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Which of the lowest risk bonds should I switch to?

I am 60 years old and I want to put my investments into the lowest risk bonds possible but I do not know which is best..

Jun 12, 2012 by Flora from Mears, MI in  |  Flag
8 Answers  |  9 Followers
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6 votes
Sean McClay Level 13

Flora,

It is very important to understand that all investments have risk, even "low risk bonds". Unfortunately you are in a little of a catch 22 with investing in bonds at this time. Bond yields and bond prices are much like a see saw (the one you rode as a child). When interest rates go up the prices on bonds tend to go down. The longer the time to maturity of your bond the bigger percentage change of the price of your bond. Think of bonds and bond maturities like this, the shorter duration is right near the middle (not a lot of movement, but lower yield), and longer duration all the way out on the edge ( more movement, but higher yield). I would tell you that even in bond mutual funds you have the ability to lose money, so be careful. If you have a substantial amount of money it may be prudent for you to interview some Registered Investment Advisors who can help you with your income needs. It is also important to take into consideration what Jeffery had to say about inflation and how it could effect your earnings power later in life if you do not have some allocation to stocks or investments that give you some price appreciation. I would suggest interviewing several Registered Investment Advisors (ask for referrals) and choose one that is best for you. If you are opposed to hiring someone to do the worrying for you, you can always look at low cost bond funds or ETF's, but please make sure to know what you are buying before investing in a bond fund or ETF. If you have any additional questions please feel free to reach out again.

2 Comments   |  Flag   |  Jun 12, 2012 from Daphne, AL
Randy Brunson

Hi Flora,

Flag |  Jul 07, 2016 near Suwanee, GA
Randy Brunson

Hi Flora, By risk, I will assume that what you are attempting to avoid is either a lot of up and down movement, or what is often called volatility, or you are working to avoid having your money go away completely. As noted by others, any investment carries risk, and most carry different kinds of risk. Even a bond fund considered "safe" will have its value fluctuate up and down. All that said, we are fans of two bond funds, BSV and BLV. These are the symbols for two of Vanguard's ETFs, which are exchange traded funds. Hope this helps. Warm regards, Randy Brunson

Flag |  Jul 07, 2016 near Suwanee, GA

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5 votes
Don Level 19

All investments, including bonds, have risk. For bonds, the keys to consider are credit risk (that the borrower will be unable or unwilling to pay you back), interest rate risk (that rates will rise and the value of your bond holdings will fall) and inflation risk (that inflation will erode the fixed value of the payments due to you. A short-duration TIPS fund would mitigate these risks but pay you practically nothing. Such is the environment in which we find ourselves.

Comment   |  Flag   |  Jun 12, 2012 from Middlebury, VT

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4 votes

Hi Flora,

The lowest risk bonds are those issued by the U.S government. Unfortunately those don't pay a whole lot these days and sometimes the yields are actually negative! If you are going to go all bonds I suggest using a combination of low cost mutual bond funds. Some government, TIPS, and corporate but remember a mutual bond fund can temporarily "loose money" when rates begin to rise. So make sure you purchase bonds with a maturity of less than seven years.

Also consider that 60 is young these days and you can live another 35 years. If you consider that your purchasing power loses about 3% a year, during that time period your money would be devalued over 100%. Although bonds are safe they lag behind inflation

Comment   |  Flag   |  Jun 12, 2012 from Cleveland, OH

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4 votes
George Cones, JD Level 20

Flora,

To add to several good responses here, there are several ways to approach investing in bonds, depending on how much you have to invest. The key to investing in bonds, or your entire portfolio, is diversification. One of the best ways to invest in the bond market is through index funds or index Exchange Traded Funds (ETFs). The Barra Aggregate Bond Index for example, represents the entire US bond market, and has thousands of US government, government agencies, and corporate bond securities.

There are also “short-duration” corporate, government/agency and government/corporate bond funds and ETFs (many that track indices). Because of the short duration, these funds would be less risky

These index mutual funds and index ETFs are the lowest cost way to get a broadly diversified bond portfolio. Vanguard has many good, low-cost choices.

An investor who has substantial assets, there are other actively managed funds that have very good long-term track records. Always try to invest in the institutional share classes when possible.

For a discussion of interest rate risks, including a discussion of duration see the link below.

http://www.brightscope.com/financial-planning/advice/guide/2924/Beware-Of-Safe-Investments-The-Hidden-Risk-In-Us-Government-Bonds/

1 Comment   |  Flag   |  Jun 12, 2012 from Wilmington, DE
Don

By the way, I love the fact that there are so many advisors here who get excited about answering thought provoking questions like this. Unfortunately, we are not very representative of the broader financial industry where the vast majority of "advisors" are trained primarily in sales rather than finance.

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Flag |  Jun 12, 2012 near Middlebury, VT

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3 votes

Hi Flora; All good points above. I personally am not a huge fan of bond funds except used as a risk diversification vehicle inside a tax-deferred account. My personal view is that we are in the 'foothills of, andcould be in for an extended period of, inflation and rising interest rates which can cause bond funds to loose value, forcing mangers to have to raise cash to meet redemption requests... not an attractive scenario. Bond funds have no maturity date so there's no promise of even principal return. You might want to read a post of mine from last month.

http://jimlorenzen.wordpress.com/2012/05/22/why-would-anyone-buy-a-bond-fund/

The comments previously made I think are correct: There is no 'safe' investment. Even a bank C.D. is little more than a bank I.O.U., although it does come with FDIC insurance... how fast they pay-off in the event of a bank failure, I don't know.

