The Stairway to Retirement: Managing Risk
Written by Steve Ciaccio, MBA, CPA, CFP®
The stairway to retirement is sometimes long and steep. Managing risk can potentially reduce the length and angle of the climb. Your ability to manage risk can be enhanced by understanding and addressing the different types of threats to your investment portfolio.
Regarding fixed income investments (for example, bonds), risk has several facets that need to be addressed. Bond laddering, when done properly, has the potential to address multiple types of risk.
Bond laddering is a form of diversification that layers your fixed income portfolio with various investments to blend features such as maturity dates, credit quality, and tax consequences, among other factors. By including a wide range of maturity dates, you can sometimes reduce your interest rate risk, which is the risk that your investments will lose value in the event of an interest rate increase. Including varying maturity dates is also often used to manage reinvestment risk, or the risk that rates will drop prior to the need to reinvest proceeds from matured bonds.
Including fixed income investments of varying credit qualities and increasing the number of issuers in your portfolio can sometimes be used to defend against credit risk, which is the possibility that one or more of the investment issuers in your portfolio will run into financial difficulties. While some low grade bonds might pay a higher interest rate, the investment often comes with a higher risk of default. Be careful when selecting credit quality. If you decide that you are able to sustain the risk of lower grade bonds, you might want to consider increasing the number of issuers so that if one of them defaults or is downgraded, it might mitigate the overall impact on your portfolio. By blending in other investments with higher credit quality, you might reduce your overall interest income. However, you might also improve your chance of mitigating potential loss of principal.
Some bonds that are issued by states and municipalities are not taxed by the IRS, although some are still subject to state income tax. They are often called municipal bonds. Avoiding federal income tax can sometimes provide substantial savings and has the potential to increase the after tax returns of your portfolio. Corporate bonds are generally taxed at both the federal and at the state level.
When buying bonds, care should be given not only to determining the credit worthiness of the issuer, but to the sustainability of the credit worthiness of that entity. Sometimes bonds are downgraded after they are issued because the issuer’s ability to pay has been damaged. Having a high credit rating today does not ensure that the bond’s rating will always remain as high, and does not guaranty against loss of value or default.
Each of the above are subject matters are complex and cannot be fully explained here. Also, there are many other factors and investments to consider. I recommend that you consult with a qualified and reputable CERTIFIED FINANCIAL PLANNER™ professional (CFP®) prior to investing.
Food for thought: How can you climb the long stairway to retirement? By taking one step at a time!
All the best to you!
Steve Ciaccio, MBA, CPA, CFP®
Steve Ciaccio, MBA, CPA, CFP® is the founder of Ciaccio Wealth Management, Ltd., located at 232 South Batavia Avenue, Batavia. He can be reached at 630-454-4599, Steve.Ciaccio@LPL.com. The opinions voiced in this article are for general information only and are not intended to provide specific investment advice, tax advice, or recommendations for any individual. Bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Municipal bonds are federally tax-free but other state and local taxes may apply. Interest income may be subject to the alternative minimum tax. If sold prior to maturity, capital gains could apply and the investor’s yield may differ from the advertised yield.
Ciaccio Wealth Management, Ltd. and LPL Financial do not provide tax advice or services. Please consult your local tax advisor regarding your specific situation.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
Copyright Steve Ciaccio 2017