Over the years, we have talked in great length about laddering your fixed-income investments to meet your liquidity needs. This concept of laddering bonds is a byproduct of your financial plan. Once you get within 10 years of a known expenditure, you should not have those assets exposed to the equity markets in order to preserve the principal.
In your plan, you likely know when your large expenditures will happen, for example, when your children attend college at age 18, and you’ll need a certain amount of money to pay for tuition. You also know you’ll have four to five years of tuition to pay. If you follow the Ten Year Rule, when your child is 8 years old, you would begin moving money from growth investments to fixed-income investments that will mature around the time of the anticipated expense.
Laddering fixed-income investments for your own retirement can be trickier as there are many more variables to consider. In 10 years, you may change your mind about retiring because your employer has offered you a substantial bonus to stay on for another three years, or you may not know your exact liquidity needs because you may choose to relocate within a few years. By working with your adviser, you selected a set of variables to best estimate your anticipated spending and income sources. Any gap between the money you have coming in and the money going out is your liquidity need that is filled by your invested assets. Ideally, by matching your investments with your expenses 10 years prior, you should be able to avoid selling your invested assets in a down market.
Generally we recommend seeking high quality municipal or government bonds rated AA/Aa2 or better by Standard & Poor’s or Moody’s. However, with a low interest rate environment, your bond buying standards have to mold as the market moves. We are also in a period where the Federal Reserve may increase interest rates. With 10-Year Treasury bonds yielding around 1.85%, it is not likely you want to lock in such a low interest rate for 10 years, as this can affect the overall performance of your fixed-income portfolio.
To combat interest rate risk, we recommend you keep the bond maturity dates short, no more than five years currently. We also purchase FDIC-insured CDs as it can be difficult to find a high quality municipal bond with a comparable interest rate. As your bonds mature, you may be able to purchase new bonds hopefully yielding more.
Some investors may also consider investing a small percentage into a maturing bond exchange traded fund. These ETFs are generally diversified, holding 100 to 300 individual corporate, municipal and high-yield bonds, in annual maturities up to 10 years. The ETF shares have a maturity date, allowing investors to plan for their known expenses. Maturing bond ETFs are not guaranteed; however, some investors may be more comfortable with the potential risk given their diversification and maturity date.
Investors may also consider taking the eighth through tenth year of fixed-income money and investing it in a high dividend portfolio that blends both high yield stocks with stocks that have a high and sustainable dividend growth rate. With this strategy, investors should look for companies that grow their earnings at an equal or higher rate than they grow their dividend to ensure that the dividend is sustainable. You do not want to own companies that borrow to cover their dividends.
If you have questions regarding how fixed-income investments should be structured in your portfolio, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
