• Share

PRINT

Most people think bonds are safe, but in today’s volatile climate, they are not.

In the not-too-distant past, bonds were portrayed as a safer investment than stocks. Investors looked to government bonds as the bedrock of a stable retirement income.

But bond yields are extremely low these days, prompting some investors to seek alternatives. This has sparked renewed interest in various investments that can generate passive income and stability.

Most people don’t remember what a bad bond market looks like because we haven’t seen one for 30-plus years! We’ve had steadily declining interest rates since the mid-1980s. Bond prices move in the opposite direction of interest rates. When interest rates rise, bond prices fall, and vice versa.

The Federal Reserve has already begun raising interest rates and expects to start selling off some of its government bonds later this year, so the climate is likely to be less favorable for long-term bonds going forward.

And with bonds paying historically low interest rates, long-term bonds falling in price could mean a low-yield investment for years.

Problems with bond funds

Bonds issue at par value of $1,000, and by buying a bond you are in effect loaning a corporation or some form of government your $1,000.

There is a length of time you have to leave it there, until it reaches what is known as its maturity date, which can range from one year to 40-plus years.

There will be a set interest rate for that length of time. So, if interest rates rise (causing bond prices generally to fall), you can hold your bond until it matures and still get your $1,000 back.

A huge issue is that most people don’t hold their bonds directly anymore; rather, they hold bonds through mutual funds.

And when you hold bonds in mutual funds, there are two problems: There is no set interest rate, and there is no maturity date. So when interest rates rise and your bond prices fall, there is no date in time when you can get your $1,000 back.

Other investments to consider

To avoid getting trapped while the outlook on bonds is not all that bright, here are two alternatives that can provide more security and a decent rate of return:

Fixed annuities and fixed index annuities: Fixed annuities, sold by insurance companies, offer long-term tax-deferred savings and monthly income for life.

They involve an upfront payment by an investor for a series of guaranteed income distributions from an insurance company. The insurer guarantees the buyer a fixed interest rate on their contributions for a specific period of time. The value of the buyer’s principal, even if interest rates rise, stays the same.

You can also choose a fixed index annuity, where your principal is protected and the return is tied to a market index, like the S&P 500. If the market is down, the worst you can do is zero gain, and it will still have a participation rate on the upside.

For example, if we have a 50% participation rate and the S&P 500 is up 12%, then 6% would be credited to your account on your anniversary date, and that new value is locked in and can’t drop below that value because of a market decline.

Annuities often generate more income than bonds of similar maturity purchased at the same time. Also, each annuity payment consists both of return on investment and a portion of the original premium itself. Only the annuity’s return on investment is taxable, while the premium portion of each payment is returned tax-free.

And because annuities aren’t priced daily in an open market as bonds are, they are better than bonds at holding their value while generating a more predictable cash flow.

Real estate investment trusts: This is the best-known bond alternative, created in the 1960s to provide investors a way to invest in funds that own, manage and/or finance income-generating real estate.

The REIT investment space is enormous; investors can target specific real estate segments and diversify across different segments. They get 90% of profits.

REITs are tax-advantaged as dividends and trade like stocks. And unlike bonds, which pay a fixed amount of interest and have a set maturity date, REITs are productive assets that can increase in value indefinitely.

Many REITs have dividend yields between 5% and 10%. Be careful, though — many REITs are not liquid if you need access to your money in the short term.

Alternatives to bonds do offer higher yield potential. But remember, that comes with more risk and/or higher cost.

It’s wise to work with an adviser to go over your options as you assess your portfolio. Differentiate between safe and risky assets, and structure your portfolio in a way that makes the most sense for you.

Dan Dunkin contributed to this article.

© 2022 The Kiplinger Washington Editors, Inc. Distributed by Tribune Content Agency, LLC.