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Retirement Articles › Retirement Plans › Importance of Fixed Income Securities for Retirees

Importance of Fixed Income Securities for Retirees

December 30, 2020
Retirement Planning Insights
438
7 Min Read

The most important objective of retirement planning is to secure an adequately funded retirement. While there are countless ways to ensure you are financially taken care of during the golden period of your life, nothing works better than fixed income securities. These securities pay you a fixed return through dividends or coupon payments at defined intervals until maturity. Upon maturity, these debt instruments return the original principal paid. Unlike variable income investments, where the payments are not known in advance and change with market cycles, payments for fixed income securities are specified in advance. Bonds are the most popular fixed-income security. However, others include money markets, preferred shares, and cash deposits (CDs). Overall, these types of investments play an essential role in your portfolio, especially when you are planning for retirement.

Here are some factors that justify the importance of fixed income securities for retirees:

  1. Assurance of principal

    A fundamental rule of investing is to change the allocation of your portfolio with time, as per your life stage. Hence, when you are near retirement or already retired, your investment portfolio should mostly comprise low-risk and stable securities, rather than variable and high-risk ones. Fixed income securities are low-risk investment options that provide assurance of your investment and peace of mind. Since these securities are mostly backed by the government, financial institutions, insurance agencies, etc., they are highly-rated in terms of safety. These market tools repay the principal amount invested in full at a defined date in the future, which is also known as maturity. In some securities, the principal to be repaid is spread across a length of time. The guarantee of your principal provides you stability and assurance of capital preservation. Moreover, this further eliminates or reduces your worries regarding your portfolio’s value fluctuations over time, which could otherwise impact your potential to meet your financial objective in the long-term.

  2. Guaranteed income stream

    In retirement, you may not have a defined source of monthly income. Even if you are working in some capacity, your retirement expenses will likely be more than your earnings. Hence, in such times, a defined income stream will be most useful. Fixed-income securities provide you with guaranteed income payments generated from a portfolio, which includes bonds, preferred stocks, and cash deposits. All these market tools pay a certain interest or a steady dividend, creating a regular flow of cash for your non-working years. The interest and dividend rates are determined when you buy fixed-income securities.

  3. Diversification

    Diversification is one of the golden rules for investing. An optimally diversified portfolio contains a combination of high-risk and high rewarding assets, as well as low-risk and medium performing options. For retirees, it is critical to ensure that your portfolio is adequately balanced to reduce risk and enable stable returns with capital preservation. Fixed income securities, and more specifically high-credit bonds, can help retirees smooth out the highs and lows of the stock market. Typically, as per historical data, bonds and stocks move independently and in different magnitudes. Moreover, since these two investment tools contrast their movements with each other, fixed income securities like bonds provide the ultimate diversification in a portfolio. A well-managed portfolio helps you generate attractive returns as well as manage volatility and mitigate risks.

  4. High liquidity

    Retirees or people heading towards retirement need immediate assurance of money. They need an investment strategy that offers predictable and high-liquid income throughout their retirement years. In such cases, fixed income securities become highly coveted because of their regular coupon payments. Moreover, since these securities are very popular and secure, there are millions of buyers and sellers interested in trading in them. Retirees can easily sell investment-grade rated fixed income securities to fulfil any emergency need or accommodate a sudden, large expense.

  5. Transparency

    When you are near retirement or living your golden years, you are more vested in enjoying those years rather than stress about market forces and possible frauds. In such situations, fixed income securities can provide the desired relief. Options like the U.S. Treasury bills, Treasury bonds, Treasury notes, municipal bonds, etc., are closely regulated and backed by the government. Further, the interest payment and principal repayment too are guaranteed by the U.S. government. Thus, eliminating any loopholes for fraud or default. Additionally, since these securities are sponsored by the government, they are heavily regulated. They follow strict issue and repayment norms, offering 100% security to the investors. You can also check the credit-rating for specific bonds issued by several leading bond rating agencies like S&P Global Ratings (S&P), Moody’s, and Fitch Group. Each of these agencies uses a unique letter-based system to easily convey if a particular bond carries a low or high default risk. Financially stable and reliable bond issuers enjoy a high credit rating.

  6. Higher priority

    Another significant benefit of investing in fixed income securities is that you, as an investor, enjoy a higher preference of claiming on assets. Typically, as a fixed-income investor, you benefit from your place in the capital structure of a company, which is issuing both shares and bonds. So, if in case the company you bought bonds from declares itself as bankrupt or decides to liquidate itself, you as a bondholder will be paid back in full before the common or preferred shareholders of the firm.

  7. Tax-exemptions

    Even retirees have to worry about the burden of taxes, especially if you hold investments that are not tax-exempt. That said, some of the fixed-income securities enjoy preferential tax treatment. This is particularly applicable for some bonds, which are exempt from federal and state income taxes. However, it is critical to note that most tax advantages are already factored in the price of the bond and consequently its yield. Also, a bond can be subject to alternative minimum tax (AMT), as well as capital gains in the long-run. But you can always consult a professional financial advisor to provide you specific tax advice to minimize your tax liabilities. That said, the tax treatment is not the same for all types of bonds. Particular municipal bonds offer the highest tax benefits since their interest is eligible for exemption under the federal law. Moreover, municipal bonds are also free from taxes in some states, specific to some conditions. Further, treasury securities interest payments, are also generally exempt from state taxes.

To sum it up

For most people, fixed-income investing is not a priority given the fast-paced and superior returns of the stock market. Despite their significant advantages, fixed-income securities also have several cons like credit risk, low returns, inflation risk, etc. But when weighed against their importance in a well-balanced portfolio, the disadvantages usually fall short. Also, these securities are the ideal choice for retirees or people approaching retirement because at this juncture in life, capital preservation and a guaranteed income stream become the most important financial goal. Moreover, to increase portfolio income, reduce risk, as well as stay ahead of inflation in the long-run, investing across asset classes, including fixed income securities, is critical for retirees. You could use specific investment strategies to ensure that your fixed-income investment choices serve to the best of their capabilities.

You can also consider consulting a professional financial advisor to identify the best fixed-income securities, which easily fit in your portfolio and work to your advantage.

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