Each one of us needs and wants enough money to retire comfortably and to suffice our future generation. But what exactly is the amount needed? According to a study conducted by Business Insider, if you want to live off an average salary of $50,000 and wish to retire in 20 years, to maintain the same lifestyle you are currently living for retirement, you would need $3,000,000. This is a far cry from what most people expect and, saving money alone will not get us there. That is why investing* is essential. Although conventional investing wisdom suggests sticking to bonds during retirement, blinded by its inherent ‘safety’ component, this advice today is futile. The general public’s ignorance about the limitations of bonds, including its interest rate risks, inflation risk, and high opportunity cost, can be detrimental to their retirement funds.
1. Interest Rate Risk
The first chief limitation carried in bonds is the
risk of interest rate fluctuations. Grey (2020) describes this risk by pointing
out the inverse relationship between interest rates and bond prices. When the
interest rate goes up, the price of the bonds you hold goes down and vice
versa. He says that depending on the prevailing sentiment of the market, such
interest rate fluctuations can decimate a person’s bond portfolio. To elaborate
further, the FINRA organization (2014) empirically describes an example of how
this effect works. They tell you to imagine if you bought a 10-year 1000$ bond
today at a coupon(interest) rate of 4 percent. Now, if the interest rate rises
to 6 percent and you wish to sell the 4 percent bond you are holding currently,
you would have to compete with these newer bonds carrying higher rates. As a
result, you would have to inevitably sell your bond prices at a lower price to
attract buyers. Interest rate risk is also known as the market risk for this
reason. Blanchett (2020) shows us the practical implication of interest rate
risks by saying that bond investors today are going to have less money in their
retirement fund ten years from now due to inflation and taxes. According to
Blanchett, investors should know the implications low-interest rates can have
and they should be prepared to make up for the lost time the low returns offer
in bonds.
*Investing is the process of laying out money in order to get more money later on. For example, keeping money in the bank gives us ‘interest’ on your money. An investor is someone who is ‘investing’.