Money magazine recently had an article on different investing strategies for those going into retirement. One strategy they laid out was what they called the “bomb-proof bond portfolio.” The idea there was to invest retirement money in bonds with the bonds maturing at different times throughout your retirement. For example, you might start your retirement with a couple of years’ worth of cash and then buy bonds that mature in three years, five years, seven years, ten years, fifteen years, twenty years, twenty-five years.
The amount invested in each bond would be the amount needed to pay for expenses until the next set of bonds matured. For example, If you needed $50,000 per year, you might have $100,000 in cash for the first two years, have another $100,000 each in the three and five-year bonds, $150,000 in the seven-year bonds, and so on. Note that $1.5 million would be needed to fund a 30-year retirement with this strategy. The last quarter million dollars would be in the bonds that would mature in 25 years.
The type of bonds selected by the strategy was US Government Treasury bonds. While the interest rates are low, the risk in the past has been almost zero (actually, the interest rates have been low because the risk has been almost zero). The idea here was not to make a significant return on investment, but to just keep up with inflation. The issue with applying this strategy today, however, is that these bonds are not as risk-free as they once were.
The debt load on the US Government is approaching unsustainable levels. Debt has increased from less than $9 T in 2008 to over $17 T today. Interest payments on the debt are still a relatively small amount compared to income from taxes and other sources, but this is largely due to low interest rates available to the US Government. This could change quickly if creditors started to feel that there was a greater risk of default or a country such as China decided to stop buying new debt for strategic reasons. Understand that government interest rates are reset constantly since debt must be refinanced regularly, so the low interest rates currently being enjoyed are not locked-in as would the interest rate on a home loan.
There are also several bills that are starting to come due for the US. Many people are starting to receive Social Security and Medicare benefits as the Baby Boom generation retires. This is coupled with declining revenues from new workers as young people increase the amount of time spent after high school before getting a significant job. All of these factors together are going to lead to a situation where the debt service will become ever larger and start to compete with government employee salaries and benefits and the provision of government services for limited revenue dollars. It is extremely likely that some sort of a default would occur if one were to set up a “bond-proof” portfolio at this point.
To find a way to provide retirement income in this environment, one needs to realize that a government default is not the same thing as an economic collapse. While there are a lot of companies that depend on the government for revenue, there are a lot that do not. The US economy is not the same thing as the US Government. A default would cause an immediate reduction in the goods and services provided by the government, and things like Social Security benefits would be cut since the government would not be able to spend beyond its revenues for a period of time, but critical services needed for businesses to operate like military protection and courts would be provided. Retirement funds should therefore be spread out into a variety of assets, including corporate bonds, common stocks, real estate (or REITs), and foreign assets. US Government securities should be viewed with a great deal more suspicion than in the past and should make up a limited portion of one’s retirement portfolio.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.