Are Bonds a Good Investment for Retirement?

Bonds Are Not Risk-Free

Because bonds are often less volatile than stocks in the short term and can potentially provide a relatively steady source of income over time, they are often considered a “safe” asset class.

But bonds aren’t free of risk. No investment is.

Investors should be aware of the risks often associated with bonds to help determine if this asset class suits their financial goals and investment strategy.

Potential Risks of Bonds

Here are some potential risks associated with bonds:

Credit or Default Risk: Credit risk, also known as default risk, is the probability a bond issuer will fail to make a principal or interest payment to the investor. What an investor earns on a bond investment often correlates to the bond issuer’s creditworthiness, often measured by bond ratings from public ratings agencies. The worst-case credit risk scenario would be an issuer defaulting on a bond an investor had planned to hold through its maturity. When this happens, the investor can lose the entire principal investment and the anticipated interest payments.

Liquidity Risk: In a market with few buyers, bondholders may be forced to sell at a steep discount to coax buyers. This is called liquidity risk, which can occur when there are no interested purchasers for a specific bond or simply not enough trading volume to receive the desired price.

Interest Rate Risk: When interest rates fall, the value of fixed income investments rises. When interest rates go up, bond prices fall in value. Investors who sell a bond before maturity (that is, before the bond contract ends) in a rising interest rate environment could lose money. This is called interest rate risk. Bonds with longer lives often have more sensitivity to interest rate risk than bonds with shorter lives because they are exposed to rising rates for longer.

Reinvestment Risk: When rates fall and cause cash flows from an investment (that is, dividends or interest), assuming reinvestment, to earn less than the original investment, this is referred to as reinvestment risk. To continue your stream of comparable bond income, you may end up paying more for a bond that yields much less.

Inflation Risk: If inflation rises, it could erode the purchasing power of investments. In other words, the interest you’re paid on a bond as well as the final payback of the principal amount may not cover as much as you initially expected. This is known as inflation risk. Even if you hold a bond to maturity, the actual value of your return may not meet your expectations. Most bonds aren’t “indexed to inflation,” which means they do not automatically increase the principal amount to keep up with inflation.

Types of Bonds

Here are a few common categories in the large universe of global fixed income securities:

Improve Your Bond Vocabulary

Bonds and fixed income instruments have their own terminology. Here are a few of the terms that bond investors should know:

Yield: The actual gains, or “realized return,” an investor earns on a bond over a specified period.

Duration: A measurement of a bond price’s sensitivity to changes in interest rates.

Maturity: The date on which a bond issuer must repay the principal amount of the bond to the bondholder.

Coupon: The annual amount of interest paid on a bond, usually expressed as a percentage, or “coupon rate.”

Issuer: A corporation, municipality, government or government agency that sells a bond to raise money.

Finding Your Optimal Portfolio Strategy

Fisher Investments doesn’t focus on any one asset class—we manage a variety of strategies including stocks, bonds, cash and other securities.

Your optimal portfolio strategy will depend on your investment objectives, time horizon, cash-flow requirements, outside income and assets, and any restrictions or customizations you may have.

Contact Fisher Investments today to learn more about bond risks and whether bonds are right for your long-term investment strategy.