Q&A Fixed Income
Question: I know you’re not a big fan of annuities because the payments don’t keep pace with inflation. But can’t you say the same about municipal bonds?
Ric: Yes, and we do.
That’s one of the reasons we don’t like munis and why we usually counsel our clients to avoid limiting themselves to “fixed income” investments. Muni bond, annuity, government bond, corporate bond — they all suffer from inflation risk; they pay a preset (or “fixed”) amount of income, but you’re living in an economy where costs are always rising.
That’s why we encourage our clients to diversify. Sure, you need some money in fixed income because it adds a degree of safety — a confidence that you’ll receive a certain amount of income (albeit eroded by inflation) that’s not affected by the stock market. But while market crashes are uncertain, inflation is for sure.
To put this into context, let’s assume you are 65 years old. Based on historical rates of inflation (an average of 3.2% per year since 1926, according to Ibbotson Associates), you’ll need
twice as much income in 23 years so that you can buy the same items you buy today. So if you’re spending $50,000 a year to support yourself — roughly $4,000 a month — you’ll need $100,000 — or $8,000 a month — to maintain your current lifestyle.
But if you keep all your money in munis, annuities and other fixed income investments, your income in 23 years will be the same as it is today. You’ll have only half as much buying power as you’ll need.
Ironically, people avoid stocks because of the perceived risks. But I’ve never met anyone who thinks stocks will be 50% lower 23 years from now.
We have other concerns about investing in munis, but that’s another conversation.