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have an annuity question?
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A better alternative to low-yield bonds?

Unintelligence paired with good intentions might make for a funny movie, but in terms of your investment choices, it can wreak havoc on a retirement goal. In his 2017 annual letter to Berkshire Hathaway shareholders, Warren Buffett noticed the effects of the declining bond market and found the low-yield bonds in his portfolio to be “a really dumb investment.” As interest rates begin their upward trajectory, bonds appear to be entering their bear phase, which means you might not get the rate of return you were expecting. How bad could it get and what can you do about it? Read on to find out what Warren Buffett did and why you might consider a smarter alternative for the “safe” money in your portfolio.

IT’S LIKE A SEESAW

Bonds have an inverse relationship to interest rates: when one goes up, the value of the other goes down. Interest rates reached an all-time record low of 0.25 percent in December of 2008, so from there, rates could only go in one direction. This March, the Federal Reserve raised interest rates to 1.5-1.75 percent, and officials project even steeper interest rate hikes for 2019 and 2020 as the economic outlook continues to improve. So what does this mean for bonds? Just think of the seesaw and you’ll understand why the outlook isn’t good. Bonds are traditionally thought of as the” safe” part of an investor’s portfolio, but as Warren Buffett discovered during the last 10 years, low-yield bonds might not pay out as advertised. As new, higher-interest rate bonds become available, the value of lower-interest bonds falls. Indeed, according to Buffett’s 2017 shareholder’s report, the bonds in his portfolio were selling for only 95.7 percent of their face value, which meant their annual yield to maturity was earning 0.88 percent, a return which doesn’t even keep up with the rate of inflation.

WOULD YOU MAKE THIS GAMBLE?

Buffett had promised the Girls Inc. of Omaha a gift of $1 million to be delivered in 2017, but he realized that unless he got his money out of bonds, he would fall short of his goal. His solution was to sell the bonds at a loss in 2012 and invest them instead in the market, understanding that there was a risk the market could fall in 2017 when it came time to sell the investments. To counterbalance this gamble, Buffett himself pledged to make up the difference. Warren Buffett is reportedly worth a mind-blowing $87 billion, so he can afford to lose a few hundred grand in the market. This probably isn’t true for you, which is why a market gamble may not be the best strategy. If you are 10 or fewer years away from your retirement goal, you might not have the stomach for market risk. You might also not want to lose your retirement money. So what is the risk-averse investor to do?

WHAT OTHER OPTIONS DO YOU HAVE?

As the time of retirement nears, many investors move an even greater percentage of their portfolio into bonds, hoping to keep more of this money safe. Given the current economic climate, this could be a recipe for disaster. Instead, consider allocating a percentage of your funds into a vehicle that offers principal guarantees. Both fixed and indexed annuities can promise investors that they won’t lose money due to market fluctuations, but they also offer a rate of return. Fixed annuities offer a declared interest rate for a set period of time, for example, 3 percent for five years. Indexed annuities, for their part, can give you the potential for even higher returns linked to a market index, for example, 6 percent guaranteed for 10 years’ time. Annuities are typically long-term investments, so you will want to take the time to shop around and compare different features and terms. To find out if a fixed or indexed annuity might be right for the bond portion of your portfolio, reach out to one of our advisors for a free consultation. We would be happy to help you invest smarter by answering any questions you might have. Get Smart: 3 Investor Tips To Raise Your Retirement IQ

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