fixed income Archives - Legacy Wealth Advisors

High inflation impacts all areas of life, from filling up at the pump to grabbing groceries from the store. Inflation is at 8.5% over the past 12 months, the highest level in over 40 years. While higher prices are an immediate sign of the times, inflation also impacts your purchasing power and investments.

Given the current economic situation, does it still make sense to invest in fixed-income vehicles like bonds? Many people use fixed-income securities to provide lower risk, but are they too conservative for the current market?

Let’s see.

What’s a Bond?

A bond is a debt security. When you purchase a bond, you give the company or government you bought it from a loan. In return, they commit to paying back the loan with interest—sounds a lot like an IOU. The institutions use the money to fund various projects.

Bonds are a type of fixed income because, in most cases, the issuer pays the investor a set interest rate over a predetermined period. However, this is not always the case, as some bonds offer variable rates. In that case, the interest rate you receive will vary.

Many people think about bonds as a “safer” investment than stocks for several strong reasons.

Their value doesn’t fluctuate as much as stocks.
Bonds offer guaranteed returns (subject to the financial health of the issuing company or institution).
Investing in them brings diversification to your portfolio

Why Is Inflation Impacting Bonds?

Fixed-income securities like bonds can play an essential role in an investor’s portfolio because they provide a reliable and stable income stream. That reliability, however, also makes them prone to losing their purchasing power with accelerating inflation.

Here’s an example:

Inflation is rising, but interest rates remain the same. If you have a five-year bond that pays out $100 in interest every month, the amount of money you receive doesn’t change. But the value of that $100 continues to decrease over time because of inflation.

The rate of interest typically remains the same on most bonds until they mature. The longer the bond takes to mature, the more future purchasing power you’re losing in a high-inflation environment.

Think of it this way: Bonds and interest rates have an inverse relationship: bond prices go down when interest rates go up, and vice versa.

Common Types of Bonds

Not all bonds are created equal. Some common types include U.S. Treasury bonds, savings bonds, I bonds, municipal bonds, and corporate bonds.

U.S. Treasury Bonds

U.S. Treasury bonds are backed by the federal government. They tend to be the safest types of bonds because they have the full faith and credit of the government behind them, but they often offer the lowest returns.

Savings Bonds & I Bonds

Many professionals are considering I bonds as a good tool for hedging inflation. I bonds are adjusted for inflation every six months and offer two types of payments: a fixed payment for 30 years and a variable payment adjusted for inflation.

I bonds have become increasingly popular with the current inflation acceleration. Over $11 billion in I bonds has been sold over the past six months, compared to around $1.2 billion in 2020 and 2021 over the same period.¹

Municipal Bonds

Municipal bonds, also known as “munis,” are issued by local government entities like the state, city, or county. The money raised by munis typically goes back into the community, like paving roads, building schools, or other projects that may benefit the public.

A significant benefit of municipal bonds is that they are typically exempt from federal income tax. Depending on your location, they may be exempt from state or local taxes as well.

Corporate Bonds

Just as you can buy stock in companies, you can also purchase corporate bonds. Unlike stocks, these bonds do not give you equity in the company. So the company’s profitability has no bearing on how much your bond earns in interest.

The upside? When the company’s performance is poor, and stock prices drop, your rates won’t be impacted.

The downside? When things are going well, and stock prices soar, you won’t benefit from the upswing.

Corporate bonds make up a significant portion of the bond market, but they tend to be the riskiest type of bonds. For example, if a company goes under, it may default on its bonds.

Can Bonds Bring Value to Your Portfolio in 2022?

Stocks and bonds tend to react differently to market conditions. In general, bonds can act as a buffer against volatility in stocks. They help create a diversified portfolio, which is imperative for long-term financial success.

Even amidst rising inflation, bonds can help mitigate risk, especially for those nearing retirement. They add stability to your portfolio and offer a regular stream of income.

3 Bond Strategies to Consider

Here are three bond strategies to consider as you consider incorporating bonds into your portfolio.

Buy Individual Bonds

You can build the fixed-income portion of your portfolio one piece at a time, buying each bond individually.

Invest in Bond Funds (ETFs)

Think of bond funds as the fixed-income version of stock mutual funds. Bond funds, or Bond ETFs, are a pooled investment vehicle that invests in various issuers, including U.S. Treasury bonds, corporate bonds, and munis.

Build a Bond Ladder

A bond ladder strategy consists of multiple bonds that mature at regularly spaced intervals. As one bond reaches maturity, the investments roll over. This strategy creates equally spaced maturities and can help investors with the goal to attain higher average yields.

Are Bonds Right For You?

With today’s high inflation and low-interest rates, many investors question whether bonds are still the right move to add more stability to their portfolios. The answer depends on your unique circumstances, including timeline toward retirement, tolerance for risk, long-term goals, and more.

At Legacy Wealth Advisors, we help clients develop tailored portfolio strategies to help weather the market volatility and hedge inflation. Feel free to reach out to our team to learn more about what we can do for you.

Sources:

1What Are I Bonds? Everything You Need to Know to Earn Nearly 10% Interest

Advisory services are offered through Legacy Wealth Advisors, LLC dba Legacy Wealth Advisors, an Investment Advisor in the State of Michigan. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any State other than the State of Michigan or where otherwise legally permitted.

