Bonds are a key part of most retirement portfolios—but they’re not all created equal. Whether you buy individual bonds, bond funds, or use target maturity bond ETFs, how you structure your fixed income strategy can significantly impact your income, liquidity, and risk exposure.
Let’s break down the pros, cons, and risks of each approach so you can make a more informed decision.
How Individual Bonds Work
When you buy a bond, you’re lending money to a corporation or government. In return, you receive interest payments (called coupons) and your principal back at maturity. It’s a straightforward contract—but things get more complex when you factor in premium and discount pricing and market risk.
- Coupon vs Yield: The coupon is the interest paid; the yield is your actual return based on what you paid.
- Premiums & Discounts: If you buy a bond above or below its $1,000 face value, your yield changes accordingly.
Example 1: Buying at a Premium
You buy a bond with a 5% coupon for $1,050.
- It pays $50 per year in interest.
- But since you paid more than face value, your yield is less than 5% — you’re earning $50 on a $1,050 investment. Even though the coupon is 5%, your actual return when factoring in the premium is only 4.76%
Example 2: Buying at a Discount
You buy the same 5% bond for $950.
- Still pays $50 per year, but since you purchased it at a discount, your yield is 5.26%
- Plus, at maturity you’ll receive $1,000.
Risks to Consider with Individual Bonds
- Interest Rate Risk: Bond prices fall when rates rise. If you attempt to sell your bond before maturity, your price could be lower.
- Credit Risk: The issuer could default. A loan is only good if the borrower can return payments. Making sure you review the balance sheet of companies is critical. If you are buying a long term bond, a solid company today might not be the same quality in 10 years.
- Call Risk: Bonds may be paid off early, ending your income stream. If you paid a premium for the bond, it will be called at face value.
- Inflation Risk: Fixed payments may lose purchasing power.
- Liquidity Risk: Some bonds are hard to sell without a discount. Making sure you have a bond ladder for your liquidity needs is critical.
What About Bond Funds?
Bond mutual funds and ETFs hold many different bonds, offering built-in diversification and daily liquidity. But they don’t have a maturity date. Instead, they continuously buy and sell bonds, which means the price can fluctuate, and there’s no guarantee of principal return. This can be unsettling for retirees who expect stable income or want to match investments to future cash needs.
Bond funds reduce credit risk, liquidity risk, and call risk, but they are much less predictable streams of income. If you are looking for predictable cash flow, bond funds may not provide it. If you are looking for bond exposure to lower volatility, these can help give you exposure to the asset in a very liquid, diversified way.
Target Maturity Bond ETFs
Target Maturity Bond ETFs are a hybrid approach. They hold a basket of bonds that all mature in the same year—then the fund liquidates, returning the proceeds to investors.
This makes it easier to:
- Build a bond ladder for predictable income
- Manage interest rate exposure
- Avoid the complexity of buying dozens of individual bonds
These ETFs trade like stocks, offer transparency, and are available in both corporate and municipal bond varieties. However, if rates have changed dramatically from the inception of the fund,
Comparison Table
| Feature | Individual Bonds | Bond Funds | Target Maturity ETFs |
|---|---|---|---|
| Maturity Date | Yes | No | Yes |
| Return of Principal | At maturity | No | At fund maturity if bought at inception |
| Diversification | Low unless laddered | High | High |
| Income Predictability | High | Variable | Moderate |
| Trading Simplicity | Low | High | High |
| Ideal For | Custom ladders, control | Liquidity, diversification | Retirement income ladders |
Final Thoughts
There’s no one-size-fits-all answer. If you value predictability and control, individual bonds or target maturity ETFs may make sense. If you want convenience and instant diversification, bond funds may still serve a role.
If you’re building a retirement income plan—or just want help reducing interest rate risk- contact us today to see what works best for your goals.
This content is for informational purposes only and does not constitute financial, tax, or investment advice. Investing in fixed income securities involves risks, including interest rate risk, credit risk, and inflation risk. Past performance is not indicative of future results. Always consult with a qualified financial advisor before making investment decisions.
