The Best Time to Start a Financial Plan is Now

by Tricia Bush, CPA, CFP^® Owner, AAA Advisory LLC

When you retire, will you want flexibility or certainty?

For much of your working life, investing is about growth. You contribute to your retirement accounts, ride out the market’s ups and downs, and give your money time to grow so it can support you in the future.

But as retirement approaches, your focus starts to shift. You’re thinking about how to protect your nest egg and turn it into a source of income. You may not want the money you’ll need to pay next year’s bills riding entirely on the stock market, especially if a downturn forces you to sell investments when prices are down.

That’s where bonds come in. They can play an important role in preparing for retirement, and there are plenty of options to choose from. Bond funds come in different varieties, and individual bonds include everything from Treasury securities to corporate bonds. Let’s look at two approaches worth understanding: a traditional intermediate-term bond fund and a ladder of Treasury Inflation-Protected Securities (TIPS).

Bond Funds vs. Individual Bonds

Think of a bond as lending money to the government or a company. In exchange, they pay you interest and agree to return your money on a specific date.

A bond fund is similar to an equity mutual fund, but instead of owning shares of companies, you own a small piece of a basket of bonds. The bond fund handles the buying and selling, making it an easy way to spread your money across many different bonds. Because bonds generally fluctuate less than stocks, bond funds are typically less volatile than stock funds. However, just like stock funds, their value can still rise and fall. The advantage is that you can generally sell your shares at any time without waiting for individual bonds to mature.

Individual bonds work differently. Each has a date when the original loan is scheduled to be repaid. If you hold the bond until maturity and the issuer meets its obligations, you know when your money is due back. That can be especially helpful when you’re planning for retirement expenses.

Option 1: Keep It Simple With a Bond Fund

Do you value flexibility and simplicity?

Think about how you approach everyday life. Are you comfortable leaving some plans open and adjusting as you go, or do you prefer to have everything mapped out ahead of time? If you’re comfortable with some uncertainty and value having fewer things to manage, a diversified intermediate-term bond fund may be a good fit for your retirement portfolio.

With a bond fund, you get exposure to many bonds through a single investment. You don’t have to select individual bonds or keep track of their maturity dates. The fund handles the details for you.

The trade-off is that bond funds fluctuate in value. When interest rates rise, existing bonds generally become less valuable, which can cause a fund’s price to fall. We saw this happen in 2022, and similar declines can occur in the future. Higher rates can eventually help a fund earn more interest, but there’s no set date when you can expect to get a predetermined amount of your original investment back.

That uncertainty may be easier to live with if you have a broader plan for covering your expenses. If you have cash set aside for near-term spending and some cushion in your budget, you may be able to cut back on discretionary expenses or delay a large purchase during a market downturn rather than sell investments at an inconvenient time.

If you have that flexibility and prefer not to manage individual bonds, a bond fund can be a straightforward way to hold the fixed-income portion of your portfolio.

Option 2: Build a TIPS Bond Ladder

Do you prefer predictability and knowing what to expect?

Maybe you’re the person who likes to book the hotel, map out the route, and know the details before leaving for a trip. You feel more comfortable when you can plan ahead and know what to expect. If that sounds like you, a strategy built around specific future dates may be worth considering.

One option is a ladder of individual bonds, particularly Treasury Inflation-Protected Securities, commonly known as TIPS.

TIPS are U.S. Treasury bonds designed to help protect your money from inflation. Their principal adjusts with changes in the Consumer Price Index, and interest payments are based on that inflation-adjusted principal. At maturity, the Treasury pays at least the original principal amount, subject to the security’s terms.

A bond ladder is simply a collection of bonds with different maturity dates. For example, you could buy TIPS that mature in 2031, 2032, 2033, and beyond, timing those dates around when you expect to need the money. Rather than relying on the market value of a bond fund when it’s time to withdraw money, you can plan around the maturity dates of your individual bonds.

This approach takes more planning than buying a bond fund, and it’s important to understand that your bonds can still fluctuate in value if you sell them before maturity. But if you hold them until maturity, you have a clearer picture of when your principal will be returned, with payments that adjust for inflation. The actual dollar amounts you receive will depend on inflation over time.

There’s one other consideration: TIPS can create a tax bill on inflation adjustments before you receive that increase in cash. Holding them in a retirement account, like a Traditional IRA, can help avoid that issue on your current tax return.

If knowing when your money will be available helps you feel more confident about retirement, a TIPS ladder may be worth exploring.

Which Approach Is Right for You?

You don’t have to choose just one. You could use individual bonds to cover expenses you know are coming and a bond fund for the rest of your fixed-income portfolio. These are just two of many options, so do your homework before investing to understand what you’re buying and the risks involved.

Disclosure: This article is for educational purposes only and is not intended as financial or tax advice. Every financial situation is unique, and you should consult with a qualified professional before making decisions regarding your specific circumstances.