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Are Bonds Worth Some Excitement?

Posted on September 17, 2019 by Editor-in-Chief

Bonds an Investment Class Worth Some Excitement, Today?

By Rick Kahler CFP®

“One thing I definitely don’t want in my portfolio is bonds,” a prospective client told me a few weeks ago. “Bonds are boring and don’t give good returns.”

Her confidence in her money script that bonds had no place in her portfolio was palpable. However, her understanding of the role bonds play in a portfolio was incomplete. I restrained myself from launching into a lecture on the importance of bonds and simply replied, “While it is true bonds can be boring, sometimes they can be phenomenally exciting.”

Certainly stocks, commodities, and real estate investments are generally much more exciting. They are many times more volatile than bonds; in just a year it’s possible they might even gain or decline 50% in value. Meanwhile, individually held bonds and their mutual funds can crank out predictable coupon yields quarter after quarter after quarter, with one-third of the volatility of stocks. The cost of the lower volatility is that the long-term returns on bonds tend to be half to a third that of stocks.

However, the bond market right now is anything but boring. So far this year, while stocks are back to prices roughly where they were in early 2018, a sharp fall in interest rates has caused bond investors to reap some significant capital gains. Bonds have an inverse relationship with interest rates. The value of most bonds increases when interest rates decline and go down when interest rates rise.

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Bonds

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How significant are the gains in bonds?

Since the beginning of 2019, investors in the 30-year Treasury bond have seen gains (interest plus price appreciation) of 26.4%. That would be an outstanding full year’s return for stocks. According to the Bloomberg Barclay’s U.S. Aggregate Bond Index, long-term bonds overall have generated a 23.5% return. Investment grade corporate bonds have returned 14.1%, while the 10-year Treasury note has gained 12.6%.

Market observers have predicted for the last decade or so that bond rates have nowhere to go but up. What we’re seeing currently is a yield on the ten-year Treasury note of just under 1.47%. At the end of 2018 it was more than 3%.

Will we see more of the same? It’s very hard to imagine that same 10-year Treasury falling another 1.5%—to zero yield. So the smart money says that most of the gains have already been taken, and anybody looking for 20-plus percent returns in long bonds going forward is just chasing them after the fact when returns are dropping.

But how smart is smart?

Just in case you agree and think interest rates have nowhere to go but up, consider that many countries in Europe actually have negative interest rates, where the investor or depositor pays to loan their money to organizations or banks. Another 1.5% fall to 0% interest rates could deliver similar 20% bond returns.

Lessons Learned

The lesson here is that even if you think of bonds as the boring part of your portfolio, there are times when they can add a little more kick to your returns than you might have expected. And in times of falling equity markets, they are an invaluable buffer against big losses. Still, with the long term probability that bonds produce a return half that of equities, there is a significant chance that they won’t sustain the 20-plus percent returns as rates stabilize and increase at some point in the future.

Unlike the misinformed prospect I visited with, most investors over the age of 40 can benefit by having a substantial slice of their investment portfolio in bonds. Whether their returns are typically boring or occasionally exciting, bonds are an important asset class for diversified investors.

Assessment: Your thoughts are appreciated.

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Filed under: Investing | Tagged: bonds, Rick Kahler CFP | 1 Comment »

Mature Company Stocks Are Not Bonds

Posted on May 15, 2019 by Editor-in-Chief

Dividends bring tangible and intangible benefits

vitaly

By Vitaliy Katsenelson CFA

You can also listen to the article here, or by clicking on the buttons below:

Like many professional investors, I love companies that pay dividends. Dividends bring tangible and intangible benefits: Over the last hundred years, half of total stock returns came from dividends.

In a world where earnings often represent the creative output of CFOs’ imaginations, dividends are paid out of cash flows, and thus are proof that a company’s earnings are real.

Finally, a company that pays out a significant dividend has to have much greater discipline in managing the business, because a significant dividend creates another cash cost, so management has less cash to burn in empire-building acquisitions.

Mature Company Stocks Are Not Bonds

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[PHYSICIAN FOCUSED FINANCIAL PLANNING AND RISK MANAGEMENT COMPANION TEXTBOOK SET]

Filed under: Investing | Tagged: bonds, Corporate Dividends, dividends, Investing, stocks, Vitaliy Katsenelson CFA | 1 Comment »

Is it Time to Reduce Your Bond Exposure?

Posted on October 7, 2014 by Editor-in-Chief

On Investment Portfolio Analysis

By Lon Jefferies MBA CFP®

For the last half-decade, investors have been continually concerned about rising interest rates and the effect they may have on the bond portion of their investment portfolio.

The fear is that if interest rates rise, the bonds currently held by investors will be outdated and provide investment returns that are less than what new bonds issued at the higher yields would return.

Concerned?