All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication or future results. Moreover, this material has been derived from sources believed to be reliable but is not guaranteed as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. Legacy Wealth Advisors does not offer tax planning or legal services but may provide references to tax services or legal providers. Legacy Wealth Advisors may also work with your attorney or independent tax or legal counsel. Please consult a qualified professional for assistance with these matters.

As you continue building your retirement income strategy, you’ve likely come across annuities.

A neighbor may have recommended them, or maybe an insurance agent sent a letter advertising their offerings, or perhaps you saw a too-good-to-be-true ad on TV. So what exactly are annuities?

Annuities are financial products that can provide guaranteed income in retirement, but there’s more to them than meets the eye.

If you’re considering adding an annuity to your retirement plan, here are a few considerations to make first.

What Is an Annuity?

Simply, annuities are insurance products.

Purchasing an annuity creates a contract between you and an insurance company. You agree to pay a specific amount to the company, and they guarantee a set amount back in return.

When purchasing an annuity, you can make a lump-sum payment to the insurance company or make payments over time. Similarly, you can either receive a lump sum payment from the insurance company or a series of regular payments. You can also choose to receive money immediately or later, depending on how your annuity is established.

The idea of an annuity is to provide retirees with a fixed stream of income. It’s an alluring offer—steady income in a world where turbulent markets, low-interest rates, and high inflation seem to be the mainstay. But annuities are complex vehicles with a significant amount of fine pint—let’s get reading.

Types of Annuities

There are three common types of annuities for individuals to choose from:

Fixed annuity
Variable annuity
Indexed annuity

Fixed Annuity

If you purchased a fixed annuity, the insurance company offers you a minimum rate of interest on the annuity and a predetermined amount of recurring payments. State insurance commissioners oversee and regulate fixed annuities.

Variable Annuity

There’s more flexibility in a variable annuity, as the company you purchase it from will allow you to direct your payments to different investment vehicles. The most common option is a mutual fund.

Because there’s flexibility in where you invest your money, your payout, too, will vary. It will depend on how much money you put in, your rate of return on the investments, and any associated expenses. The SEC regulates this type of annuity.

Indexed Annuity

An indexed annuity acts almost like a hybrid between fixed and variable, meaning it combines common features of insurance products and securities.

The idea is that the insurance company you purchase your annuity from will provide you payouts with a return based on the stock market index, like the S&P 500. In a fixed index annuity, you remain protected from market volatility while still benefiting from market upswings.

Just like fixed annuities, state insurance commissioners regulate indexed annuities.

Pros of Annuities

People choose to purchase annuities primarily for these three reasons:

Regular payments over time
Death benefits
Tax-deferred growth

Let’s take a closer look at each potential benefit.

Regular Payments Over Time

Perhaps the most consistent fear about retirement is running out of money.

It’s challenging to structure a retirement income and spending plan that will sustain you for the rest of your life, and a guaranteed income stream can be a great comfort in that department.

When you purchase an annuity, your provider establishes a set schedule of payments to be made over a specific period. Doing so creates long-term, stable income that helps bring peace of mind to individuals and couples during retirement.

The payout period may be over the remaining lifetime of the annuity holder or even over the lifetime of their spouse, or other designated beneficiary, meaning that annuities could also be part of your estate plan.

Death Benefits

Should you die before you begin receiving payments, your beneficiary will still be able to benefit from monthly payouts from your annuity.

Tax-Deferred Growth

Any growth due to returns earned from your annuity isn’t taxed until you begin receiving payments. This perk allows you to save money over time without paying taxes on the growth until you make withdrawals.

Cons of Annuities

While guaranteed income in retirement is appealing, there are some significant considerations to make before purchasing an annuity.

A few common concerns include:

Fees and commissions
Lack of liquidity
Conservative returns

Fees and Commissions

Annuities come with a cost—often a high cost.

And for some, the cost of added fees and commissions makes them a less-than-desirable retirement income option. You can expect different annuity types to come with different price tags.

The more complex, the more expensive the product is likely to be.

Lack of Liquidity

Once you’ve put your money into an annuitized contract, you’ve made a long-term commitment that can be very difficult and costly (if even possible) to get out of.

For younger couples who have their peak earning years still ahead, it may not make financial sense to tie up so much of their money in this long-term financial product, especially if they have short-term goals like buying a home or paying for a child’s education.

Conservative Returns

Again, an annuity offers steady, guaranteed income. With that said, it’s a conservative investment option. This can make it appealing for those approaching retirement who don’t have time on their side to ride out potential market volatility. But for a younger couple, these more minimal returns would almost surely be an unnecessarily conservative option.

Legacy Wealth And Annuities

Financial advisors tend to have mixed reactions to annuities.

Our Legacy Wealth advisors understand that they can be a good fit for some, but their cost is often a significant deterrent. We tend to see annuities oversold by other advisors, even when a better-suited option may be available for their clients.

If you’re considering purchasing an annuity, it’s a big financial decision that you shouldn’t take lightly. Our team would be happy to help you take a closer look at the benefits and considerations of annuities, just reach out to schedule a time to talk.

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Are Bonds Still Good Investments?