For stable income generation and to lower the risk of their investment portfolios, retirees rely heavily on bonds. Some are concerned about the negative effects of tighter monetary policies on retirement portfolios, as the Federal Reserve is planning multiple interest rate increases this year.
CNBC reports that Jerome Powell, the Chairman of the Federal Reserve, predicted a series rate hikes this year and reduced pandemic-era supportive measures from central bank to combat rising inflation. CNBC reports that December’s increase was 7% year-over year. This is the fastest pace since 1982.
Bond investors are concerned by the increased rate outlook. Bond prices tend to have an inverse relationship. Higher rates equal lower bond values. This situation is also known as interest risk.
For example, a $1,000 10-year bond with a 3% coupon will still pay 3% but the bonds value could drop to $925 if the market interest rates rise to 4.4% in a year. This price drop is expected because new bonds would have a more attractive coupon of 4%. Older bonds with lower coupons would become less appealing, so buyers would demand a reduced price.
Brad Lineberger, a certified financial planner, is president of Seaside Wealth Management in Carlsbad, California. He warned that investors will sell their current bonds to get higher-paying ones. This would cause overall prices of debt to fall due to the new supply.
Also, the duration is important. The longer a bond’s duration, the more sensitive the debt security will be to interest rates or a steeper fall-off in its price.
Paul Winter, a CFP, and owner of Five Seasons Financial Planning, Salt Lake City, suggested that investors concerned about rate risk should consider bond funds or bonds with shorter durations to limit pullback.
Winter explained to CNBC that bonds with lower coupon rates and credit quality are less sensitive to higher interest rate, all other factors being equal.
ETF investors have an option to manage their risk and still generate income.Nationwide Nasdaq 100 Risk-Managed Income ETF, which seeks current income with some protection against the downside.
NUSI employs a rules-based options strategy to generate high income. This strategy uses the Nasdaq-100 Index (an index of the 100 biggest non-financial stocks) on the Nasdaq exchange. The ETF could be used as a hedge or to complement traditional fixed and equity income allocations.
The Nationwide Risk-Managed income ETF uses a collar strategy in order to generate monthly income. Collar strategies allow you to hold shares of the stock while also buying put options that protect the security and writing calls for it. A put option grants its owner the right, but not obligation, to sell the asset at a certain price and at a given date. A call option gives its owner the right, but no obligation, to buy the asset instead.
Visit the website for more news, information, or strategy.Retirement Income Channel.
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Nasdaq-100 Index: A rules-based, market capitalization-weighted index of the 100 largest, most actively traded U.S companies listed on the Nasdaq stock exchange.
Duration – a measure of the sensitivity of the price of abondor otherdebt instrumentto a change ininterest rates. A bond’s duration is easily confused with its term ortime to maturitybecause certain types of duration measurements are also calculated in years.
Coupon – the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.
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Tom Lydon’s views and forecasts are only his opinions. They may not come to fruition. This site should not be construed or used as an offer to purchase, solicitation of an offer for sale, or recommendation for any product.