Bond Investing For Dummies book cover

Bond Investing For Dummies

By: Russell Wild Published: 08-28-2012

Your friendly guide to trading the bond and bond fund market

Bonds and bond funds are among the safest and most reliable investments you can make to ensure an ample and dependable retirement income—if you do it right! Bond Investing For Dummies helps you do just that, with clear explanations of everything you need to know to build a diversified bond portfolio that will be there when you need it no matter what happens in the stock market.

This plain-English guide clearly explains the pros and cons of investing in bonds, how they differ from stocks, and the best (and worst!) ways to select and purchase bonds for your needs. You'll get up to speed on the different bond varieties and see how to get the best prices when you sell.

  • Covers the ups and downs of today's market, which reinforces the importance of bonds in a portfolio
  • Explains how a radical fall in interest rates make bond investing trickier than ever
  • Explores the historic downgrade of U.S. Treasuries and its possible effects on government bonds

If you're an investor looking for a resource that helps you understand, evaluate, and incorporate bonds into your portfolio, Bond Investing For Dummies has you covered.

Articles From Bond Investing For Dummies

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Bond Investing For Dummies Cheat Sheet

Cheat Sheet / Updated 02-25-2022

If you want to invest in bonds, you need to know how to read the bond ratings that the big three rating companies use and how to figure whether a taxable or tax-free municipal bond is the better investment. Knowing the right questions to ask about a bond can save you money, and you can find answers to many of those questions on the Internet.

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A Few Examples of Investment Portfolios

