How Bonds Work, Ep # 123

You know that you need to have a diversified portfolio with both stocks and bonds, but do you know how bonds work? On this episode of Retirement Starts Today we have 2 fantastic listener questions that deserve detailed responses. John wants to know how bonds work before he begins investing in them and George has a question about annuities and mortality credits.

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Outline of This Episode

[2:22] How do bonds work?
[3:44] How much interest is earned through bonds?
[7:12] Can individuals buy bonds?
[12:26] What are mortality credits for annuities?
[17:05] Sign up for the Secure Act webinar

How bonds work

John is approaching retirement and has all of his money in stocks, he knows he should be more diversified but he never really understood how they work. Bonds are like giving out a loan where you earn interest. It’s like having a mortgage but in reverse. Bonds are an important part of a diverse portfolio. Are bonds a part of your asset allocation?

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How much interest is earned with bonds?

This question is not that straightforward since it all depends on when and where you purchase the bond. Did you buy the bond directly or on the secondary market? Bonds have a declared coupon rate at issue which is determined on the corporate issuer. They want to make sure the rate is just right. Too high of an interest rate wastes money for the company, but too low of an interest rate will not attract new investors.

Many people buy bonds on the secondary market. This is where bond owners sell their bonds before they reach their maturity date. Since interest rates are always changing, the secondary market moves around with the prevailing interest rate.

How can individuals buy bonds?

Most of the time investors buy their bonds inside a mutual fund or ETF. Similar to the way we buy stocks in large groups, there is safety in buying bonds in large groups. We do this to diversify and protect ourselves from default. Make sure you’re not trying to generate 100% of your retirement income from bond dividends. Listen in to learn why I think total return investing is a better idea.

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What are mortality credits for annuities?

George is looking to purchase a fixed income annuity, but when he plugs in the figures to an online calculator he comes up with 2 very different numbers. So he is wondering what mortality credits are for annuities. It’s important to remember that although mortality credits may look and act like returns, they aren’t really returns in the traditional sense. Basically, mortality credits are the reward you get for being one of the last people in your annuity group still standing. Find out how I remember what mortality credits are by listening in until the end.