There is validity to this concern – if an investor could buy a bond yielding 4% on the open market, why would anyone buy a bond that yields only 3%, unless they could do so at a significant discount? Given that today’s interest rates are considerably lower than historical averages and expected to rise in the future, would now be a good time to sell some of the bonds in your portfolio?

Consider the Timing

First, let’s consider one of the most basic principles of investing – that markets are unpredictable. Are we certain that interest rates will rise, and are we confident this rate increase will happen soon? I’d contend the answer to both questions is no.

Actually, the majority of investors have believed interest rates would rise since the first round of quantitative easing took place in 2009, and have suspected rates would rise in every calendar year since. Quite simply, this has not happened. In fact, interest rates are currently lower than they were during the majority of 2009 despite five years of buzz about interest rate hikes.

During this five-year period, how have bonds performed? From 2009 through 2013, the Barclays Aggregate Bond Index (AGG) returned 5.93%, 6.54%, 7.84%, 4.22%, and -2.02%, respectively. Bonds only declined once during the five-year period, by a relatively nominal -2.02%, and still averaged a compound rate of return of 4.86%—not bad for the conservative portion of a portfolio.

Additionally, various bond categories have done even better than the Aggregate Bond Index, which consists of just U.S. government and corporate bond holdings. For instance, emerging market bonds (EMB) achieved a compounded return of 9.30%, while high yield bonds (HYG) returned 12.26% annually over the same five-year span. An investor whose bond portfolio was diversified among a range of asset categories has far from suffered since the expectation of a rate increases began.

Will You Miss the Stability of Bonds?

Let’s also consider the consistency of bonds. Since 1980, the Aggregate Bond Index has achieved a positive return an astonishing 31 out of 34 years (91% of the time!). Given this data, perhaps bonds aren’t as likely to decline in value as some investors think.

Equally amazing, although the bond index has achieved an annual return as high as 32.65% during this time period (in 1982), the largest loss it ever suffered in a calendar year over the same period was just -2.92% (in 1994). Over the entire 34-year period, the index obtained an average annual gain of 8.42%. Bottom line: Over the last 34 years, bonds have offered a lot of return for relatively little risk.

Diversification: the Most Important Factor

Not putting all your eggs in one basket is another basic principal of investing, and the primary motivation for having a significant portion of your portfolio allocated in bonds. It is important to remember that for an investor with a long-term perspective, equities will likely provide the majority of investment growth and return in a portfolio while bonds are needed to reduce volatility and risk.

For example, while a portfolio that was 100% stocks suffered a 38.6% loss in 2008, a portfolio that was 50% stocks and 50% bonds suffered a loss of only 14.5% the same year—still not pleasant, but much more manageable.

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Correlation

Bonds reduce risk in a portfolio because their return has a low correlation to the return of stocks. How low? Since 1928, both the S&P 500 and the 10-year treasury note have lost value during a calendar year only three times (in 1931, 1941 and 1969). That is less than 4% of all annual periods!

Further, since the Barclays Aggregate Bonds Index was created in 1973, the index has never decreased in value in the same year as the S&P 500. Amazing, but true! Clearly, bonds are fulfilling their role as a diversifier and reducing the volatility in your portfolio.

There is Always a Role for Bonds

Despite the continuous threat of rising interest rates, bonds have continued to perform. More importantly, history illustrates that mixing bonds with stocks smoothes out the investment results of your portfolio.

Assessment

Don’t get sucked in by the media buzz. Bonds are too valuable an asset to disregard.

The Author:

Lon Jefferies is a Certified Financial Planner with a fee-only approach to ensure the client’s best interest is the top priority. He isn’t paid commission and gains nothing through recommendations but his client’s satisfaction. He has contributed to national publications like The Wall Street Journal, The New York Times, USA Today, Morningstar.com and Investment News.

Conclusion

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Filed under: Investing, Portfolio Management | Tagged: bonds, Investing, Investment Portfolio Analysis, Lon Jefferies MBA CFP® | 1 Comment »

How Have Bonds Responded to Higher Interest Rates?

Posted on February 6, 2014 by Editor-in-Chief

A Survey of Economists

By Lon Jefferies MBA CFP™

Recently, I pondered the possibility of interest rates rising and the impact it might have on bonds. The article was motivated by a Wall Street Journal survey of 50 top economists who forecasted the yield on the 10-year Treasury bond to rise to 3.47% by the end of 2014.

As you may know, the investment return of existing bonds tends to move inversely to interest rates. Consequently, there has been significant concern that bond values are due for a considerable drop, and investors have constantly questioned whether they should reduce their exposure to fixed-income investments.

The Forecast Results

So how has the economists’ forecast panned out through January? The 10-year Treasury bond began the year at 3.03%, but ended January at 2.65% — a significant decline.

