The Bond Investing Guide Every High Net Worth Investor Needs
Bonds play a significant role in the wealth-building process and your retirement income strategy.
As you grow your wealth, you might want to concentrate on stocks, but bonds offer high-net-worth investors unique opportunities to potentially preserve and provide improved stability within an investment portfolio.
It's no surprise then that bonds should be a major component of high net worth retirement planning.
Let's take a look at how bonds could potentially help your portfolio and the types of bonds you might want to consider investing in.
If you think you may need to review your holdings feel free to request a portfolio checkup, and we will help.
Bonds Are Still Important
As a quick review on bonds, remember that, unlike stocks, they are debt securities. A bond is an IOU from the bond issuer/borrower to you, the lender, in which they will pay you interest for borrowing that money over a set period of time.
They are legally binding contracts that require the issuer to pay you the stated interest payments (also known as the bond coupon) and return your principal at the end of the bond term, or maturity date. The binding agreement is a central difference between stocks and bonds and why they are generally considered safer.
Bond prices and interest rates are also inversely related. For example, when interest rates rise, bonds typically fall, and vice-versa. But, with high inflation and historically low-interest rates, many investors are questioning the bond market’s relevance. After all, investors continue to face challenging headwinds when it comes to keeping pace or outpacing inflation with bonds alone.
However, the fixed income asset class can play a vital role toward your comprehensive investment objectives. Financial and economic factors impact bonds differently than stocks, so bonds often react differently than stocks.
For example, in the chart below, we show the returns of the Bloomberg U.S. Aggregate bond market vs. the 20 worst quarters for the S&P 500 since 1990.
As you can see, the bond market increased in value during 16 of the 20 worst quarters for the stock market, illustrating the potential diversification benefits to holding bonds during volatile times.
Many bonds, such as short-term and high credit quality bonds, tend to be more stable than stocks and provide consistent interest payments.
Bonds also may provide a source of liquidity outside of your stock portfolio for specific needs such as income in retirement or major purchase like a car or vacation.
While not guaranteed, including bonds in your portfolio may also provide a source of funds to help rebalance your portfolio when stocks are down.
For example, the S&P 500 had negative returns in 2008, 2018, and so far in 2022 as depicted in the chart below.
In all four periods, the fixed income market outperformed the stock market, thus providing a source of funds to rebalance your portfolio. This means that investors who had exposure to fixed income may have been able to sell some of their fixed income investments (while prices were higher) and purchase stocks (when prices were lower).
But, like most types of investments, there are some downsides to bonds.
For example, some bonds may not keep pace with inflation. Also, unlike U.S. Government bonds, some bonds aren’t guaranteed to pay back the principal (junk bonds). Finally, some individual bonds may be costly to buy or sell on their own, which is why many investors get exposure to bonds through diversified bond index funds, like mutual funds or exchange-traded funds.
With these tradeoffs in mind, here are some bonds to consider.
Treasury Inflation-Protected Securities (TIPS)
Treasury inflation-protected securities, or TIPS, are exactly what they sound like. They are US Treasury securities whose interest payments adjust with inflation.
You receive a fixed interest rate set by a competitive auction when each issue is offered. But that rate is based on the principal amount, which is adjusted for inflation every six months.
You can buy TIPS from the Treasury at treasurydirect.com or through a registered broker. Since the US Treasury market is large and active, many Treasury bonds, including TIPS, are available in the secondary market. You can also purchase them at issue by placing a bid in one of the regular auctions. Most individual investors will place non-competitive bids, meaning they will take the rate determined by the auction. You are limited to $5 million of non-competitive bidding.
An easier way to purchase TIPS may be to purchase a diversified mutual fund or exchange-traded fund (ETF) that is specifically designed to invest in TIPS on your behalf.
In addition to inflation protection, TIPS also provide tax benefits if you are taxed by your state or municipality because the interest and principal growth (if you bought them at a discount) are exempt. They are still subject to federal income taxation.
You’ve probably heard about I-bonds recently—they are having a moment. They're all over the news, and for good reason. The current I-bond rate is an annualized 9.62% as of this writing!
Like TIPS, they are a tool to protect you from inflation.