Article / Updated 07-06-2021

Here are some examples of investment portfolios based on real, live clients with bond portfolios. Their names have been changed to protect the identities of these good people. Perhaps you will see some similarities between their situations and yours. Jean and Raymond, 61 and 63, financially quite comfortable Married in 1982, Jean and Raymond raised three children; the third is just finishing up college. Jean and Raymond are public school teachers, and both will retire (he in two years, she in four) with healthy traditional pensions. Together, those pensions, combined with Social Security, should cover Jean and Raymond’s living expenses for the rest of their lives. The couple will also likely bring in supplemental income from private tutoring. Jean’s mother is 90. When Mom passes away, Jean, an only child, expects to receive an inheritance of at least $1.5 million. Mom’s money is invested almost entirely in bonds and CDs. So what should Jean and Raymond do with the $710,000 they’ve socked away in their combined 403(b) retirement plans? Jean and Raymond are in the catbird seat. Even if they were to invest the entire $710,000 nest egg in stocks, and even if we were to see the worst stock market crash in history, Jean and Raymond would likely still be okay. The couple certainly doesn’t need to take the risk of putting their money in stocks because they don’t need to see their portfolio grow to accomplish their financial goals. But given their pensions, is investing in stocks really that risky? No. If Jean and Raymond want to leave a large legacy (to their children, grandchildren, or charity), a mostly stock portfolio may be the way to go. Because equities tend to be so much more lucrative than fixed income in the long run, a greater percentage in equities would likely generate more wealth for future generations. Ignoring for the moment a slew of possibly complicating factors from the simple scenario above, they should feel comfortable with an aggressive portfolio: perhaps two-thirds in equity (stocks and such) and one-third in fixed income (bonds and such). It’s not what most people think of as appropriate for an aging couple, but it makes a whole lot of sense, provided Jean and Raymond are fully on board and promise not to cash out of stocks (as many investors do) the first time the market takes a dip. Kay, 59, hoping only for a simple retirement Kay, divorced twice, earns a very modest salary as a medical technician. She scored fairly well in her last divorce. Thanks to a generous initial cash settlement, as well as having made a good profit on the sale of her last home, Kay has a portfolio of $875,000. Kay doesn’t hate her work, but she isn’t crazy about it, either; she would much rather spend her days doing volunteer work with stray animals. After careful analysis, she figures that she can live without her paycheck quite comfortably if she pulls $45,000 a year from savings. Her children are grown and self-sufficient. Kay’s example illustrates why simple formulas (such as your age = your proper bond allocation) don’t work. Kay is roughly the same age as Jean in the previous example. And Kay, like Jean, is financially comfortable. But it would be a big mistake for Kay to take the same risks with her money. Unlike Jean, Kay does not have a spouse. Nor does Kay have a pension. And unlike Jean, Kay is not expecting a big inheritance. Kay can't afford to lose any significant portion of her nest egg. She is dependent on that nest egg to stay economically afloat. At her current level of savings and with a fairly modest rate of growth in her portfolio, Kay should be able to retire comfortably within four to five years. In Kay’s case, she has more to lose than to gain by taking any great risk in the markets. On the other hand, if things work out as she plans, Kay may be spending 30 or more years in retirement. So an all fixed-income portfolio, which could get gobbled up by inflation, won’t work. In Kay’s case, depending on her tolerance for risk, a good recommendation would be a portfolio of 50 to 55 percent stocks and 45 to 50 percent bonds, as shown. Juan, 29, just getting started Three years out of business school with an MBA, Juan, is single and happy in his city condo. And he's earning an impressive and growing salary. But because he has been busy paying off loans, he has just started to build his savings. Juan’s 401(k) has a balance of $3,700. Juan is another example of why simple formulas don't work. He should probably tailor his portfolio to look something like Jean and Raymond’s, despite the obvious differences in age and wealth. Juan is still many years off from retirement and doesn’t see any major expenses on the horizon. His budding 401(k) is meant to sit and grow for a very long time — at least three decades. History tells us that a portfolio made up of mostly stocks will likely provide superior growth. Of course, history is history, and we don’t know what the future will bring. So it would still be a good idea to allocate 20 to 25 percent bonds to Juan’s portfolio. Before moving any money into stocks or bonds, however, Juan would want to set aside three to six months’ worth of living expenses in an emergency cash fund, outside of his 401(k), just in case he should lose his job, have serious health issues, or face some other unforeseen crisis. Miriam, 53, plugging away Never married, with no children, Miriam wants to retire from her job as a freelance computer consultant while still young enough to fulfill her dreams of world travel. Her investments of $75,000 are growing at a good clip, as she is currently socking away a full 20 percent of her after-tax earnings — about $20,000 a year. But she knows that she has a long way to go. Miriam is right; she has a long way to go. To fulfill her dreams of world travel, Miriam needs considerably more than a nest egg of $75,000. In this case, the bond allocation question is a tough one. Miriam needs substantial growth, but she isn’t in a position to risk what she has, either. Cases like Miriam’s require delicate balance. She should most likely opt for a starting portfolio of mostly stocks and about 25 to 30 percent bonds, but as Miriam gets closer to her financial goal in coming years, she could up that percentage of bonds and take a more defensive, conservative position.

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Is Now the Time to Buy Bonds?

