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Are bonds a ‘safe’ investment?

April 22, 2018

Every week, Simply Money’s Nathan Bachrach, Ed Finke and Amy Wagner are answering your financial questions in The Cincinnati Enquirer. If you, a friend, or someone in your family has a money issue or problem, please feel free to send those questions to yourmoney@enquirer.com

 

Tim in Cleves: Are bonds still considered a “safe” investment? I’m nearing retirement and trying to figure out how to protect my money. 

Answer: First, a definition: A bond is simply an ‘IOU.’ You loan a company, government or municipality money for a set period of time, then that entity pays you regular payments at an agreed upon interest rate. If the entity is still solvent by the time your bond ‘matures,’ you then get your initial investment back. 

Historically, bonds have tended to move in the opposite direction of stocks. So, when stocks have struggled in the past, bonds acted as a shock absorber to that instability. Another way bonds are beneficial is the potential income they provide. Today, bonds are paying more income than at almost any time over the past three years, however, they’re still not the big income producers they used to be 20 or 30 years ago.  

One of the biggest risks with bonds is if interest rates rise very quickly. This is because interest rates and bond prices usually move in opposite directions, so as interest rates rise, the value of bonds falls. You can offset that risk by owning some shorter-term bonds because these are less sensitive to interest rate movements.  

Another risk is the credit-worthiness of the issuer. On the riskier end of the spectrum is a high-yield bond (AKA, ‘junk bond’) – you get a higher yield because there’s a higher risk of default. On the other end of the spectrum is a U.S. Treasury bond – this is commonly considered one of the safer types of bonds because the government has the power to tax you, the taxpayer, to pay the bondholders.   

Lastly, the length of time you hold onto your bond, the riskier the investment. Essentially, you’re exposing yourself to more risk by allowing your money to be tied up for a longer amount of time. So, for example, a 10-year bond would be riskier than a 1-year bond.  

The Simply Money Point is that there is no such thing as a risk-free investment, so there will be periods of time when bonds drop in value. But over the long run, we believe that bonds should continue to be an important part of any well-diversified investment mix. 

 

Michelle and Doug in Oakley: Our daughter is 23 and interested in using a robo-advisor. Is this something you would recommend? 

Answer:  A robo-advisor is an automated, digital financial advisor. It uses software and algorithms to create an investment mix of stocks and bonds for your needs.  

For someone like your daughter who’s just beginning her financial journey, a robo-advisor could be a good way to go. Since she’s probably new to investing and mostly focused on saving, it would be an easy and low-cost way for her to get started. If a robo-advisor helps her establish smart investing habits at her young age, that’s a fantastic benefit. 

But there are also some downsides that come with robo-advisors, particularly if you’re further along in your financial journey – and especially if you’re nearing retirement. The biggest is that financial planning has a lot of moving parts. Many times, a robo-advisor only factors in your risk tolerance, amount you have saved, age, and retirement year. But there are so many additional factors that you need to consider when planning for the future: your goals, your insurance needs, your Social Security claiming strategy, your tax strategy, your debt-to-asset ratios, and more. Financial planning should be personalized to match your lifestyle goals. 

Likewise, Simply Money Advisors also believes that building relationships is extremely vital to your financial success. For example, if the stock market dips five percent and you get nervous, you may decide to put all your money in cash, meaning you might miss out on some eventual gains. But if you had been working with a trusted financial planner, he or she could have helped you decide if moving your money to cash was the best decision for your financial future. A human advisor can be your buffer, helping you weigh out the pros and cons of all of your financial decisions.  

The Simply Money Point is that there are pros and cons to working with a robo-advisor. You need to decide what’s best for you and your stage in life. But it’s always nice to have someone holding your hand, especially if you’re nearing retirement.

 

Responses are for informational purposes only and individuals should consider whether any general recommendation in these responses are suitable for their particular circumstances based on investment objectives, financial situation and needs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing, including a tax advisor and/or attorney. Nathan Bachrach and Ed Finke and their team offer financial planning services through Simply Money Advisors, a SEC Registered Investment Advisor. Call (513) 469-7500 or email simplymoney@simplymoneyadvisors.com.

Investing Retirement