This week we focus on the benefits of bond ladders over bond funds for financial planning, particularly in retirement. We discuss three main reasons we prefer bond ladders:

1. Guaranteed Cash Flow: Bond ladders provide predictable cash flow by using individual bonds that mature at different times, ensuring cash availability when needed, especially in retirement.

2. Peace of Mind: Bond ladders give clients confidence that they will have access to guaranteed income, especially during stock market downturns, offering financial stability.

3. Deflation Protection: While deflation isn't an immediate concern, bond ladders can provide protection if prices fall, as they tend to increase in value when interest rates drop, offering a safer alternative compared to bond funds.

Bond funds might offer higher returns, but it is important to consider safety and security in bonds for long-term financial planning. We encourage the use of bond ladders for peace of mind and stability, while also diversifying investments in stocks for growth.

Resources:

- Alliance of Comprehensive Planners: https://www.acplanners.org

- John's firm website: https://www.trinfin.com

-Find us on Facebook: www.facebook.com/friendstalkfinancialplanning

#ACPMemberWisdom #bonds #bondladders #stripladders #investing

TRANSCRIPT:

Bridget: Hey John. I love bond ladders, and I like them more than bond funds most of the time. That's what we're going to talk about today, three reasons why I like bond ladders, on Friends Talk Financial Planning. Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer, I've got a fee-only financial planning practice in Middleton, Wisconsin. And before we jump into why bond ladders can be more appealing than bond funds, I just want to remind everybody to hit that subscribe button. That helps other people find this content on YouTube. And with that, I'm looking forward to digging into that idea. I certainly like bond ladders more than bond funds as well. But I’m interested in hearing your reasons.

You do more research on this, Bridget, and have a little more well-thought-out process, so I'm interested in hearing what you have to say. What are the key talking points or the things that you think about when it comes to building a bond ladder, meaning a series of individual bonds, versus buying a bond mutual fund?

Bridget: Well, I look at the function of the safe part of your portfolio. So the function of that is not to make tons of money. The function of the stock part of your portfolio is to make a lot of money. The function of the bond part of your portfolio is to be there when you need it. And so that's one of the reasons why I like bond ladders: it guarantees cash flow if you do it right.

By doing it right, I mean use US Treasury strips that mature at different times, generally 5 to15 years. We start with 5 to 10 years. Then you know that the US government is going to pay you in that time, and you have the bond to prove it in your account. What are your thoughts here? I'm sure you have more color on this.

John: Yeah, I agree with that. I'll start with the technical side then move bigger picture. We certainly use treasuries for shorter term things. CDs fit in my view on that. We’ll use some agencies like Fannie Mae and Freddie Mac, things that are explicitly backed by the government. I think we've got some Tennessee Valley Authority bonds that we have in the portfolio, but things that are backed by the government explicitly for that safety reason. The US Government can print money, so that's that security side. FDIC insured on the CDs, that sort of thing.

So maybe a little bit of a technical difference, but you can get higher returns, generally speaking, using corporate bonds, bonds from IBM or Apple or those sorts of places. But that guarantee of federally protected bonds is really important. And you mentioned earlier that we look for returns in the stocks and then the bond side of things is for security. And one of the phrases I use for the bond side of things, especially when you're talking about bond ladder for income, is return of our money, not return on our money.

We want to get good interest rates, but that's not the goal of that. And how I describe it is sort of like having a garden or being a farmer. When you grow crops, that's where you make money. That, to me, is the stocks. And then when you have good crops, you can some of those things and put them in your pantry for use in the future. And that's where that bond idea comes in. That's the security in the bond ladder. At some point we're going to have a drought or a flood or whatever out in our farm fields, out in our gardens, and those things can help us then. They're not growing, right? How are your pickles growing in your pantry?

That's a stupid question, right? Everybody knows that. But we apply that same thing. It's not like saying, “How is my applesauce growing?” It's like asking, “Is my applesauce there when I need to eat it? Is it there when I need it?” That thought process really resonates with me. And that's the approach that I take with that guaranteed side of things, the security part. And from a bond fund standpoint, it’s not necessarily super high risk. We can get a conservative one, but it doesn't have that level of guarantee.

I started my business right after 9/11 and the tech bubble burst in 2001. And being through the credit crisis and a few other things, most of the time you look at that bond ladder and you go, “Oh man, those returns are no good.” But when things go badly, and we've got that pantry stocked full of pickles and applesauce, man, is that a great resource and a great feeling. So that's how I look at that side. That security is just really critical, and you don't get it in the bond mutual fund.

Bridget: So you like the 15 years of pickles. I want 15 years’ worth of pickles so that I know if there's a big flood, I got my pickles.

John: Yeah, that's right.