Article / Updated 07-01-2021

After suggesting a bond portfolio — or any other kind of portfolio — to a new client, dealers often hear, “But . . . is now a good time to invest in bonds?” The answer is yes. You can’t predict the future of interest rates With stocks, the big concern people have is usually that the market is about to tumble. With bonds, the big concern — especially these days — is that interest rates are going to rise, and any bonds purchased today will wither in value as a result. But interest rates are almost as unpredictable as the stock market. Yes, the government has more control over interest rates than it does the stock market, but it doesn’t have complete control, and the actions it decides to take or not take are not for you to know. And furthermore, even if you could predict interest rates (which you can’t), and even if you did know that they were going to rise (which you don’t), now still is a good time to buy bonds. This is assuming, of course, that you’ve done the proper analysis, and you’ve decided that more bonds belong in your portfolio, and you have cash in hand. What do you do with it? You have three savings/investing options, really: Keep it in cash. Invest it in equities. Invest it in fixed income. If you invest in equities (stocks, real estate, commodities), you mess with your overall portfolio structure, making it perhaps too risky. If you keep cash (a savings or money market account), you earn enough interest to maybe keep up with inflation — but after taxes, probably not. In either scenario, you lose. Now, suppose you choose to go ahead and buy the bonds, and interest rates, as you feared, do rise. That isn’t necessarily a bad thing. Yes, your bonds or bond funds — especially those with long maturities — will take a hit. The value of the bonds or the price of the bond-fund shares will sink. In the long run, though, you shouldn’t suffer, and you may even benefit from higher interest rates. After all, every six months with individual bonds, and every month with most bond funds, you get interest payments, and those interest payments may be reinvested. The higher the interest rate climbs, the more money you can make off those reinvestments. Waiting for interest rates to fall — which they may or may not do — just doesn’t make sense. When interest rates are very low, as they are these days, it makes sense to lean your bond portfolio more toward the short-intermediate side than the long-term. Yes, you’ll get a lesser yield, but you’ll take a softer punch when interest rates do rise. A good aim normally is an average maturity in your bond portfolios of five to seven years. These days, you might accept the lower yield that comes with a bond portfolio with an average maturity of three to five years. Don’t pay too much attention to the yield curve Another difficult decision for bond investors putting in fresh money occurs at those rare times in history when we see an inverted yield curve. The yield curve refers to the difference between interest rates on long-term versus short-term bonds. Normally, long-term bonds pay higher rates of interest. If the yield curve is inverted, that means the long-term bonds are paying lower rates of interest than shorter-term bonds. That situation doesn’t happen often, but it happens. The reasons for the yield curve are many and complex, and they include inflation expectations, feelings about the economy, and foreign demand for U.S. debt. Whatever the reasons for an inverted yield curve, it hardly makes sense to tie up your money in a long-term bond when a shorter-term bond is paying just as much interest or possibly a slight bit more. Or does it? Some financial planners disagree, but it’s not always a bad idea to invest in longer-term bonds even when the yield curve is a slight bit inverted. Remember that a large reason you’re investing in bonds is to have a cushion if your other investments (such as stocks) take a nosedive. When stocks plunge, money tends to flow (and flow fast) into investment-grade bonds, especially Treasuries. Initially, the “rush to safety” creates the most demand for short-term bonds, and their price tends to rise. Over time, however, a plunge in the stock market often results in the feds lowering interest rates (in an attempt to kick-start the economy), which lifts bond prices — especially the price of longer maturity bonds. In other words, long-term Treasuries are your very best hedge against a stock market crash. Consider another reason for investing in longer-term bonds, even if they aren’t paying what short-term bonds are paying. What if interest rates drop, regardless of what’s going on in the stock market? Sometimes interest rates fall even when the stock market is soaring. If that’s the case, once again, you may wish that you were holding long-term bonds. Adhere — or not — to dollar-cost averaging Instead of throwing all your money into a bond portfolio right away, some people say it makes more sense to buy in slowly over a long period of time. As the argument goes, you spread out your risk that way, buying when the market is high and when the market is low. And if you invest equal amounts of money each time, you tend to buy more product (bonds or fund shares) when the market is low, potentially adding to your bottom line. This approach to investing is called dollar-cost averaging. Dollar-cost averaging makes some sense if you are taking freshly earned money and investing it. If you have an existing pool of cash, however, it simply doesn’t make sense. The cash you leave behind will be earning too little for the whole scheme to make any sense. If you have a chunk of money waiting to be invested, and you have an investment plan in place, go for it. Buy those bonds you were planning to buy. There’s no reason to wait for just the right moment or to buy in dribs and drabs.

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Questions to Ask a Bond Broker about a Bond

