Do You Have Too Many Bonds In Your IRA?

Written by: Jack Boylan

Probably. How do I know that? Well, of course, I don’t, but I do know that too many people use bonds in their IRA for all of the wrong reasons. While it is important to have a balanced portfolio it is also important to have your investments in the right vehicles. For example, a tax-free municipal bond inside of an IRA would be silly as the interest does not need to be sheltered from taxes. Now, with taxes having changed a bit at the beginning of the year, for some people tax distinctions have blurred among dividends, interest and capital gains. However, one thing hasn’t changed and that is many, if not most people will be in a smaller tax bracket upon retirement than they were when working full time. For those that are still in the higher bracket, waiting until the last possible minute (70 ½ years old) to take out any money, and even then at the bare minimum required, also factors into the equation.

Without getting mired in the various tax consequences, as you are probably well aware of where you stand, the bond portion of your IRA deserves special attention. There are basically two main reasons people have for possibly overweighting bonds inside of their IRA and both seem to make sense at first blush. The first is simply that an IRA is a retirement account (it’s right there in its name!) and therefore the logic (and instinct) goes it is much more important to be extra conservative with this money. The other reason is that since an IRA is tax-deferred, the interest rate received on any bond portfolio is even that much better and over time the total return will be more than satisfactory, if not especially spectacular. And the truth is if you are at or very near retirement those reasons are difficult to combat. But, as anyone who has looked at their statement these last couple of months can attest, bonds do not always equal safety. It has been brutal and let’s face it, if interest rates keep going up, it’s going to be even worse.

A further problem is that while those bonds you own do indeed get protected from taxes (for a while anyway), with interest rates so low for so long it is nearly irrelevant. Does it really matter if the tax equivalent yield on your 1% bond is nearly 1.4%? Kinda, but not if the bond itself goes down 20%. Then it would take over a decade to get back enough interest (and appreciation as it got closer to maturity) to break even, tax equivalent or not tax equivalent.

It may be time to take a look at your portfolio and where some of your investments are located. Overall, it is the correct balance of your investments in totality that matter the most. And, as always, it is imperative that you are prepared for all types of markets. But to get back to example above, if your bond portfolio really does take 5 or 10 years to break even, then what is the point? In that case, stocks could be a sound alternative, with much more of a chance to grow your retirement account in a significant way. Yes, as one gets older and closer to retirement, it often makes sense to ratchet down some of the excess risks in the portfolio. But as the bond market has recently shown, there are risks in every investment. And with those bonds carrying such low yield, the risk profile may not get better anytime soon. It may be a good time to think about what your investment goals are and how the IRA as a vehicle fits into that. What are you hoping to accomplish with your IRA? You may find that having some traditional risks, such as stocks, inside of your IRA may be more of a fit than you originally thought.


Do You Have Too Many Bonds In Your IRA?

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