Blog

What’s the Point of Bonds in a Portfolio? (And Why Individual TIPS, Held to Maturity, Are Unique)

Broadly speaking, bonds can be used to perform either of two distinct roles in a portfolio.

The first role: they are the “thing in the portfolio that’s safer than stocks but which still generally provides more return than cash.”

And for that role, as long as you stay away from bonds that are so risky that they actually aren’t safer than stocks (i.e., bonds with super long durations or extremely poor credit ratings), just about any bonds can do the trick. You can use individual bonds or a bond fund. And as long as it’s low-cost, any of several different types of bond fund would be fine:

Short-term Treasury fund,
Intermediate-term Treasury fund,
Total bond market fund,
Short-term TIPS fund, or
Intermediate-term TIPS fund.

Any of those will work. The intermediate-term funds are riskier than the short-term funds, and a “total bond” fund is riskier than a Treasury fund, but that, in itself, is neither good nor bad. We can adjust the overall risk level to whatever we want it to be by adjusting the overall stock/bond allocation as needed.

The second role that bonds can play is that they can be used to offset specific costs at a specific date in the future. (“Asset-liability matching” is the technical term for this concept.) For instance, if I expect my first year of retirement to be 10 years from now, and I want to have $60,000 of spending power available in that year, I could buy bonds that mature in that year, to provide me with a very safe way of satisfying that spending.

But here’s the key point: for this purpose (asset-liability matching), it is only individual TIPS, held to maturity, that can do the job.

It has to be TIPS* (rather than “nominal” bonds, which are not adjusted for inflation), because we want a certain amount of purchasing power at some point in the future, rather than a certain dollar amount.

And it must be individual TIPS, rather than a TIPS fund.** And that’s because the only way to have a certain amount of known spending power at some specific date in the future is to hold the TIPS to maturity. With a typical bond fund, the fund is constantly buying new bonds. (It must. Otherwise it would eventually hold nothing but cash as the bonds matured.) And as a result, whenever you sell shares of a bond fund, you’re effectively selling bonds prior to maturity. And so, at the time you buy the fund, you don’t know what it will be worth when you eventually sell it. (For example, if I knew that I wanted to have $10,000 of spending power 10 years from now, a TIPS fund doesn’t achieve that goal for me, because I don’t know what the fund will be worth 10 years from now.)

*I Bonds also work, though they have two major limitations in that they cannot be purchased inside retirement accounts and you’re limited to $10,000 per purchaser per year.

**One exception: BlackRock does offer ETFs that hold TIPS to maturity. For example, iShares iBonds Oct 2028 Term TIPS ETF (IBIE) owns nothing other than TIPS maturing in 2028. And the ETF will hold those TIPS until they mature, and then the fund will liquidate, distributing cash to shareholders. So it works very similarly to just buying 2028 TIPS on your own and holding to maturity.

What is the Best Age to Claim Social Security?

Read the answers to this question and several other Social Security questions in my latest book:


Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less

Click here to see it on Amazon.

Disclaimer:Your subscription to this blog does not create a CPA-client or other professional services relationship between you and Michael Piper or between you and Simple Subjects, LLC. By subscribing, you explicitly agree not to hold Michael Piper or Simple Subjects, LLC liable in any way for damages arising from decisions you make based on the information available herein. Neither Michael Piper nor Simple Subjects, LLC makes any warranty as to the accuracy of any information contained in this communication. The information contained herein is for informational and entertainment purposes only and does not constitute financial advice. On financial matters for which assistance is needed, I strongly urge you to meet with a professional advisor who (unlike me) has a professional relationship with you and who (again, unlike me) knows the relevant details of your situation.

You may unsubscribe at any time by clicking the link at the bottom of this email (or by removing this RSS feed from your feed reader if you have subscribed via a feed reader).

What's your reaction?

Excited
0
Happy
0
In Love
0
Not Sure
0
Silly
0

You may also like

Blog

I Bought MPACT

This week, I bought MPACT (Mapletree Pan Asia Commercial Trust) when share prices of stocks ...

Leave a reply

Your email address will not be published. Required fields are marked *

More in:Blog