Article / Updated 03-26-2016

As you enter the world of bond investing, you may choose to work with a broker. But use some caution. Ask the questions in the following list — and get acceptable answers — before parting with your cash. Who is the bond issuer? Is it the U.S. Treasury? General Electric? Dade County, Florida? The Russian Federation? Moe’s Hardware Store? A bond is an IOU, and an IOU is only as good as the entity that owes U. In addition, different kinds of bonds have different characteristics, such as taxability, callability, and volatility. How is the bond rated? Especially among corporate bonds (more likely to default than municipal or agency bonds), you want to know whether the company issuing the bond is financially stable. Ratings are readily available through any brokerage house. What is the maturity date? Long-term bonds tend to pay higher rates of interest, but your money is tied for longer and the price of the bond, should you wish to sell it before maturity, tends to be more volatile. What is the yield-to-maturity? There are many ways of measuring a bond’s return. Yield-to-maturity is perhaps the most important measure. (Bond funds, which have no maturity, can be more difficult to compare.) Is the bond callable? Can the issuer of the bond hand you back your money at any time? All things being equal, a callable bond is not desirable, and you should get more interest in compensation for the call feature. What’s the worst-case yield? Suppose the bond does get called. What would be your yield on the bond at that point? When comparing callable bonds, this figure is very important. May I please have the CUSIP? The CUSIP (Committee on Uniform Security Identification Procedures) identification allows you to go to www.investinginbonds.com or www.finra.org to see what recent trades have been made on any particular bond. Doing so gives you a very good idea of what a fair price would be for the bond you’re being offered.

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How to Read Bond Ratings

Article / Updated 03-26-2016

Before you buy a bond, get an idea of how much financial muscle the issuer has. Bond ratings are available through any brokerage house. Three of the most popular rating services are Moody’s, Standard & Poor’s, and Fitch. The following table shows the system each uses to rate bonds: Bond Credit Quality Ratings Credit risk ratings Moody’s Standard & Poor’s Fitch Investment grade Tip-top quality Aaa AAA AAA Premium quality Aa AA AA Near-premium quality A A A Take-home-to-Mom quality Baa BBB BBB Not investment grade Borderline ugly Ba BB BB Ugly B B B Definitely don’t-take-home-to-Mom quality Caa CCC CCC You’ll be extremely lucky to get your money back Ca CC CC Interest payments have halted or bankruptcy is in process C D C Already in default C D D Bond ratings are available through any brokerage house.

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Important Websites for Bond Investors

Article / Updated 03-26-2016

Successful bond investing isn’t about luck, it’s about researching markets, comparing offers . . . and luck. These seven websites serve as your navigation guide through the vast universe of bonds and bond funds. Investing in Bonds.com Run by the Securities Industry and Financial Markets Association, this is the place to go to find out overall bond market yields and, perhaps more importantly, what individual bonds (which you can look up by their CUSIP number or issuer) are selling for. Financial Industry Regulatory Authority This independent securities regulator was formed in June 2007 when the National Association of Securities Dealers merged with the New York Stock Exchange Member Regulation. Find scores of information on bond yields, prices, and trends. TreasuryDirect Find out what your savings bond are worth. Buy and sell U.S. Treasury bills and bonds at no cost. Bloomberg Go to Market Data→Rates and Bonds for up-to-date information on multiple bond markets. Yahoo! Finance Find scads of information on individual bonds and bond funds. Go to Bond Screener for a complete bond shopping guide. MoneyChimp In this simple calculator, you put in the price of the bond, the coupon rate, and the maturity date, and out comes the all-important yield-to-maturity. Morningstar Click the Funds icon on the bar at the top of the screen to find lots of information on any bond fund you can imagine, including Morningstar’s exclusive rating system. (Avoid one-star funds; shoot for five stars.)

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How to Choose between a Taxable and a Tax-Free Municipal Bond

Article / Updated 03-26-2016

As a bond investor, you’re probably most interested in the bonds that will leave you with more money at the end of the day. If it comes to a choice between taxable and tax-free municipal bonds, grab your calculator and apply the following rather simple formula to determine the potentially more profitable bond: Start with 100. Subtract your tax bracket to find your reciprocal. If you are in the 28 percent bracket, for example, subtract 28 from 100. That number — 72 — is called the reciprocal of your tax bracket. Divide the municipal yield by the reciprocal. The result tells you what you would have to earn on the taxable bond to equal the amount you would get on the tax-exempt municipal bond. Using these numbers, consider a muni (a short, and rather endearing, abbreviation of municipal bond) paying 5 percent: 5 / 72 = 6.94 percent That number, 6.94, represents your tax-equivalent yield, or your break-even between taxable and tax-exempt bond investing. If you can get 5 percent on a muni versus 6.94 percent on a taxable bond, it won’t matter which you choose, as far as take-home pay. (Of course, other factors may matter, such as the quality or the maturity of the bond.) If the taxable bond is yielding greater than 6.94 percent, it will likely be your best bet. If the taxable bond is yielding less than 6.94 percent, you’re likely better off with the tax-free bond.

