Diversify into Tax-Free Bonds
The sell-off that racked the markets last month was the best thing that could have happened to retired investors.
No, I’m not being a wise guy.
In addition to creating better buying opportunities, sell-offs also drive home the critical and painful point that we have to hold less volatile, more conservative investments as we age.
And there’s nothing like a sell-off to remind those who were sucked in by sky-high stock indexes that we can’t afford the risk most stocks carry (quality dividend payers excluded). We no longer have the time to recover from a major market calamity.
In case you don’t already know, this recent sell-off was no calamity. By historic standards, it was routine. Take a look at 1987 and 2008 – those were calamities.
But while the sting of overreaching with our investments is still fresh in our minds, let’s consider an alternative to a portfolio of all stocks.
These may be the perfect retirement vehicle. You’ll never have a calamity or even a routine stock sell-off with them… but most people know zip about them.
Defaults in tax-free bonds are very rare, and the few that do occur are in nonrated bonds. Want a life free of money troubles forever? Never own a nonrated tax-free bond; buy BBB- or higher only.
General obligation bonds (GOs) are backed by the taxing power of the state that issues them. And no one has ever lost a penny in principal to a GO.
Four GOs defaulted back in the Great Depression, but three returned all their principal. The fourth returned all the principal plus the interest due the bondholders.
There are states like Maryland that have never had a default and many whose bonds are so secure that the little guy never gets a chance to buy them. The institutions scoop them up and hold them forever before they ever come to market.
I hate to sound obvious, but their interest is tax-free. While we’ll never get out from under taxes completely, one of the benefits of tax-free investing is how good it feels when we are able to legally beat Washington out of a couple bucks.
Even investors in the lowest tax brackets can benefit from tax-free investing. Your taxable equivalent yield isn’t as high as it would be in the higher tax brackets, but the safety is.
And as rates continue to move up, yields on tax-free bonds – even for those in the lowest tax brackets – will become more attractive.
Tax-free bonds are stable, predictable and reliable. You can own them and sleep at night.
So if you’ve reached the age where sleep is as important as the few extra points you might earn in stocks (key word: “might”), it’s definitely time to add some bonds to your portfolio.
If you need higher returns (who doesn’t?), consider corporate bonds. BBB- and higher have a success ratio of 98%. And even high-yield bonds, better known as “junk bonds,” have a long-term success ratio of 94%.
Here are investments that pay exactly as promised 99.99%, 98% and 94% of the time, and you’re lying awake at night worrying about your stocks because…?