Bridget: It totally makes sense. And I think when people are retiring, if you're 70 and the stock market tanks and you see that, wait, I've got my cash guaranteed for the next 15 years. That gives people a lot of peace of mind.

John: Yeah.

Bridget: They can see it, and it's peace of mind. I know I've got cash coming in.

John: And for me, Bridget, those are like two branches of the same things. We've got this guarantee. The government can literally print money. And then there's also (and you hinted towards it) a psychological side that it gives you peace of mind. And one of the things that I value from the bond ladder side of things is what I call liability matching. It's kind of like what a pension plan would do or an insurance company. Hey, we know we have to pay out this much. We're going to buy a bond that matches up to this, and that's what we do.

And I think you do the same for cash flow in retirement. Hey, I need to spend $100,000. Let's have a bond mature, so there's $100,000 guaranteed for one year and two years and three years out. It’s kind of like when I was a kid (maybe you were the same) and I'd save money in envelopes for different things. There's my vacation money in this envelope, and there's my Christmas money in that envelope. And it's no different than if I had that sitting in my checking account. If I had $1,000 for those things, it doesn't matter if it's in the checking account or in my little envelopes, but when I can look in that envelope and go, “Oh, there's my $300 I've got for buying Christmas gifts,” there’s peace of mind knowing it was in that little envelope.

What I find for clients and for me, when we can look and go, “Oh, geez, Bridget, you need to have, $75,000 a year from your portfolio. And there it is. Here's these CDs, here's these bonds that mature in the next 5, 10, 15 years.” Yeah, okay. That's exactly where it will come from. Even if we could do a similar thing with the bond mutual fund, it's not in those envelopes which gives that peace of mind.

Bridget: Exactly. It's not guaranteed cash flow. The other thing is that, to get a little bit more technical, we look at, okay, how much cash do you need? And then, are you going to be getting something like Social Security or a pension?

John: Right.

Bridget: And we kind of plan it out. Oh, I think you're going to take Social Security at this age or this age. And so, there's some guesswork, and it's not perfect. And that's okay. So that's the other thing about it; there's some guesswork, so it's not perfectly accurate. And pro tip, we don't always take the money from the bond that's matured and have that for cash because sometimes we're rebalancing the portfolio, and it just kind of depends on how that's working at the time.

So we want to make sure that our rungs are there, but exactly how the cash flow is working changes. Sometimes we're selling stocks, so we use that, and then we use the money from the bond ladder to just buy more rungs. So it just depends on when you're rebalancing. It's a little bit more complicated than maybe what we're describing, but I feel like our viewers can handle it. It's fine. It's not that bad. So we've got guarantee, we've got peace of mind, and our third thing is kind of arcane, and I don't think anybody's thinking about this, but we think you should, is deflation protection.

So it's saying that if prices start going down, you still know you're going to get this money. So people are always talking about it after there's a big downturn and when there's a crisis like they had in Japan. Deflation is hard and it takes a long time to get out of, like the US's experience during the Great Depression. It's just hard to get out of deflation. And the people that manage the economies do their best, but it's not easy to get out of it. So what's the chance of deflation? Not that big. I don't think it's that big.

But again, there's a psychological risk of it, and people really don't want to see it. And if it's happening, you'd be really happy with the bond ladder. There're all kinds of things that we do like this. We buy insurance. Why is that? Well, because there're all these risks out there. So deflation, even though it may seem like it's not that big of a risk, you don't want to wait around until it happens. and this is really a third benefit. I wouldn't say it's the first benefit. Does that make sense?

John: Yeah. Most of our conversations, what we hear and think and feel, are about inflation and how prices are going up. But you hit it on the head. When prices go down, it seems like a good thing, but the economic implications of that are actually way more dangerous. And we just saw this in a sort of a microcosm.

As interest rates fell over the past couple of years, bond value shot up. So if you had some individual bonds, if you had a bond ladder and you saw that, that's sort of the idea. When things go down and rates go down, the value of the bonds that you currently own goes up. And it's too complicated to get into all the details, but that is a benefit of having a bond ladder, individual bonds versus a bond fund.

Bridget: And it's hard to protect yourself against deflation. That's the other thing. So it's a way to do it. The other is just having money in savings accounts. So it seems like that's a great way to wrap it up. This is our latest episode on bond ladders versus bond funds. Oh, one of the things before we end is that you can make more with bond funds.

John: Oh, yeah, right. There's a potential to get higher returns.

Bridget: Yeah. And so, hey, if that's your number one thing, go for that. But we suggest making money in stocks…

John: Yeah, make money in stocks.

Bridget: And letting your bonds be safe. So, I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients, so we'd love to hear from you. But if you like what you hear on our show and would like to find an advisor in your area that thinks similarly to us, we're both members of the Alliance of Comprehensive Planners. And you can find an advisor near you at acplanners.org.

Bridget: And don't forget to subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.