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The Four Major Types of Investment Bonds

Article / Updated 03-26-2016

Investment bonds are issued by thousands of different governments, government agencies, municipalities, financial institutions, and corporations. They all pay interest. Following are some important considerations about each of the major kinds of bonds. Treasury bonds Politicians like raising money by selling bonds, as opposed to raising taxes, because voters hate taxes. Of course, when the government issues these Treasury bonds, it promises to repay the bond buyers over time. The more bonds the government issues, the greater its debt. The interest payments on that debt are an enormous burden, currently totaling more than $450 billion a year. There are many kinds of Treasury bonds — from EE Bonds to I Bonds to TIPS — and each has unique characteristics. All of them, though, are backed by the "full faith and credit" of the federal government. Despite its huge debt, the United States of America is not going bankrupt any time soon, and for that reason, Treasury bonds have traditionally been referred to as "risk-free." Careful! That does not mean that the prices of Treasury bonds don't fluctuate. When bond experts speak of treasury bonds as having no risk, or almost no risk, what they mean is that the bonds have no credit risk. But Treasury bonds are very much subject to the other kinds of risk that beset other bonds: interest rates, inflation, and reinvestment. Corporate bonds Bonds issued by for-profit companies are riskier than government bonds but tend to compensate for that added risk by paying higher interest rates. For the past few decades, corporate bonds in the aggregate have tended to pay about a percentage point higher than Treasury bonds of similar maturity. Since 2008, this spread has broadened to about a percentage point and a half. Corporate bonds tend to get called a lot. That means that the corporation changes its incorporated mind about wanting your money and suddenly throws it back at you, canceling the bond. Bond calls tend to happen when rates have fallen. That adds a heavy dose of unpredictability to what should be a predictable investment. Agency bonds Federal agencies, such as the Government National Mortgage Association (Ginnie Mae), and government-sponsored enterprises (GSEs), like the Federal Home Loan Banks, issue a good chunk of the bonds on the market. Even though these agencies' offerings differ quite a bit from one another, they are collectively referred to as agency bonds. What we call agencies are sometimes part of the actual government and sometimes a cross between government and private industry. To varying degrees, Congress and the Treasury will serve as protective big brothers if one of these agencies or GSEs were to take a financial beating and couldn't pay off its debt obligations. In general, agency bonds are considered the next-safest thing to Treasury bonds. As such, the interest paid on these bonds is typically just a smidgen higher than the interest rate you would get on Treasuries of similar maturity, although in very recent times, you can get a smidgen-plus. Municipal bonds The bond market, unlike the stock market, is overwhelmingly institutional. In other words, most bonds are held by insurance companies, pension funds, endowment funds, and mutual bonds. The only exception is the municipal bond market. Municipal bonds (munis) are issued by cities, states, and counties. They're used to raise money for either the general, day-to-day needs of the citizenry (schools, roads, sewer systems) or for specific projects (a new bridge or stadium). Interest on most municipal bonds is exempt from federal income tax. Traditionally, the interest rates paid have been modest, but many individual investors — especially those in the higher tax brackets — could often get a better after-tax return on munis than on comparable taxable bonds. Like corporate bonds, but unlike Treasuries, municipal bonds are often subject to being called. You may think you're buying a ten-year investment, but you may be forced to relinquish the bond in two years instead. Munis tend to be less risky than corporate bonds but not as safe as Treasury and agency bonds. It's important to know before investing whether the local government issuing a bond has the wherewithal to pay back your principal. Cities don't go bankrupt often, but it does happen.