Remember money is worth only what it purchases. If real inflation is around 3%, money in a coffee can will still lose 3% per year in purchasing power; so $1,000 would purchase only $858 (in today's dollars) in goods or services 5 years from now.... and that's ignoring taxes!

I would recommend talking with an advisor about your personal situation and your goals before making a decision you may regret.

View all 5 Comments   |  Flag   |  Jun 12, 2012 from Moorpark, CA
Don

Yes, I agree this is a real risk. You are especially exposed if you are in long term and safe haven funds that investors have flocked to of late chasing returns. For my clients I avoid all of these funds because the back draft could be so severe. But not all bond funds will get hit by this to a material extent. Also, the worst case scenario envisions rapidly rising rates. rates will rise, but long term public and private sector deleveraging could moderate the pace more than many fear.

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Flag |  Jun 12, 2012 near Middlebury, VT
James P. Dowd, CFA

I would like to offer an alternative perspective on bond funds. In my view, bond funds have three advantages compared to individual bonds: (1) Diversification. Few individual investors have a sufficiently large investment portfolio that they can be as well diversified through direct investments in bonds as through an investment in a bond fund. This may be a minor consideration if the securities are homogeneous like U.S. Treasuries, but it can be critically important if the portfolio includes any credit risk. (2) Institutional transaction charges. The retail brokerage market for bonds is highly inefficient. Transparency is poor, bid/ask spreads are wide, and it is difficult for retail investors and advisors alike to obtain institutional-style access to markets. Bond fund managers have such access, and many bond funds have very low cost structures. (3) Professional management. There are frequent anomalies in the bond market, and professional managers are better-equipped than are individual investors to seek relative value and higher marginal returns.

There are other differences between bonds and bond funds, as others have pointed out. Bonds mature, bond funds do not. And the risk of bond funds can be difficult to understand, especially for large funds with a broad array of bond types. But I believe the aforementioned benefits, coupled with the benefit of liquidity at NAV, make bond funds a better option for most individual investors.

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Flag |  Jun 12, 2012 near San Francisco, CA

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3 votes

Hi Flora, At the risk of confusing you even more - my wife says I'm pretty good at doing that - let me add something that hasn't been addressed yet and few ever think about:

When you invest in a bond fund, it's important to know what your investment really is: You are NOT investing in bonds. You are not even investing in a diversified portfolio of bonds.

What you own are shares of stock in a company that does bond trading as a business. The value of the investment company shares rise and fall with the value of their portfolios. While the bonds the company holds do pay yields, what shareholders receive is a stock dividend on their shares in the bond trading company.... One of the reasons why, when their stock falls in value due to rising rates, the company's stock dividend rarely, if ever, increases.

Advisors like myself who may use bond funds (usually index funds or ETFs only in tax-deferred accounts), do so not so much because of the asset class (bonds vs stocks, commodities or real estate), but for the correlation attributes (the shares of bond trading companies don't tend to move in 'lock-step' with the other asset classes, thereby reducing risk). But, outside of a tax deferred account, I agree with renowned Fidelity portfolio manager (and deciple of Warren Buffett) Peter Lynch who said, "I can't think of a single reason why anyone would ever own a bond fund." Again, it's really buying shares of stock in a bond trading company.

1 Comment   |  Flag   |  Jun 13, 2012 from Moorpark, CA
Don

Jim, I honestly believe that's a strange and confusing bit of minutiae to bring up in a forum like this where we are trying to help average investors (I think!). The fact of the matter is that over the long run bond funds tend to perform very much like the underlying bonds they hold and not at all like the mutual fund companies holding them. On another level, the tax treatment of bond fund interest is the same as the underlying bonds - that is, taxable at ordinary income levels when held in a taxable account. So I can't really understand the point you are trying to make.

Flag |  Jul 16, 2012 near Middlebury, VT

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2 votes

Here is a twist I didn't see fully discussed. Government bonds could be the most irrational place for a taxpayer to invest. First, you are lending money to an entity that has force control over you to pay yourself the interest back. Next you place that entity in a position to need to tax you more in order to pay you back. Finally, you pray that the entity doesn't decide to print money to pay you back because then the purchasing power of the repaid debt will be worth less.

Food for thought.

Comment   |  Flag   |  Jul 16, 2012 from Austin, TX

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2 votes
Ryan Level 19

Many investors have a fear of risk, in fact, across the spectrum of investments, nothing is riskless when all factors are adding into the equation. If an investor starts a conversation with a question about the lowest risk bonds, my concern would automatically turn to principal preservation. Being in the lowest historical yield environment on record the conversation might turn to items covered by FDIC that might yield a percent or two less than perceived safe bonds but would have FDIC backing. I would probably even suggest they avoid brokered CDs for reasons such as seeing fluctuations in principal if/when interest rates rise since they are market valued. So if I were starting this chat with Flora, I'd do a little digging and see what truly is the most important part of the equation: a little yield with full safety or a little more yield with a likely potential of some fluctuation in value in the course of holding the bond or bond fund.

Comment   |  Flag   |  Jul 17, 2012 from Gettysburg, PA

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