The Case for Investing in Bonds During Retirement
This Center for Retirement Research at Boston College brief is by *Anthony Webb published August, 2009
Introduction
For households seeking retirement income security, short-term deposits (such as money market accounts, certificates of deposit, and Treasury bills) seem an ideal and appropriate investment choice – particularly given the recent extraordinary turbulence in the financial markets. Over the past year, an investment in short-term deposits would have actually outperformed investments in corporate bonds and far outperformed corporate stocks.
Retired households exhibit a strong preference for holding such apparently safe investments. One study found that 86 percent of households nearing retirement (ages 60-64) had bank accounts, while only 33 percent owned stocks directly and only 7 percent owned bonds directly. And the desire for short-term investments increased with age. But short-term investments, while safe, produce uncertain returns.
This Issue in Brief highlights the trade-off that households must make between a guaranteed return of capital and a guaranteed return on capital – they cannot have both at the same time. Short-term deposits provide a guaranteed return of capital, but offer no guarantees as to the return the household will receive on its capital. In contrast, a portfolio of Treasury bonds of appropriate maturities provides a guaranteed return on capital, but with the return of capital guaranteed only at maturity. This brief argues that retired households seeking a secure and dependable income should prioritize return on capital over return of capital. For such households, the true risk-free asset is a portfolio of bonds and, in particular, inflation-protected bonds of appropriate maturities.
*Anthony Webb is a research economist at the Center for Retirement Research at Boston College
Here's part of that 6 page PDF:The Special Case of Treasury Inflation-Protected Securities The United States government also issues Treasury Inflation-Protected Securities (TIPS), bonds whose interest payments and eventual repayment of capital are linked to the Consumer Price Index. Because of inflation-indexing, the TIPS yield is expressed in real terms. By comparison, the yield on a Treasury bond is typically expressed in nominal terms, and both the value of the investment and the interest payments are eroded each year by inflation. The anticipated real income of a Treasury bond equals the nominal yield, minus anticipated inflation. Figure 4 [in the PDF] shows the yield on a TIPS with an original maturity of 30 years. For comparison, it also shows the yield on a 30-year constant maturity Treasury bond, net of anticipated inflation. The yield on TIPS, and the anticipated real yield on the Treasury are almost equal. However, a risk-averse investor might prefer the TIPS because it protects him against unexpectedly high inflation.
The full paper is in PDF form