Fixed Income Retirement…or not?

One of the most archaic yet still widely used sales tactics for individuals heading into or already in retirement is the concept of the fixed income plan.   The plan is sold by a commissioned based stock broker (aka financial advisor these days) and is sold at high commission levels.   Here is how the plan works.

A retired investor (like you) is thinking of how to best protect your remaining investments that for some reason you are holding outside of an annuity or IRA account.   Without much knowledge, you contact your stock broker (aka financial advisor) who is more than happy to sell you some bonds.   Bonds, other than US Treasuries or Muni bonds, operate in a world of smoke and haze for most investors.   Your stockbroker’s company owns a large inventory of bonds that it bought in bulk at a discount some time ago.   They mark up the price, sometimes 5-15% more than what the bond is really worth…and then sell it to you guaranteed to pay you out regular payments at a fixed interest rate.

Here are the issues that we have with this “plan”.  One, you should be drawing retirement income either from an annuity or IRA.  You should not under any circumstances be walking in off the street and buying bonds from anyone and holding them in a taxable account with your broker.   The only exception here may be with US Treasuries or Municipal bonds, but most certainly not with any other kind of bond.   There is a simple reason for this…you are taxed on the interest income which in most cases is fairly low as it is because bond return rates usually run in the 2-5% range.   This taxation is eating away at your “income” from your bonds.

The second issue is that you are paying an outrageous commission to your stock broker (aka financial advisor) for doing nothing.   Your stockbroker does not know or care what the tax implications may be, or how the bonds will compliment the rest of your investment portfolio.   For example, you could be sold corporate bonds of long maturity which have the same risk as holding stock in that same company.  You are simply being sold excess inventory at a premium price.

Third, the smoke and haze portion of bond pricing.   With the exception of US Treasuries and Municipal bonds which now have fairly open information about recent sales and direct buy programs, there are no hard set prices for most bonds sold to individual investors (like you) on the secondary market (through your stock broker).   It is to be noted that for the most part, you will see generally the lowest yields from US Treasuries compared to yields advertised in the 5%+  range.  These “high yield” bonds are for very risky bond issues from corporate sources or going bankrupt states like California selling municipal bonds to fund ill-planned and timed infrastructure projects.

And finally, we do not like putting our clients in a vulnerable situation subject to volatile interest rates and the possibility of inflation.   At the time when our clients need the most stability while still maintaining growth, it is difficult to hedge against changes in interest rates or inflation possibilities with anything other than TIP’s  or very short term US Treasuries.   Again this issue here with short term bonds is that the yields will be low, and if not traded in a tax deferred account such as an IRA or variable annuity, you run the risk of significant and immediate tax implications on the interest income.   This tax burden against the low yields of these short term bonds will nearly wipe out most appreciable gain..i.e. the “fixed income”.

In summary, to rely upon a tactic like fixed income investing for retirement will in most cases cost you more than the investments are worth due to high commissions and unclear pricing, and will stick you with a taxable event (exceptions for US Treasuries and Municipal bonds), for investments that are as risky or carry more risk than other investments.

We like bonds as part of a balanced and diversified portfolio, but we rarely if ever recommend this strategy for retired investors seeking safe investments and steady interest payments.   That just does not exist in fixed income investing.