Creating A Ladder for Retirement Income
Laddered bonds are an effective means of finishing that climb to financial success. For those who begin turning 60 this year, this simple investment tool can help soon-to-be retirees maintain financial health in the years to come. If you are retired or planning on retiring soon, a tailor-made laddered bond portfolio can provide a dependable income stream without compromising your growth investments-even during your retirement years!
We hear two main, albeit misinformed, views about bonds. Some recommend retirees hold all of their investments in bonds to guard against losing their investment in the market just when they will need the money the most. Others advise the exact opposite: avoid bonds because of the market always outperforms bonds.
Both are overreactions. Diversification is the best means of guaranteeing an income stream while allowing for growth. Like the iron rods below deck in the centre of sailing ships, bonds keep you upright in stormy weather so that you can enjoy a smooth ride.
In the years before retirement, while accumulating wealth, your portfolio mix is not as critical. In fact, with time on your hands, there is considerable room for mistakes. As long as you are adding to your portfolio you can weather most storms in the financial markets. Living off your income and continually saving will keep your portfolio value heading up even if your investment plan is somewhat lacklustre.
This does not hold true once you are retired. Invest too conservatively and your assets won't keep up with increases in the cost of living and you will run out of money. Without your income to support your lifestyle and add to your investments your portfolio must have significant appreciation.
Invest too aggressively and you may still be penniless at the eleventh hour. A dip in the market will dramatically change the value of your portfolio. And with no additional money being invested, what you do take out for living expenses in a down market represents a large portion of your wealth. The portion you must spend in down years will never rebound, and the setback can also cause you to run out of money.
Bonds have an important place in a portfolio while you are adding to your portfolio, but during retirement and in the five years beforehand their use becomes critical. We use bonds to provide enough stability to give our clients an income stream for 5-7 years at a time. With a guaranteed income for 5-7 years, you are then free to invest the remainder of your portfolio in appreciating stock. (Remember, you have a time horizon of at least 5-7 years with this strategy to weather the storms.) If the markets drop, you won't need to try to live off a depreciated portfolio, further disabling your future income.
For clients with sufficient total assets, we recommend a tailor-made laddered bond portfolio. This is comprised of individual bonds that mature at the time of need for the amount of need. A laddered bond portfolio should also include bonds which increase in size providing assets maturing in amounts that go up by the rate of inflation. Unlike bond funds, individual bonds have no expenses, which helps boost your returns.
Part of any laddered bond portfolio should also include structuring your bonds so that you receive interest payments in different months. Since bonds pay interest twice per year, buying six individual bonds will allow you to set up your bonds so that you receive one interest payment each month. The interest from the bonds could be used as income, or if the bonds have been purchased to mature as expenses are needed then the bond income can be invested back into appreciating stocks.
Investing the additional interest generated by a bond portfolio allows you to continue "dollar cost averaging" into the markets even during retirement. These stock investments appreciate in value and provide growth in your portfolio assets.
To keep your cash stream flowing, sell some appreciated stock and buy a new bond to add to the end of your ladder when markets are right. When the market has done well, take some of your profits off the table and buy individual bonds maturing in a year at the end of your ladder.
Conversely, when the markets drop, postpone adding a bond to your ladder until your stock portfolio rebounds. This is the exact opposite of what the majority of investors are doing. Most investors will sell their stocks after a bad year in the markets and buy bonds. Then, after a good year in the markets they will sell their bonds and go back into stocks.
We recommend being a contrarian. Follow your overriding investment strategy, but when stocks do poorly, rebalance your portfolio with more stocks. And when stocks do well, take some of your profits and buy an additional year of bonds maturing.
Using this method of laddering your bonds will provide 5 years of guaranteed income and the opportunity to reinvest for growth. The longest downturn we have seen thus far in the markets is 3 years. A 5-year laddered bond portfolio will allow you to get through a slump without depleting your portfolio when it's at its lowest.