If you're retired or getting close, someone has probably told you the safe part of your money belongs in bonds. Sixty-forty. Or "more bonds, fewer stocks as you get older." For about thirty years that was solid advice.
Then 2022 happened, and a lot of retirees found out that advice has a weak spot nobody warned them about.
Here's what bonds actually do, what an annuity actually does, what each one costs you, and where each one belongs.
What bonds are supposed to do
A bond is a loan. You lend money to the government or a company, they pay you interest along the way, and at the end of the term they hand your money back.
In a retirement plan, bonds have two jobs: produce some income, and hold steady when stocks fall. The second job is the important one. The real reason to own bonds in retirement isn't the interest. It's that when the stock market drops 30%, you have something that didn't drop, so you aren't forced to sell stocks at the bottom to pay your bills.
Why rising rates push bond prices down
Say you buy a bond paying 5%. A year later, interest rates have gone up, and new bonds pay 6%. Nobody will pay full price for your 5% bond when they can get 6% elsewhere. If you want to sell it, you have to sell it at a discount. That's the whole relationship: when rates go up, the value of existing bonds goes down.
With a single bond, that loss is only on paper if you don't sell. Hold it to the end and you still get your full amount back. Time fixes it.
The catch: most people own bond funds, not bonds
Most retirees don't own individual bonds. They own bond funds, inside a workplace retirement plan, a target-date fund, or whatever an advisor set up years ago.
A bond fund never matures. It's a pool of bonds that's constantly being bought and sold, so there's no end date coming to hand your money back. When rates rise, the fund's value drops, and you're simply down.
What happened in 2022
In 2022 interest rates went up faster than they had in decades. The broad U.S. bond market lost about 13%, its worst year on record. The stock market fell about 18% the same year.
So the retiree who thought they owned a shock absorber found out both halves of their money fell together, in some cases the very year they started living off it. And when fear takes over in a market like that, people sell everything, bonds included.
That's not a reason to hate bonds. They still have a place. It's a reason to know what you actually own, and whether it really protects you the way you think it does.
How a fixed index annuity works
A fixed index annuity is an insurance contract, not an investment. Your money isn't in the stock market. You give an insurance company money, and they credit you interest based on a formula tied to a market index, with a floor that's usually zero.
That means in a down year you're credited nothing. Not a loss, just zero. And for this comparison, the key point is this: rising interest rates don't lower your account value. The rate shock that hammered bond funds in 2022 doesn't touch the principal in a fixed index annuity.
Side by side, honestly
Where the annuity wins
- No interest-rate risk to your principal.
- No negative years from the market.
- If you add an income feature, a paycheck for life that doesn't depend on the market cooperating.
Where bonds win, and they genuinely do
- Getting to your money. You can sell a bond fund on any business day and have the cash the next day.
- Seeing what you own. You can see exactly what you hold and exactly what it's worth.
- Upside when rates fall. When rates come down, bond values go up. An annuity does nothing for you when rates are being cut.
The three costs of an annuity people underweight
- The surrender period. Seven to ten years is common. During that time, taking out more than the free withdrawal amount costs you a penalty. Bonds have nothing like it.
- Fees for extra features. Some annuities have them, some don't, and there are a lot of versions, so it gets confusing. If you want the guaranteed lifetime income feature, there's often a yearly fee, and it comes out of your account every year whether the index cooperated or not.
- The guarantee is only as strong as the insurance company. A Treasury bond is backed by the U.S. government. An annuity is backed by an insurance company's finances. Both can be fine, but they aren't the same thing, and you should know which one you're relying on.
So which one?
It isn't either-or. If someone tells you to move everything into one thing, that isn't planning.
The better question is: what job does each dollar have? Every choice gives you something and costs you something. Start with what you're solving for, then decide what you're willing to give up for it.
- Money you may need in the next two or three years shouldn't be in either one. That's cash.
- Money whose job is to hold steady and pay you an income you can't outlive behaves differently from money whose job is to stay flexible and available.
For a lot of retirees, the honest answer is some of both. The annuity covers the floor, the income you can't afford to lose. The bonds provide flexibility and dry powder. And you size each one to the job it actually has to do.
