Bonds Are Not As Safe As They Seem; Here’s Why

Opinions

Date: 27.02.2018

After nearly a decade of low interest rates, the saber rattlers at the Federal Reserve are looking to sing a different tune. As investors have attempted to maximize their fixed-income yields, their investment maturities are now in danger of principal loss.

Why worry? A sudden move in rates could leave investors with brutal losses.

In a recent Bloomberg TV interview, former Fed Chief Alan Greenspan said, “The bond market bubble will eventually be the critical issue. We’re working, obviously, toward a major increase in long-term interest rates, and that has a very important impact on the whole structure of the economy.” (As quoted in “Former Fed Chair Alan Greenspan Sees Bubbles in Stocks and Bonds,” J. Smialek. 31 Jan. 2018. Bloomberg.) Greenspan cited the growing federal deficit as the reason behind the bond bubble, and that raising interest rates too quickly will fuel inflation. What’s behind the bubble? Well, the fact that we’re beginning to run an ever-larger government deficit, and debt has been rising.

Ray Dalio, the billionaire hedge fund manager, has said that the bond market has slipped into a bear phase. He warned that a rise in yields could spark the biggest crisis for fixed-income investors in almost 40 years. (N. Kumar and E. Schatzker. 24 Jan. 2018. “Dalio Says Bonds Face Biggest Bear Market in Almost 40 Years.” Bloomberg.)

Paul Singer, one of Wall Street’s most prominent hedge fund managers, is calling this ‘the biggest bond bubble’ ever. Singer says the bubble in bonds could prove financially fatal for investors, who have been forced to pile into investments they deem safer than most. (M. Decambre. 19 Aug 2016. “Why one prominent hedge-fund boss is calling this ‘the biggest bond bubble’ ever.” MarketWatch.)

Janus Capital’s Bill Gross has likened such a scenario to a supernova that could explode one day.

In an August 2016 report, Fitch’s analysts estimated that a hypothetical reversion by interest rates to 2011 levels could result in nearly $4 trillion in losses.

Did you think interest rates were going to stay low forever?

Many mutual fund and hedge fund managers now predict that the Federal Reserve will alter its easy money policy that has been in place since the economic crash of 2008 and increase rates faster than previously discussed and that our economic growth is in the final stages of the growth cycle.

As interest rates rise, bond prices will drop, creating a loss.

What is a safer, better option? Hybrid fixed index annuities with guaranteed income riders.

A hybrid fixed index annuity is an attractive alternative to traditional fixed income options, like bonds, to accumulate financial assets (tax-deferred) before and during retirement.

A hybrid fixed index annuity is an insurance vehicle that eliminates downside risk while allowing for the opportunity to earn interest credits tied to the upward movement of a market index. These annuities give the owner a portion of the interest credits when the market index rises and the interest credits are locked in and eliminate financial market risk when the market has a correction.

As we get older and approach retirement, the element of risk becomes more important. Risk of losses becomes a critical issue and worry.

We all know that stocks are much riskier than bonds, yet in periods of rising interest rates, bonds will become riskier. Since stocks bear much more risk, we typically de-risk our portfolios to preserve wealth and attempt to lock in a desired retirement lifestyle.

The strategy of allocating more heavily to bonds as we approach retirement has become conventional wisdom, but those tired rules have proven incorrect. Asset allocations of 60/40, or even 70/30, bonds to stocks are very common. This “allocation” may seem sound from a risk perspective, but will it meet our return expectations going forward?

NO!

Why?

Because a hybrid fixed index annuity is a contract, issued by an insurance company with guarantees backed by its claims-paying ability. It is an accumulation vehicle with growth potential leading up to retirement with an option to annuitize in retirement or take systematic withdrawals.

In the accumulation phase, growth potential is based upon the positive performance typical of an equity index like the S&P 500 and grows tax-deferred, subject to floors and participation rates, which we will discuss below.

A major advantage of an HFIA is the ability of the insurance provider to “transform” equity returns into a more “tailored” return/risk profile by eliminating downside risk and providing an opportunity for interest credits based upon a portion of the chosen market index.

There is good news, and there is bad news. The good news is that we are living longer. The bad news is that we are living longer. Today’s workers are looking forward to retirement, but they want to know that when they do eventually retire, they will have enough income to last a lifetime. The biggest fear is outliving your money.

Guaranteed Income for Life: The Secret Sauce

With your hybrid fixed index annuity, you can elect a guaranteed lifetime income rider (there may be a fee involved) that guarantees you income for your lifetime.

Typically, this rider will pay you and your spouse a guaranteed income for as long as both of you live, no matter how long that is. Some of these riders offer a guaranteed fixed rate for an extended period, while others base the income on the upward movement of the market indexes.

More Secret Sauce: Long-Term Care

Many of these hybrid fixed index annuities have an enhanced income feature for long-term care needs. These riders typically double the income you receive for up to five years if you have a qualifying event (usually being unable to perform at least two of the six basic activities of daily living), helping to ease some of the concerns related to significant health issues as you age. For investors who can’t afford or don’t qualify for traditional long-term care, this is a unique option to mitigate the cost of a health care crisis.

 

Disclosure: This content was brought to you by Impact PartnersVoice. Michael Neft is an investment advisor representative and managing partner of Duke and Duke Wealth Management, LLC, and is a Registered Investment Advisor and managing partner of Secure Retirement Strategies. Marc Smith is a managing partner of Secure Retirement Strategies. Insurance offered through licensed professionals at Secure Retirement Strategies.

https://www.forbes.com/sites/impactpartners/2018/02/16/bonds-are-not-as-safe-as-they-seem-heres-why/#5650efa56f4c

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