds, short-term corporate and municipal bond funds, floating-rate loan funds and funds that pursue absolute-return strategies. "Although these investments will earn less in the short term than a riskier bond portfolio, rising interest rates will not hurt your principal value nearly as much," he says.

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14 Comments
Joe T
January 19, 2014 at 2:01 pm

To Ed Kaiser,

I am relatively new to the Bond game although my Mother-in-law invested in them for years. I am probably mistaken...but I thought I Bonds worked on a variable rate? I wish I could get you to educate me on these.

Thanks

Ed Kaiser
January 18, 2014 at 2:31 pm

Dear Mr. Sullivan: I agree on someof your thoughts, however, the photograph leading into your narative is of US Savings Bonds either EE or I variety. I disagree in that I-Bonds, which I have been purchasing since late 1999 to the present, offer inflation protection, and the I-Bonds I purchased in 2000, and 2001 are currently paying upwards of 6%, and are State tax exempt. I-Bonds have proven to me to give an excellent return when compared to MM's yielding less than 1%, they are extremely safe, and I sleep comfortably at night knowing one-third of my retirement is earning 6% or more and has been for the last several years.

Robert H
January 18, 2014 at 12:30 pm

US Savings Bonds interest is exempt from State and local income tax. Maturity periods take much longer these days. Longer time after purchase before you could cash-in the bonds if needed.

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