Some people worry about investing their long-term savings in stocks. That's because stocks have the potential to be quite volatile, whereas bond values don't tend to fluctuate as rapidly.
But the reality is that going too heavy on bonds during your working years could hurt you in the long term. You'll need plenty of savings to get by in retirement, since Social Security will generally only replace a limited percentage of your earnings. Plus, there's the potential for those benefits to undergo cuts. And so it pays to invest in assets with solid growth potential.
That's why I tend to favor stocks over bonds in my portfolio these days. My goal is to build up a large enough nest egg to cover my bills in retirement without financial stress.
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But during retirement, I plan to put more money into bonds. And there's one specific type of bond I intend to buy and hold.
Municipal bonds have their benefits
There's no need to completely dump your stocks once you enter retirement. In fact, you'll need some stocks in your portfolio to keep generating solid growth.
But once you retire, you should expect to shift toward safer investments, like bonds, to a large degree. And while you could load up on corporate bonds, municipal bonds may be a better bet.
Municipal bonds are those issued by cities, states, and other localities. They work similarly to corporate bonds in that you invest a sum of money, collect interest payments (usually twice a year), and then redeem your bonds at their maturity date.
What makes municipal bonds such a great investment, though, is that the interest income you collect from them is always exempt from federal taxes. The same can't be said for corporate bond interest. Furthermore, if you hold municipal bonds issued by your state of residence, you can avoid state and local taxes on your interest payments, as well.
Now it's worth noting that if you sell municipal bonds at a profit, you won't get out of paying capital gains taxes. But still, taxes can be a huge burden for retirees. And they're something I want to deal with as little as possible. That's why I plan to focus on municipal bonds down the line.
I like the idea of generating steady income I don't have to pay taxes on, especially since as of now, I have all of my retirement funds in a traditional savings plan, not a Roth. That means my withdrawals will be subject to taxes unless I do a Roth conversion.
A good option to fall back on
It's important to keep your money invested during retirement without taking on undue risk. Municipal bonds are a great way to strike that balance, all the while opening the door to steady income that the IRS can't tax you on. So while municipal bonds may not be an optimal investment during your working years, you may find that they're a very suitable investment once your career comes to an end.
