6 WAYS BONDS CAN BITE YOU IN 2017 CAN CAN IN 2017

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1 6 WAYS BONDS CAN BITE YOU IN 2017 CAN CAN IN IN WHY WHY YOU YOU SHOULDN T SHOULDN TBE BE COUNTING COUNTING ON ON BONDS BONDS FOR FOR INCOME. INCOME. 1

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3 BONDS ARE WIDELY KNOWN FOR BEING LESS RISKY THAN MANY OF THEIR OTHER INVESTMENT COUNTERPARTS. Unlike the vehicles our firm normally use for retirement income, bonds are a loan. Unless the issuer defaults, bonds don t rely on the market to do well to produce returns. Even if the issuing company doesn t see gains, the investor will still be able to make money from their bond. The question is whether or not your bond can keep pace with inflation. The average rate of inflation in the United States between 1913 and 2013 is 3.22%. 1 If you purchase a bond that doesn t match this rate, then you could actually be losing the purchasing power of those funds. A bond used to be known for being a conservative asset in your portfolio that could generate stable cash flow, especially during market swings. We recommend you avoid buying for yield rather than delving deep into the product types, because not all bonds are the same. In some, the issuer has a right to repay their debt before maturity. Other bonds can be difficult to sell, as many of us learned in 2001 and 2008 when the market experienced a dramatic downturn. The list below highlights the six ways your bonds may not meet your needs and objectives, let s explore these issues a little deeper v Interest Rates Bond Funds Credit-worthiness The Risk of Liquidity The Risk of Inflation Reinvestment 1 McMahon, Tim. Long Term U.S. Inflation. Inflation Data, April 1,

4 1 INTEREST RATES WHEN INTEREST RATES GO UP, BONDS GO DOWN. HAVE YOU HEARD THAT BEFORE? IT S TRUE The reverse is also true when interest rates fall, the price of a bond issued when interest rates were higher rises The value of a bond changes every day and is determined by numerous reasons in response to the movement of interest rates and a bond s price. You may consider the relationship of interest rates and a bond s price similar to that of the see-saw pictured below. Interest rates will rise eventually, and it could be soon. When they do, your coupon rate (or interest payments) on the bonds you own will not be attractive to buyers. You may have to offer them at a lower price, which enables them to get essentially the same return as if they purchased a new bond at the higher rate. To find out how much exposure your bond has to increasing interest rates, you should understand duration: a number reflecting how much your bond investment will likely change when interest rates rise. The degree of share price fluctuation caused by interest rate movements varies according to the maturity and type of bond held by the Fund. Normally, a longer-term bond fund will experience more share price fluctuation than a shorter-term bond fund. The following table provides some examples of how bonds of different maturity lengths react to a change in interest rates. 4

5 Bond Maturity Bond Prices and Interest Rates Initial Principal of $1,000 ad Yield of 10% 1% Rise in Rates 1% Decline in Rates Short Term (2.5 year maturity) $ % $1, % Intermediate-Term (7 year maturity) $ % $1, % The 10% growth shown is hypothethical and is not intended to show, or project, the performance of any bond fund for any period or time. Long-Term (20 year maturity) $ % $1, % A fund that holds high-yield bonds and convertible bonds is less sensitive to interest rate movements. High yield bonds and convertible bonds resemble equity securities in that at times, their price movements are affected more by changes in the financial position of the issuer than by interest rate movements. One final point to consider is that a bond fund s share price generally tends to fluctuate less than the price of an individual bond due to the diversification of the fund s portfolio. 5

6 2 BOND FUNDS Many are not aware that bond funds carry additional risks that individual bonds do not because they are not sold with a set maturity date like individual ones are. Here too bond fund returns also decline when interest rates rise. Fixed-income securities within a bond fund are designed with staggered maturity dates to maintain the income purpose. Bond fund managers replace bonds as they mature and they may have to sell some holdings to meet the commitments. Sometimes, that means their higher-yielding ones. Sometimes, that means replacing them with lower-yield ones. You may find your investment is outside your risk-tolerance comfort zone, and/or your income needs are not being met. 6