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Five Things You Need to Know before Investing in Bonds

Article / Updated 03-26-2016

A bond is really not much more than an IOU with a serial number — you lend someone your money for a period of time, and they promise to pay you back (with interest) after that time is over. There is money to be made in bond investments, but before you wade into that ocean, here are some of the basic concepts and vocabulary you need to know. Risk equals reward Bonds aren't insured by the FDIC the way bank CDs are. When you fork over your money to buy a bond, your principal, in most cases, is guaranteed only by the issuer of the bond. That "guarantee" is only as solid as the issuer itself, and the interest rate paid is generally based on the stability and financial strength of the bond issuer. Riskier bonds pay some kind of risk premium, yielding higher rewards. That's why U.S. Treasury bonds (not very risky) pay one interest rate, General Electric bonds (slightly riskier) pay another rate, and Sprint Nextel bonds (quite risky) pay yet another rate. Bonds that carry a relatively high risk of default are commonly called high-yield or junk bonds. bonds issued by companies and governments that carry very little risk of default are commonly referred to as investment-grade bonds. The maturity rate Almost all bonds are issued with life spans (maturities) of up to 30 years. Few people are interested in lending their money for longer than that. In bond lingo, bonds with a maturity of less than 5 years are called short-term bonds, bonds with maturities of 5–12 years are called intermediate-term bonds, and bonds with maturities of 12 years or longer are called long-term bonds. In general, the longer the maturity, the greater the interest rate paid. Cutting maturity short A bond that is callable can be retired by the company or municipality prior to the bond's maturity. Because bonds tend to be retired when interest rates fall, you don't want your bond to be retired; you generally aren't going to be able to replace it with anything paying as much. Because of the added risk, callable bonds tend to carry higher coupon rates to compensate bond buyers. Diversification Some people invest in bonds as a steady source of income, but a far better reason to own bonds is to diversify a portfolio. Bonds tend to zig when stocks zag, and vice versa. The key to successful investing is to have several different asset classes — different investment animals with different characteristics — all of which can be expected to yield positive long-term returns but that do not all move up and down together. Taxes Back in the early days of the bond market in the United States, the federal government made a deal with the cities and states: You don't tax our bonds, and we won't tax yours. And, so far, all parties have kept their word. When you invest in U.S. Treasury bonds, you pay no state or local tax on the interest. And when you invest in municipal (muni) bonds, you pay no federal tax on the interest. Accordingly, muni bonds pay a lower rate of interest than equivalent corporate bonds (the interest from which is taxed), but you may still wind up ahead after taxes.

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Case Studies in Bond Portfolio Allocation

