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The Eight Most Important Questions for Retirees Can Ask about Bonds

If you’re a retiree, chances are that you’re faced with a flood of advice on how to invest your money. With so much information out there, it’s increasingly difficult for retirees to separate the wheat from the chaff. Still, one consideration should be held above all others: don’t accept cookie-cutter advice such as “the percentage of assets you hold in bonds should be equal to your age.” Instead, it’s important to keep in mind that everybody’s situation is different, from their specific investment needs to their tolerance for risk .

Rather than focusing on specific advice, the best starting point for retirees who manage their own money is to ask themselves a few key questions. The guide below, while not telling you exactly where to invest or in what percentages, can help serve as a starting point for your decision-making process.

How well do I truly understand the nuances of the financial markets?

This is the big one – retirees often have more time to devote to their investments than they did while they were working, and in some cases – particularly those who have lost a spouse – may be learning about investments for the first time. This can create the dynamic where “a little knowledge is a dangerous thing.” If you’re finding the process of managing your money to be too daunting – or if you just can’t understand the lingo and they way markets work – there are plenty of fee-only investment advisors that can take the weight off your shoulders. As with any service provider, it’s better to ask for references rather than going in blindly.

The bottom line: the urge to do-it-yourself is admirable, but it can lead to mistakes that are impossible to overcome once you no longer have the steady income of regular employment.

Do I understand the difference between conservative and aggressive bond investments?

This is the follow-up to the first question, since bonds come in many flavors and not all our consistent with the goal of principal protection. Before constructing a bond portfolio, make sure you know the true risks of the securities you’re thinking of buying and not simply picking the investment with the highest yield. Make sure you fully understand the risks of any investment you’re thinking of buying, because retirement isn’t the time for surprises.

How much can I afford to lose?

Every retiree is in a different situation when it comes to income and expenses. While a person receiving a lifetime pension has the knowledge that they will be able to maintain a certain standard of living even if something happens to his or her next egg, a person who is dependent on Social Security has a much greater need to keep their savings intact.

In short, if preserving your principal is the highest priority, only the safest investments – i.e. those least likely to generate large short-term losses – will do. At no point is taking undue risk a wise strategy for an investor in this situation. And bonds – while generally safer than stocks – can indeed lose money in the short term, particularly for those who own bond funds instead of individual bonds. Learn more about the pros and cons of bond funds here .

On the other side of the coin, someone with a large nest egg and a steady stream of income may be missing out on the opportunity for longer-term growth of assets they can pass on to their heirs if they take too conservative of an approach. In this case, the investor may be able to consider higher-risk segments of the bond market or a higher allocation to stocks.

Overall, however, an investor in retirement needs more protection against the potential for severe principal fluctuations. Investors do tend to gravitate toward bonds and away from stocks as they age because bonds tend to be less volatile. In this regard, a larger allocation to bonds is makes sense.

What’s my risk tolerance?

This is another big issue for retirees – one investor could be in exactly the same situation as another, but if one of them has a substantially higher aversion to risk, it’s not appropriate that they would hold the same investments. Why? Mainly because the investor with low risk tolerance is more likely to react emotionally to falling markets, which may lead he or she to sell a longer-term investment at precisely the wrong time. As a result, it’s important not to take on too much risk if you’re not used to seeing your account balance fluctuate – and possibly fall – on a day-to-day basis.

What are my income requirements?

Many retired people count on their savings to generate income, since Social Security typically provides only a little more than half of the income retirees require. Bonds can help bridge this gap, and they can do so with a relatively modest level of risk if the investor chooses the appropriate vehicles. Investors can accomplish this with either funds or individual bonds, but again, the key consideration is to avoid the temptation to choose investments solely based on their yield. As always, make sure your balancing the need for income with the need for capital preservation and diversification.

Is my purchasing power at risk?

Taking too conservative of an approach can prevent loss of principal, but it also can lead to loss of purchasing power due to the impact of inflation. If your investments are earning 1% a year and inflation is running at 2%, the amount of goods and services your savings can buy you is actually falling by 1% per year even though you’re “earning” that 1% interest. In this sense, being too conservative carries risks of its own. No matter what your situation, it’s always wise to take the impact of inflation into account.

bonds.about.com/od/TIPS/Treasury-Inflation-Protected-Securities-tips.htm>Treasury Inflation Protected Securities. both of which offer both safety (if held until maturity) and inflation protection.

What’s my tax bracket?

Investors in higher tax brackets may be better off owning municipal bonds, which are exempt from federal tax and in some cases from state and local taxes as well. While municipal bonds are useful in this situation, they often don’t make as much sense for someone in a lower tax bracket – as many retirees often are. Learn more about all the considerations associated with municipal bonds – including risks and tools for determining whether munis are right for you – here .

Is managing my money really how I want to spend my time?

This is the final consideration. Many people work all of their lives to be able to enjoy life in their golden years. In many cases, spending time worrying about investing doesn’t fit with that picture. In this case, a fee-only advisor (as opposed to one that works on commission) makes all the sense in the world.

Putting it All Together

From these questions, it should be apparent that no single consideration takes precedence. Every investor has a different combination of needs, knowledge level, and risk tolerance. As a result, there are no easy answers to the question “Which investment is right for me?” It’s therefore essential to avoid any information source that tells you otherwise. Bonds can be used conservatively or aggressively in any situation, but they can be particularly useful in a retirement portfolio. Just make sure you understand the risks and that your investments are appropriate for your life stage and financial circumstances.

Disclaimer. The information on this site is provided for discussion purposes only, and should not be construed as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities. Always consult an investment advisor and tax professional before you invest.