By Rick Law, Estate Planner, Elder law Attorney, And Senior Advocate In Illinois
Investment type number 3: traditional low yield “safe” systems and Inflation’s impact on your retirement.
All investments offer a balance between risk and potential return, and this balance tends to vary by the type of investment, the issuing entity and the state of the economy. Bonds are no exception to this risk and return rule, although in some cases they are considered lower risk, especially compared to stocks.
Some reasons for this include the fact that bonds offer a promise of returning the face value of the security to the holder at its maturity date.
Most bonds pay their investors a fixed rate of interest income. This income, just like the return of the bond’s face value, is also backed by a promise from the bond’s issuer. But, because of this “safety,” bonds normally have historically lower average returns when compared with other investments. therefore, investors need to be aware that even though bonds are considered to be “safe,” this implied safety could be washed away by other unforeseen risks.
Of importance to retirees and others living on fixed incomes produced by bonds, there is interest rate risk. This means that when interest rates go up, the price of bonds falls. Conversely, when interest rates fall, the price of bonds goes up. Because of this, the longer the bond’s maturity, the greater its interest rate risk.
Bonds also have something called duration risk. The modified duration of a bond is technically a measure of its price sensitivity to the movement of interest rates. This is primarily based on the average time to the maturity of its interest and principal cash flows.
Duration will allow an investor to more easily compare bonds with varying maturities and coupon rates by creating a simple rule. For example, for each percentage change in interest rates, the value of the bond will decline by its modi#ed duration, stated as a percentage. For instance, an investment with a modi#ed duration of #ve years will rise 5 percent in value for every 1-percent
decline in interest rates, and it will fall 5 percent in value for every 1-percent increase in interest rates.
Another concern of retirees who are invested in bonds is inflation risk. This causes the dollar of tomorrow to be worth less than the dollar of today, essentially reducing a retiree’s purchasing power.
When living on a totally fixed income with the constant increase in prices of goods and services, retirees cannot afford to take too much risk with their future purchasing power.
There are other types of risk that are associated with specific types of bonds. For example, bonds issued by a corporate, municipal or government agency may possess “call” risk. This means they include a “call provision” that entitles their issuers to redeem them at a specified price on a date that occurs before the bond’s actual maturity date.
Falling interest rates could accelerate the redemption of a callable bond, causing the investor’s principal to be returned sooner than expected. In this case, the investor will have to reinvest the principal, likely at a lower interest rate. In addition, for a bond that is called either at or close to its par value, investors who paid a premium amount for the bond will also risk losing some of their
Another type of risk that is associated with government agency, corporate, or muni bonds is liquidity risk.
With liquidity risk, investors could have a difficult time finding a buyer when they want to sell. This may force the investor to sell their bond at a big discount to its market value. This risk is especially prevalent with lower rated bonds, bonds that are part of a small issue and bonds that have recently had their credit rating downgraded.
Other issuers, such as those for corporate and municipal bonds and mortgage-backed or asset-backed securities, have speci#c types of risk as well. Credit risk, for instance, is the risk that the borrower will not be able to make interest payments when they are due, which could eventually lead to a default.
If a corporate debt issuer takes on a leveraged buyout, merger or debt restructuring, it runs the gamut of event risk. This can happen if the underlying company takes on an additional debt load, which can cause the value of its bonds to fall or even interfere with its ability to make payments.
There’s more to come! Stay tuned for more quality info from my retirement and portfolio lessons. It’s your retirement, and your well being at stake. I want you to be prepared for what life may throw at you!
If you’re ready to start getting your estate in order and secure your assets for the “worst-case” scenario, please give our office a call at 800-310-3100. Your first consultation is absolutely free. We’ll let you know what steps you need to take, right now, to protect yourself and your family. Call now.
Rick L. Law, Attorney, Estate Planner for Retirees.
Rick was named the #1 Illinois elder law estate planning attorney by Leading Lawyer Magazine. He has been quoted in the Wall Street Journal, AARP Magazine, TheStreet.com, and numerous newspapers and articles. Rick is the lead attorney for Law Elder Law, LLP, focusing in Estate Planning, Guardianship, and Nursing Home Solutions. His goal is to give retirees an informed edge when it comes to dealing with an uncertain future. Get flexible retirement strategies that work during good times and bad, plus information on how you can save your home and assets from being used to pay for long term care. Appointments available in Chicago, Aurora, Oak Brook, Schaumburg, and Joliet. Call 800-310-3100 for your free consultation now!