7 6 WAYS BONDS CAN BITE YOU IN 2017 CREDITWORTHINESS 3 Bond returns depend on the financial stability and projected ability of the bond issuer. Credit rating agencies, such as Moody s and Standard & Poor s, perform this review of corporate or government issuers. Yields to the investor correlate with how much risk he/ she is assuming. High yield corporate bonds, emerging markets, floating-rate bonds and low-grade municipals pay the most, but you assume a higher risk of the issuer defaulting. Investment-grade corporate bonds are moderate investments, and Treasury bonds are considered the lowest risk. Bond funds investing in bonds of a lower credit quality may offer higher yields, but they may also have a higher degree of investment risk. And the opposite is true for higher quality bond funds, such as funds investing in U.S. government securities, which typically offer relatively lower yields. 77

8 4 The Risk of LIQUIDITY THE ABILITY TO SELL YOUR BOND IS DEPENDENT ON THE STOCK MAR- KET S UPS AND DOWNS. DEPENDING ON THE BOND TYPE, YOU COULD HAVE TO SELL FOR A LOWER PRICE IF YOU ARE ABLE TO SELL IT AT ALL. THE BOND MARKET IS LESS LIQUID THAN THE STOCK MARKET. GOVERNMENT BONDS TYPICALLY SELL QUICKLY, WHILE CORPORATE BONDS CAN BE MORE DIFFICULT. TO PUT IT SIMPLY, YOU TAKE A BIGGER LIQUIDITY RISK WITH A SMALLER ISSUER. 5 INFLATION When inflation is higher, the value of your bond which is calculated after inflation can decline. For example, a 5-year bond at 5% would essentially be a -2% bond if inflation was at 7%. Shorter-term bonds and TIPS (Treasury Inflation Protected Securities), as well as commodities like gold, are often used for inflation defense. 8

9 6 REINVESTMENT When investors bonds mature while interest rates are decreasing, the bond issuers need to find reinvestment opportunities which can result in a lower rate of return, less income. Risk levels vary here too by bond type the higher the coupon, the greater the reinvestment risk. 9

10 About Joshua Mellberg and J.D. MELLBERG FINANCIAL JOSHUA MELLBERG IS THE CEO AND FOUNDER OF J.D. MELLBERG FINANCIAL BASED IN TUCSON, AZ AN INDUSTRY-LEADING FINANCIAL ORGANIZATION THAT SPECIALIZES IN HELPING CLIENTS ACHIEVE A MORE FINANCIALLY CONFIDENT AND ENJOYABLE RETIREMENT. Josh entered the financial services industry immediately after college, working with a trust company and later a captive insurance company. These two jobs taught him two valuable lessons. The first was that every client who purchased a trust didn t actually need one, and secondly that a successful company needs to find products their clients need, rather than look for clients to sell products to. These insights empowered Josh to start J.D. Mellberg Financial, where he vowed to always offer clients a wide array of proven retirement products and services to help protect and then help manage their retirement moneys to fit their personal situation. Founded in 2005 and fueled by Josh s passion for empowering retirees, J.D. Mellberg Financial has helped thousands of seniors design income strategies to better meet their needs and goals in retirement. Today more than 10 million people all across the United States have visited J.D. Mellberg s websites to find out how financial professionals with this expertise help each client design retirement income strategies to suit his/her goals. Josh s popular financial information videos have been downloaded and viewed more than four million times over the past year, with an average of 350,000 visitors each month. Josh has been featured on CNBC, PBS, Yahoo! Finance, and is a weekly contributor to New York Daily News. He has given hundreds of lectures on retirement preparation, tax-minimization, and income planning strategies all over the nation. Josh also regularly holds national training events for financial professionals within the industry. A third-generation Arizonan, Josh resides in Tucson with his fiancé and their three dogs. When he isn t in the office, you ll find him soaking up time with family and friends or traveling around the world. 10

11 PLANNING YOUR RETIREMENT With J.D. Mellberg Still have questions? We believe in informing people so they can make empowered decisions. We ve helped out thousands of retirees and pre-retirees reach their retirement financial goals using our NextGen Annuity Strategies TM. Call J.D. Mellberg Financial at to find out how we can help you retire with confidence. 11

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