One popular approach to retirement investing has long been bond ladders, but this tried and true method has always had a few drawbacks. One is inflation risk. Another is the difficulty of creating a diversified portfolio because of the minimum price for buying bonds.
Also, it’s not easy to invest the interest earned. Unless you’re a millionaire, chances are you have to wait some time until you’ve earned enough interest to make another bond purchase.
At the same time, bond funds have had their own pros and cons.
The advantage of a fund was that you got greater diversification and better pricing, plus the research of the fund manager. The downside: It’s harder to tailor a fund to one’s income needs, compared to a personally tailored bond ladder.
Now a trio of new bond fund products on offer by Fidelity, iShares and PIMCO provide smaller investors with the opportunity get more of the benefits of a bond ladder without the usual bond fund downsides.
PIMCO is offering what Morningstar’s director of mutual fund analysis Russell Kinnel says is a fund that “in effect is its own bond ladder.”
The funds, called PIMCO Real Income 2019 (PRIFX) and PIMCO Real Income 2029 (PRIIX), contain a variety of Treasury Inflation-Protected Securities (TIPS) with a variety of maturities in order to produce predictable monthly income.
PIMCO has applied for a patent on the technique, so it may not get much competition. The funds are designed to pay down the principal by the maturity date to maximize the payouts. Kinnel warns that the PIMCO funds are not cheap and because the income earned is taxable, they are more suitable for people who expect to be moving into lower tax brackets in retirement.
Meanwhile Fidelity approaches the challenge differently, with four defined-maturity muni bond funds launched last week.
These funds have four different maturity dates: Fidelity Municipal Income 2015 (FMLXX, Fidelity Municipal Income 2017 (FMIFX), Fidelity Municipal Income 2019 (FMCFX) and Fidelity Municipal Income 2021 (FOCFX).
With these, investors can create a ladder of funds, instead of bonds. Morningstar’s Kinnel says Fidelity’s goal is “to produce as high an income stream as possible up until the maturity date, while still maintaining principal.” The investor selects the mix of maturities to meet anticipated income needs.
The new Fidelity funds will compete with iShares’ earlier products, a set of muni-bond ETFs that target each year from 2012-2017 and that liquidate on the maturity date with the money returned to shareholders.
Kinnel notes that the iShares ETFs, like nearly all ETFs, are passively managed and seek to match an index’s return by creating a portfolio similar to their respective index. He notes, “Matching an index security by security isn’t practical in the muni space because of the limited liquidity in munis. Thus iShares (which are run by BlackRock and have an expense ratio of just 0.30%), are trailblazers.” He adds, “It will be interesting to see how they work out.”
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