Smart DirectionsEmmet O’Neal LibraryMountain Brook, AL

Bonds and Annuities

Disclaimer• Andreas Rauterkus is not a registered

investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Andreas Rauterkus does not purport to tell or suggest which investment securities attendants should buy or sell for themselves. You should always conduct your own research and due diligence and obtain professional advice before making any investment decision.

Objectives

• What are annuities and bonds

• How to pick annuities and bonds

• What are the risks?

Annuities• Lump sum of cash invested to produce a monthly

stream of income for a fixed period or for life• The income can start now (immediate annuity) or in

the future (deferred annuity)• The minimum investment in an annuity is usually

around $5,000

Types of Annuities• SINGLE PREMIUM DEFERRED ANNUITY (SPDA)

– guarantees you a specific interest rate for a specific period of time– taxes are postponed until money is withdrawn

• SINGLE PREMIUM IMMEDIATE ANNUITY (SPIA)– guarantees you an immediate fixed income for the rest of your life,

and, in some cases, continuing for a certain period even after death

• VARIABLE ANNUITY– money is used most often to purchase different mutual funds– in the end you will never get back less than what you originally

deposited or whatever the current value of the account is

Types of Annuities• INDEX ANNUITY

– The index annuity tracks an index such as the Standard and Poor's 500 index, and your return on your money will usually be a percentage of what that particular index did

– you do not participate in any downside risk•  TAX SHELTERED ANNUITY (TSA)

– money is invested on a monthly basis• SURRENDER PERIOD

– amount of time during which you have to keep the majority of your money in the contract

– surrender periods last from five to 10 years– If you take out money early, a surrender charge is due

Bonds• A bond is basically a traded loan• Bonds are debt securities that provide a predictable

stream of income• Some interest income is tax exempt• Bonds can have maturities of up to 30 years• Face values typically range between $1,000 and

$5,000• Bonds are traded “over-the-counter”

Types of Bonds• Secured bonds• Debentures

– Unsecured• Zero-coupon bonds• Corporate bonds• Municipal bonds• U.S. Treasury bonds• Agency securities• U.S. savings bonds• Callable bonds• Convertible bonds

Earnings Potential• Payments are normally fixed over the life of the

bond

• Interest payments are called coupon payments

• Interest rate = coupon rate

• Coupon rate is not the yield that you can earn on your bond investment

What affects bond prices?• If interest rates rise, bond prices fall and vice versa

• Maturity

• Default risk

• Likelihood of being called

Example• Buy five year 6% coupon bond at $1000 par value• Now interest rates rise to 7%• New bonds would be issued with 7% coupon rate• Bond price should fall to $958.42• If interest rate drop to 5%, bond price should be

$1,043.76

Yields• Coupon yield

– coupon rate– In example: 6%

• Current yield– Interest payment as % of current price– In example: 60/958.42 = 6.26%

• Yield to maturity– Yield if bond is held to maturity

Risks of Bond Investments• Interest rate risk

– Impact of changes in market interest rates on the value of a bond

• Default risk• Bond ratings

• Anything rated below BBB or Baa is considered “junk”

S&P

Moody’s

What it Means

AAA

Aaa

The highest possible rating, indicating the agencies‘ highest degree of confidencein the issuer‘s ability to pay interest and repay the principal.

AA Aa A very high rating, only marginally weaker than the highest. A

A

High capacity to repay debt but slightly more vulnerability to adverse economic developments.

BBB Baa The lowest investment-grade rating, indicating ―adequate capacity to pay principal and interest but more vulnerability to adverse economic developments.

How to minimize interest rate risk• Don’t buy bonds when interest rates are low or

rising

• Avoid long term issues

• Acquire multiple maturities

• Bond mutual funds best choice for individual investor

What Can Bond Do For You?

• Means to diversify your portfolio

• Relative safety of bonds

• Income component

• Large variety of bonds offers array of risk choices