On August 5th I had the pleasure of visiting the
investment Special Interest Group of OLLI at UNC Asheville. The Osher Lifelong Learning Institute is a
program for “experienced” people to continue their education. This was my third visit and I hope they want
me back.
After the meeting, I was asked to clarify a couple of the
things I said. I think I did a better
job the second time and I’m going to expand on those answers for the next two
blogs. If you happened to be there, I hope you’ll
share these with the group since I’m not sure if the folks who asked the
questions are on the blog list.
The first question was about the relationship between bond
prices and yields.
I’ve always made a mess of trying to connect all the moving
parts conceptually but I wrote a blog last year with a practical example that
does a credible job. If you will click here for
the backstory, I’ll add some practical context.
My example was very bearish.
For the last 34 years, the bond market has been in a strong bull market.[i] Rising bond prices have dropped yields from
all-time US highs to all-time world-wide lows.
This is a chart from the US Federal Reserve showing the
yields on the US 10-year Treasury note going back to 1981. They peaked at 16% and closed last week at
1.59%.
When I talk to bond investors, they don’t always realize
that individual bonds only ever pay as much as their scheduled interest and
maturity payments. Rising prices only
affect when you enjoy the benefits.
Gains you book over the life of the investment are actually prepaid
interest you won’t see in the future. New
buyers and reinvested dividends buy new bonds at higher prices but you have to
split the lower income more ways.
Last year I shared my concern with the way my industry
markets, manages and enforces inflexible asset-allocation models. By that I mean portfolios with preset
percentages of stocks, bonds and cash.
Some of them periodically rebalance to those ratios while other follow a
“glide-path” and automatically increase fixed-income holdings as the owner gets
older.
If you’ll take a quick peek at the opening chart on my target-date podcast, you can see that by retirement, this version has roughly 2/3 of
the portfolio in either bonds or cash. Most
of these allocation models were adopted 10 to 15 years ago. Rates were a lot higher then. Once the prospectus is printed, the asset mix
is set.
This is where I think investors need to be smart. Asset allocation modeling is the industry-standard
for the retail investment business. Tens
of trillions of dollars are managed on some version of that glide-path. Years ago, managers bet the farm that those income
projections would hover around historical averages.
They didn’t.
The market meltdown drove rates lower than they have ever
been. It would take a crippling bear
market like in my example to drive them up to anywhere near those levels again.
Admitting this would be a disaster for the industry. For 25 years, the business has told investors
those allocations were sacred – that they must buy-and-hold through all market
conditions to benefit from the long-term trends.
Who’s going to tell millions of retirees they might run out
of money? Who’s going to tell them and
millions more 401(k) participants they have to reallocate to more volatile
holdings?
Nobody. Better to
keep getting paid and let customers figure that out for themselves.
Calm down. This is
good news.
If you are a long-term bond owner, you’ve already gotten
most of the income you ever will as appreciation. Bonds are still at all-time high prices. Let the next guy keep your 1.59% along with
the potential volatility of rising yields.
If they rise, you will be adding more volatility anyway so do it in
something with more upside potential.
Here’s a little homework to see if you are on a glide-path
that isn’t going where you want:
1) Open
your statement and calculate the percentage of your portfolio in bonds and
money-markets. Is it close to your
age? Double-check it on the glide-path
chart.
2) Divide
the current income those investments produce by the value of the
investments. Is that percentage enough
to cover inflation, taxes and spending money?
3) Then
tally what percentage of your portfolio can’t reasonably support your lifestyle
anymore. Who came up with that idea?
Next week I’ll take a stab at a deeper question. See you then, sh
The opinions expressed here are those of Skip Helms and do not
necessarily reflect those of LPL Financial or anyone else. Investing involves
risks, including the loss of principal. Past performance does not guarantee
future results. Please consider potential transactions carefully and read all
appropriate materials before investing or sending money. Bonds are subject to
market and interest rate risk of sold prior to maturity. Bond values will
decline as interest rates rise and bonds are subject to availability and change
in price. Rebalancing a portfolio may cause investors to incur tax liabilities
and/or transaction costs and does not assure a profit or protect against a
loss. Securities offered through LPL Financial, Member FINRA/SIPC. OLLI, Helms
Wealth Management, and LPL Financial are separate entities.
