Bond Ladders in 2024: How to Use Bonds to Secure Your Retirement?

So, you want to create retirement income, leveraging bonds and retirement, but you're not quite sure the best way to accomplish that, that's what we're going to talk about today. Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial, also a certified financial planner practitioner, and I'm here to talk to you about using bonds in retirement. How do we use bonds in retirement? You want to leverage a bond to generate retirement income, and you might be doing so in order to minimize your risks in retirement of not being able to meet your income needs due to market fluctuations, maybe dividend income getting cut.

You want a more certain strategy around generating retirement income, and most often that is done leveraging bonds, but there's a lot of different ways to accomplish that. So today, I want to talk to you about some of the nuances of bonds, the things that we need to understand, and how we go about ultimately starting to create a bond ladder and purchasing those bonds for yourself. First of all, what is a bond? A bond is essentially a loan, so a corporation says, hey, we need some money.

They go out, they want to raise some money, and they're going to do that in the form of a bond. You go out and say, hey, I will loan you $100,000 in return for a certain amount of interest, and that interest, it has to be pretty competitive, because these corporations are competing against one another in the bond market for these dollars, so you loan them $100,000, maybe they're going to pay you 4%, 5% per year, and that 5% is going to be paid back to you over time, over the term of that bond, typically in semi-annual coupon payments. Now there are different types of bonds, zero-coupon bonds, original-issue discount bonds.

Most commonly, we think of a traditional bond as one that's going to pay us semi-annual coupon payments, and it's going to come due over a period of years. Three years, five years, 10 years, even as long as a 30-year bond that you might be valuating purchasing. That's how that bond's going to work.

You're going to purchase it at an amount at the end of the term. They're going to give you back what's known as the face value or the par value of that bond. And now, let's take a look at our next slide and compare that to the way most people own bonds.

So most often, you're not going to be owning an individual bond. Most people, if you're like most people, you own an ETF or mutual fund inside of your 401K, your IRA, or a brokerage account. And that fund owns a lot of different bonds.

That fund owns all of these different bonds, and you don't own any of them. You own the fund itself, which means you lose control over those bonds that are purchased, when they're sold, what kind of bonds are purchased, and ultimately, you're participating in what's known as total return versus when you're purchasing a bond and you own that bond yourself, you have control over when that bond is sold. And there's something very important for us to understand when we're going to own a bond fund or we're going to own individual bonds for that matter, and that is the relationship with interest rates.

If interest rates go up, bond prices go down. If interest rates go down, bond prices go up. So, if we go out today and we buy ourselves a bond for $100,000 that's paying 5%, a year from now, let's say interest rates change and the companies need to stay competitive, now that bond with similar credit quality is paying 7%.

Now, why would I want your 5% bond when I can get a similar credit quality bond today at 7%? I wouldn't unless you're willing to sell it at a discount to create value for me. You're going to sell this bond at a lower dollar amount, say $9,000 or $8,000 or a 10% or 20% discount over what you may have paid for it in order to generate a total return for me as the new buyer that's competitive in the market, closer to that 7% number that I could get today. Now, if you own that inside of a bond fund, you don't have control like you do in that individual bond.

If interest rates do go up and your bond value drops by 10%, 20%, 30%, 40%, even 50%, how much does that really impact you over the life of that bond? You may not really care because you have control over if you sold that bond or not. You decide, hey, I know the bond value is lower, but I'm just going to hold this thing to maturity and they're going to give me back my original investment versus if I own it in the bond fund, I don't have that control. If there's a panic in the market, what happens? Now, that bond fund, even though the bond fund manager knows if we just hold these bonds maturity, everything's going to be okay.

It doesn't matter because now they may be forced to liquidate some of those bonds and take them at a loss and pass those losses on to yourself. So if you're truly trying to create a retirement income strategy leveraging bonds and you want to reduce as much risk as possible, then you want to own individual bonds. If we want to own individual bonds, how do we go about creating that income strategy? That income strategy is what's known as asset liability matching.

Your liabilities are your expenses in retirement. Those expenses that you have each and every month, each and every year, you want to have a payment coming from a bond every single month or every single year systematically in order to match up with those expenses. In order to match those liabilities with the asset, we're going to build what's known as a bond ladder.

Let's say that you want to immunize your expenses over a five-year period, immunizing yourself against interest rate risk and market fluctuations by having those contractual obligations from the corporation to send you that payment periodically. If you're buying those five-year bonds, you have a one-year bond, a two-year bond, a three-year bond, a four-year bond, and a five-year bond. Now, let's say you want to satisfy a $50,000 annual income.

Do you just buy five $50,000 bonds that are going to come due every year at $50,000 and use that as your income for the year? No, because each one of these bonds are generating coupon payments or interest along the way. And that interest bounces out some of those dollar amounts are coming due. So you may need to own a $40,000 bond because you're going to collect another $10,000 in interest and so on and so forth.

Now, after this first bond comes due, you're most likely going to want to continue to ladder out those bonds so that you continue to immunize yourself over a five-year period against any market fluctuations. So if you want to continue to keep that five-year bond ladder going, you've now eliminated that one-year bond. Maybe you're taking a chunk of dollars from your equities to rebalance, moving it over and buying another five-year bond.

The next bond comes due and you're buying another five-year bond. And eventually, all you have in that portfolio are five-year bonds that are coming due once a year. And I say, Casey, I'm ready for this.

I want to go out and buy myself some bonds and build myself a bond ladder. Well, it's not quite that easy and this is why. You want to go out and buy an original issue bond? You're not going to be able to do that unless you're investing billions of dollars because those are purchased by corporations.

They're going out and negotiating those deals and most of those original issue bonds are being purchased by major institutions versus where most retail investors, they're going to be purchasing it like yourself on a secondary market, not buying an original issue bond on the primary market. And what's the difference there? Well, if you're on the original issue market, you might be buying a bond that has a face value of $10,000 where it ultimately comes due at $10,000 and you pay $10,000. But on the secondary market, they're going to be trading.

You're going to be buying that from investor to investor. And so you may be paying $9,000 for a bond that's going to come due at a face value of $10,000 or $11,000 for a bond that's going to come due at the face that value of $10,000. And this is where it gets a little tricky because we want to make sure we create a diversified portfolio.

And if you're going out and building a five-year bond portfolio but you only own five individual bonds, you could be taking on significant default risk because there is risk that those bonds do default and the loan does not get paid. So just like building an equity portfolio where you don't want to maintain any more than 10% in any individual holding, that would be the maximum amount you would want in any individual corporation when it comes to building out that bond ladder. And this is also why it takes a pretty significant dollar amount to build the bond ladder.

Somewhere typically between $250,000 and $1 million in order to create a five to 10-year bond ladder in order to maintain that diversification and get a good deal when you're making these purchases. You want to make sure an institution is making these purchases for you because they're able to get a better return, ultimately because they're getting a better price than you might be getting when you're buying a very small amount of bonds at a time. Now, if you're saying to yourself, I like the idea of creating a bond ladder, I'd like to see what a bond ladder would look like from my portfolio.

We're happy to build a bond ladder for yourself and show you exactly what that would look like. All you have to do is schedule a time to visit with one of our fiduciary financial planners that will visit with you, provide you with a free bond analysis and a bond report so you can determine if this is the right fit for you. We'll visit with you online anywhere in the country.