Article / Updated 03-26-2016

Here are a few examples of bond portfolio allocation solutions. Just as there are no hard and fast rules for the percentage of a portfolio that should be in bonds, there are no absolutes when it comes to what kind of bonds are optimal for any given investor. Jean and Raymond, 61 and 63, financially fit as a fiddle These folks have a solid portfolio of nearly three-quarters of a million dollars. A fat inheritance is likely coming. They are both working in secure jobs, and when they retire, their (inflation-adjusted) pensions and Social Security should cover all the basic bills. With their children and grandchildren in mind and having little to risk with any volatility in the markets, Jean and Raymond have decided to invest about two-thirds of their savings (all in their retirement accounts) in equities — mostly stocks, with some commodities. They have chosen to invest the other third (about $235,000) in fixed income. Financially fit as they seem, Jean and Raymond still could use an emergency kitty. Because both are older than 59 ½ and are allowed to pull from their retirement accounts without penalty, three months’ living expenses ($15,000) should be kept in cash or in a very short-term bond fund. That leaves them with $220,000. Chances are this money won’t be touched for quite some time — perhaps not until after Jean and Raymond have passed to that great teachers’ lounge in the sky, and their children and grandchildren inherit their estate. That being the case, it warrants investing in higher yielding bonds. Just in case the economy takes a real fall and the lion’s share of the estate goes with it, these bonds should be strong enough to stand tall. About 30 percent of the remaining pot (approximately $66,000) could be put into intermediate-term conventional Treasuries, either in a bond fund or individual bonds. Another 30 percent should go into a fund of investment-grade corporate bonds. The corporate bonds over time will tend to return higher interest than the government bonds but may not do quite as well if the economy hits the skids. And another 30 percent of the bond allocation should go to Treasury Inflation-Protected Securities (TIPS), again either in a TIPS fund or individual TIPS purchased free of markup on the Treasury’s own website. Then, Jean and Raymond might devote 10 percent of their bond allocation to a foreign bond fund. See this chart that reflects good recommendations to Jean and Raymond. Kay, 59, approaching retirement Kay, a divorced medical technician, is currently on her own. She needs a larger emergency fund than do Jean and Raymond. Having no pension, she will also be reliant on her portfolio when she retires and can’t take quite as much risk as the older married couple. (Simple formulas that say you need to take less risk as you get older simply aren’t very helpful much of the time.) Kay’s healthy portfolio of $875,000 is divided 50/50 between equities and fixed income. That equates to $437,500 in fixed income. Where to put it? She should first allot four to five months of her fixed income to either a money market fund or a very short-term bond fund. That would still leave $418,000 or so to invest in higher yielding instruments. It would be good to set up a bond portfolio for her with the intention of making the move to an annuity when Kay is in her mid-60s (provided interest rates at that time are favorable). Kay needs a bond portfolio that will be there for her in four or five years, providing income and, more importantly, providing the cash she’ll need to live on in retirement should the other 50 percent of her portfolio — the stocks — take a dive. With $418,000 to invest in bonds, almost twice what our teacher couple has to invest, she could have a somewhat more diversified bond allocation. Kay may start by taking a third of her bond money ($139,000) and buying either a Treasury Inflation-Protected Securities (TIPS) fund or individual TIPS through TreasuryDirect. These bonds offer modest rates of return but adjust the principal twice a year for inflation. If inflation goes on a rampage, Kay will have some protection on the fixed-income side of her portfolio. As a rule, people with higher allocations to fixed-income should have more inflation protection on that side of the portfolio, as they’ll have less inflation protection from stocks. With the other two-thirds of her bond portfolio ($279,000 or so), she should devote equal allocations to intermediate-term traditional Treasuries, short-term Treasuries, long-term investment-grade corporate bonds, intermediate-term investment-grade corporate bonds, international bonds, and high-yield bonds. Juan, 29, building up his savings Juan’s 401(k) has a current balance of just $3,700, but he’s making a good salary. Juan should first save up enough so he can set aside three to six months’ living expenses in an emergency cash fund. Given that his 401(k) money is not going to be touched until Juan is at least 59 ½ (and able to make withdrawals without penalty), he has decided to allocate only 20 percent of his retirement fund to bonds — just about right. The purpose of those bonds is to somewhat smooth out his account’s returns, provide the opportunity to rebalance, and be there just in case of an economic apocalypse. Juan, of course, is prisoner to his 401(k) investment options, whatever they may be. If his employer’s plan is like most, he may have the option of one mixed-maturity Treasury fund and one mixed-maturity corporate-bond fund. Whichever way he goes shouldn’t make a huge difference over the next few years. Should Juan leave his job, he may be able to transfer his 401(k) to his new place of employment, or he may be able to roll it into an individual retirement plan (IRA). The latter is usually better because IRAs typically offer better investment choices at lower costs. At that point, should Juan open an IRA, and should the balance grow beyond several thousand dollars, he should look for greater diversification of his bonds. Miriam, 53, behind on her goals With $75,000 in savings and the good majority in stocks, Miriam’s 25 percent in bonds ($18,750) must serve two purposes: First, it must provide ballast to smooth out the year-to-year return of her investments. Second, it may well help provide cash flow when Miriam is able to retire and fulfill her dreams of world travel. Miriam is currently making serious bucks in her job as a freelance computer consultant — about $160,000 a year. But she lives in New York City, paying high city and state taxes. She rents rather than owns her home, so she gets no mortgage deduction. Most of her $75,000 in savings sits in a taxable brokerage account. Given Miriam’s relatively high tax bracket, it would make most sense for Miriam to have her $18,750 of bonds in her taxable account socked away in high-quality municipal bonds. Locally issued munis would offer income exempt from federal, state, and local taxes, and these would be good candidates. But for the sake of diversification, she should have a mix of both local and national muni bonds. With less than $20,000 to invest in munis, she would be chewed up and spit out by the markups should she start dabbling in individual issues.

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