Fixed-income investors in low-interest-rate environments often discover that the higher rate they receive from their current bonds and CDs doesn’t last until maturity. In many cases, they will receive a notice from their issuers stating that their principal is going to be refunded at a specific date in the future. Bonds that have call features provide this right to issuers of fixed-income instruments as a measure of protection against a drop in interest rates.

• To balance her portfolio, she decided to invest in investment-grade corporate bonds.
• Your optimal portfolio strategy will depend on your investment objectives, time horizon, cash-flow requirements, outside income and assets, and any restrictions or customizations you may have.
• Our estimates are based on past market performance, and past performance is not a guarantee of future performance.
• Many people think bonds—also called “fixed income”—are a simple way to earn a safe return, but the reality can be quite different for those preparing for retirement.
• As the bond reaches its maturity date, interest payments on bonds cease, and the issuer repays bondholders the principal amount.

Counterbalance the Risks of Stocks in a Retirement Portfolio

Let’s say Apple Inc. (AAPL) decides to borrow $10 million in the bond market and issues a 6% coupon bond with a maturity date in five years. The company pays its bondholders 6% x $10 million or $600,000 in interest payments annually. But with some planning, you can ease the pain before it happens to your bond. Make sure you understand the call features of a bond before you buy it, and look for bonds with call protection. This could give you some time to evaluate your holding if interest rates experience a decline. Finally, to determine whether a callable bond actually offers you a higher yield, always compare it to the yields of similar bonds that are not callable.

Financial Accounting I

If that happens, overall interest rates will fall as the Fed looks to reduce interest rates to stimulate economic growth. That makes it highly likely that investors won’t earn the current 5.8% rate if they reinvest their CDs next year. For the cost of conversion, we have covered in another article on convertible bonds. In order to illustrate this, let’s assume that  ABC Co has outstanding bonds with a par value of $100,000 which is due to repay by the end of December 31, 2020. In this example, we assume that the interest on the bonds has been paid separately. Target date funds are the most popular type of fund of funds, says Steve Athanassie, CFP.

Tax-Exempt Versus Taxable Bonds

Bonds can be more complex than stocks, but it’s not hard to become a knowledgeable fixed-income investor. For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. They range from AAA or Aaa (the highest quality) to D or C (in default). Understanding these ratings is vital for assessing the level of credit risk involved in a bond investment.

At first glance, this strategy seems brilliant and, frankly, “too good to be true.” And, of course, that is the case. When analyzing callable bonds, one bond isn’t necessarily more or less likely to be called than another of similar quality. You would be misinformed to think only corporate bonds can be called. The main factor that causes an issuer to call its bonds is interest rates.

What makes more sense: owning individual bonds or bond funds?

NerdWallet, Inc. is an independent publisher and comparison service, not an investment advisor. Its articles, interactive tools and other content are provided to you for free, as self-help tools and for informational purposes only. NerdWallet does not and cannot guarantee the accuracy or applicability of any information in regard to your individual circumstances. Examples are hypothetical, and we encourage you to seek personalized advice from qualified professionals regarding specific investment issues. Our estimates are based on past market performance, and past performance is not a guarantee of future performance. A municipal bond has call features that may be exercised after a set period such as 10 years.

The corporation can debit the bond’s payable account and credit the gain on the retirement of the bonds and cash account to produce a journal entry for gain on bond retirement. Sally’s portfolio manager knows that the interest rate of 9% will likely not what does it mean to retire a bond be able to beat inflation in the coming years. In this way, Sally can benefit from bond retirement or maturity after 20 years and enjoy a wholesome retirement while protecting her portfolio that contains high-risk, high-return investments as well.

One feature, however, that you want to look for in a callable bond is call protection. This means there’s a period during which the bond cannot be called, allowing you to enjoy the coupons regardless of interest rate movements. In some circumstances, the corporation or company wishes to retire all or some of its bonds before the maturity date.

Bonds should be balanced with other assets, such as stocks and real estate, to create a diversified portfolio. The right mix will depend on an individual’s risk tolerance, income needs, and time horizon. Inflation risk is the risk that rising prices will erode the purchasing power of bond income. Inflation can be especially harmful to fixed-income investors, as the income from bonds may not keep pace with the increasing cost of living. The regular interest payments from bonds can provide a consistent income stream, supplementing other retirement income such as social security or pension payments. In return, you get interest on the loan, and you get the entire loan amount paid back either on a specific date (known as the bond’s maturity date) or at a future date of the issuer’s choice.