They function differently from TIPS, however. They have a fluctuating interest rate that is composed of two parts:
A fixed component that remains the same for the life of the bond.
A variable component that adjusts every six months for inflation.
Like TIPS, they are exempt from state and local taxation. Each individual is limited to a total of $15,000 worth ($10,000 online and $5,000 in paper bonds using your tax refund) of purchases each year.
You must wait at least one year after buying before you can sell an I-bond, and if you sell within five years, you’ll forfeit 3 months' worth of interest.
Since I Bonds are inflation-protected, you’ll likely see them boasting a higher interest rate than other types of bond investments.
Municipal Bonds, or “Munis,” issued by state and local government entities (such as school districts) are a classic staple for high-net-worth investors.
They have earned their place in most portfolios because they are usually tax-free at the Federal level and often at the state and local levels. To get the state and local tax exemption, you need to purchase bonds from an issuer in the same state you live in.
But just because you have a high income doesn’t mean that municipal bonds are right for you.
For example, we often find that some high-income investors may be better off purchasing corporate or government bonds within their tax-deferred accounts rather than purchasing municipal bonds within their taxable brokerage accounts. Like anything, the right municipal bond strategy depends on your unique situation.
Corporate bonds are issued by for-profit companies. Because a governmental taxing authority doesn’t back them, they are often riskier, and their yields tend to be higher than comparable Treasury and municipal bonds.
Issuers of corporate bonds have credit ratings similar to your credit score that can help you sort through them by risk profile.
Building A Bond Strategy
Now that you understand a little more about the different types of bonds and how they can help you, it’s time to think about how to incorporate them into your strategy.
Fixed income and bond returns can differ depending upon the types of bonds that you include in your investment portfolio and the timing of your investment.
That's a great reason to think about diversifying your bond portfolio across different segments of the bond market. While diversification does not guarantee against loss, history has shown that spreading out your investments may provide a benefit over the long-term.
A great, low-cost way to buy bonds for your portfolio is via bond funds, either mutual funds or ETFs. They make it easier for you to diversify your bond portfolio and reduce the complexities of buying and selling bonds on your own. Plus, they tend to pay more frequent dividends than individual bonds alone.
You can find a bond fund for just about any type of bond exposure you want. Some examples of different types of diversified bond funds that we utilize at Covenant Wealth Advisors are:
Fidelity Short-Term Bond Index (FNSOX)
DFA Five-Year Global Fixed-Income Portfolio (DFGBX)
iShares S&P Short-Term National Muni Bond ETF (SUB)
But, bond funds aren’t the only investment option for high-net-worth investors. You may also consider building out bond ladders. A bond ladder is a strategy whereby you purchase individual bonds with different maturities, volatility, and credit quality, like a high-yield bond. Keep in mind that higher-yield bonds tend to be riskier investments.
As a bond matures, you can reinvest the proceeds in a new bond with a different interest rate. The downside of bond ladders may include a reduction in diversification (vs owning bond funds), potentially higher costs of acquiring the bonds, the work involved in maintaining the bond ladder in the first place, and a lack of liquidity for certain bonds.
Bonds May Provide Benefits to Your Retirement Portfolio
To re-cap, owning bonds isn’t just about their level of return which sometimes seems small. They are a tool and can bring additional benefits that are paramount to your retirement portfolio.
Depending on the types of bonds you hold and the percentage they make up of your total asset allocation, they may provide stability to counter the fluctuations in your stocks, serve as an income source in retirement, are sometimes tax-free, and may provide liquidity for big purchases in retirement.
So, are bonds a good investment? Ultimately, stock markets don’t always go up, and high-net-worth investors like yourself should consider the potential benefits of including bonds in your retirement portfolio.
If you’d like to review your bonds to make sure they are serving as they should in your larger investment strategy or would like to talk about how bonds could help you, we will review your portfolio with you.
Find some time on our calendar today!
About Mark Fonville, CFP®
Mark is a fee-only financial advisor at Covenant Wealth Advisors. He specializes in retirement income planning, investing, and tax planning for people aged 50 plus who want to enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond and Williamsburg, VA. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital.
The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place.