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Why Bonds Aren't Enough to Retire On

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One of the most popular rules of financial planning is that as you grow older, your portfolio should be more conservative. Although that maxim is largely true for the majority of investors, you shouldn't automatically draw the conclusion that many people jump to next: that you should own a bunch of ultra-safe bonds in your portfolio as you get close to retirement.

One size doesn't fit all
In an effort to keep the sometimes intimidating subject of financial planning as simple as possible, you'll often see financial planning advice given in very broad, general terms. So intuitively, a rule of thumb like increasing your bond exposure as you grow older makes a lot of sense. After all, as you age, the amount of money you'll earn during the rest of your career steadily falls, while the size of your nest egg goes up. In other words, with more money to protect and less income to offset losses, you won't want to take as much risk.

But underlying that general advice is something that's specific and unique to every single person out there: When it comes to saving for retirement, what you've done in the past largely defines what you'll need to do in the future. In particular, the less financially secure you are as you approach and enter retirement, the less you can afford to reduce your risk dramatically and still be assured that you won't run out of money.

The moving target
Of course, if you've saved enough money, you can get by with just bonds. For instance, say you want $50,000 in annual income from your retirement portfolio. With the yield on the iShares Barclays 7-10 Year Treasury ETF around 3.1%, you'll need a nest egg of more than $1.6 million just to produce the income you need.

Even worse, that figure doesn't even include inflation. To get inflation protection, you'll want an investment like iShares Barclays TIPS Bond (NYSE: TIP  ) , whose average real yield to maturity is a rock-bottom 0.2% right now. Even if you go with a 30-year inflation-indexed bond yielding 1.8%, you'd need almost $2.8 million to generate the $50,000 you want annually.

Going beyond Treasuries
That's why going beyond the safest bonds is so important. Other income-producing securities can help supplement your income in retirement without ratcheting up your risk level too far. They include the following:

  • Corporate bonds. Without leaving the bond realm, corporates have somewhat higher yields than safer Treasuries. iShares iBoxx Investment-Grade Corporate Bond (NYSE: LQD  ) yields 4.23%, while SPDR High-Yield Bond (NYSE: JNK  ) produces income at a yield of 6.48%.
  • REITs. Real estate investment trusts have earned a reputation as high-yield powerhouses. The highest yields lately have come from mortgage REITs like Annaly Capital (NYSE: NLY  ) and American Capital Agency (Nasdaq: AGNC  ) , which have profited from interest rate spreads. But more traditional REITs like Simon Property Group (NYSE: SPG  ) specialize in a variety of pure real-estate plays, and while their yields don't approach what mortgage REITs pay, their fortunes aren't as directly tied to interest rates remaining low.
  • Dividend stocks. Finally, even among the riskier asset class of equities, you can find healthy income. Dividend stocks that have grown their payouts over time are just as good as an inflation-indexed bond in terms of providing higher income that keeps up with the cost of living. Whether you go with well-known blue chips like ExxonMobil and AT&T or with a fund like Vanguard Dividend Appreciation (NYSE: VIG  ) , a decent chunk of stocks that pay dividends can go a long way toward diversifying your portfolio from too much bond exposure.

Invest smarter
If you could save as much as you wanted, then bonds would be a reasonable option for living out your retirement years in style. But most of us have to make do with more modest sums of money. With the right investment strategy, you don't have to be a billionaire to get the portfolio income you need to retire comfortably.

Once you've picked smart investments, you'll want to track them. To stay up to date on all the news covering companies like Annaly Capital just click HEREto add it to My Watchlist. Sign up now and you'll get immediate access to a new special report, "6 Stocks to Watch from David and Tom Gardner." Click here to get started -- it's all free.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger likes owning a bit of everything. He owns shares of Vanguard Dividend Appreciation. The Fool owns shares of Annaly Capital and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you everything you need.


Read/Post Comments (1) | Recommend This Article (8)

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  • Report this Comment On March 17, 2011, at 3:52 PM, Paulistano wrote:

    I don´t find this a very helpful article as it merely states the obvious.

    One factor that is seldom mentioned in this kind of article is health; many older people will not be physically or mentally up to being active investors and will rely on a steady unchanging portfolio.

    The other most obvious factor is that capital preservation is absolutely essential and government bonds (usually indexed to inflation) are the only way of being (virtually) certain of doing this.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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