As a result, bonds have generally increased in value. For instance, the iShares Investment Grade Corporate Bond ETF (LQD) is up 1.88% since the New Year, while the iShares Barclays 7-10 Year Treasury Bond (IEF) is up 3.06%. Even the SPDR Barclays International Treasury Bond ETF (BWX) is up .45% in 2014.

Why?

What has caused this unexpected result?

First, the historical inaccuracy of interest rate forecasts is well documented. A study by the University of North Carolina found economists predict future rates far less accurately than a random coin flip would fare as a predictor. Rising interest rates have been a general expectation since shortly after the market crash of 2008. Remember all the people who refinanced their homes away from an adjustable-rate mortgage to a fixed mortgage from 2010-2011 out of fear of rising rates? That rate hike still hasn’t come.

But, more important than the unpredictable nature of interest rates is the way bond performance has historically been related to the stock market’s performance.

In difficult market environments, the investment returns of stocks and bonds tend to have an inverse relationship. In fact, the S&P 500 (a broad measure of the U.S. stock market) has decreased in value during a calendar year five times since 1990 (1990, 2000, 2001, 2002, 2008). In all five instances, the value of U.S. Government Bonds (as measured by the Barclays Long-Term Government Bond Index) has increased (6.29%, 20.28%, 4.34%, 16.99%, and 22.69%, respectively).

Performance of Equities

How have risky stocks performed in 2014? The S&P 500 is down -3.46%, the Dow Jones Developed Market ex-U.S. market index (a measure of international stock performance) is down -3.64%, and the iShares MSCI Emerging Markets Index is down -8.63%.

It appears investors have fled stocks in a declining market and sought solace in the fixed income benefit that bonds provide, in-step with historic behavioral norms. Of course, higher demand for bonds means higher values. This last month has been a nice reminder of the stability bonds can add to a portfolio in a time of declining stock prices.

Assessment

While it is reasonable to expect interest rates to rise by some measure over the long-term, it would clearly be a mistake to dramatically shift your asset allocation away from bonds if they were determined to be a part of an investment portfolio that matches your risk tolerance.

January 2014 illustrated that bonds tend to increase in value and add benefit to a portfolio during market pullbacks, regardless of what interest rates are doing. In fact, bonds’ historical inverse relationship with stocks may be a larger determinate of performance than interest rate expectations.

More:

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Filed under: Investing | Tagged: bonds, BWX, fixed income investments, IEF, Lon Jefferies, LQD, S&P 500, U.S. Government Bonds, Wall Street Journal | 2 Comments »

The Impact of Rising Interest Rates on Bonds

Posted on January 7, 2014 by Editor-in-Chief

On Interest and Exchange Rates

By Lon Jefferies MBA CFP® www.NetWorthAdvice.com

An interest rate hike has been widely anticipated for some time. According to an October survey of 50 top economists conducted by the Wall Street Journal, the yield on the 10-year Treasury was forecasted to rise nearly one percentage point to 3.47% by the end of 2014.

What impact would such a rise have on your investment or retirement portfolio?

The Impact

Christopher Philips, a senior analyst in Vanguard’s Investment Strategy Group, points out the historical inaccuracy of such forecasts.

For instance, a similar survey conducted in 2010 had economists predicting a 4.24% 10-year Treasury yield by the end of the year, an increase from 3.61% at the time of the forecast. In actuality, rates declines to 3.30% at year-end. The inaccuracy of these forecasts is well documented.

In fact, as Allen Roth mentioned in the December issue of Financial Planning Magazine, a 2005 study by the University of North Carolina titled “Professional Forecasts of Interest Rates and Exchange Rates” found economists predict future rates far less accurately than a random coin flip would fare as a predictor.

Clearly, we can’t be confident what interest rates will do in 2014, but what if economists are finally correct and rates rise? How damaging would an interest rate increase be for bonds? If interest rates rise one percentage point next year, the intermediate aggregate bond index is expected to lose -2.8% — far from catastrophic. Of course, such potential risk is notably minimal when compared to the downside of owning stocks (remember the -36.93% loss endured by the S&P 500 in 2008?).

Historical Performance

It is also interesting to study how bonds have historically performed in periods of rising interest rates. Craig Israelsen, a BYU professor, recently documented how bonds performed during the two most recent periods of rate increases. Israelsen points out that although the federal discount rate rose from 5.46% to 13.42% from 1977 through 1981, the intermediate government/credit index had a 5.63% annualized return during that period. The next period of rising interest rates was from 2002 through 2006, when the federal discount rate had a fivefold increase: from 1.17% to 5.96%. During this period, the intermediate government/credit index obtained a 4.53% annual return. Clearly, even in an environment of rising interest rates, bond performance was surprisingly strong.

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Most importantly, investors should never forget the value bonds add to a portfolio as a diversifier to stocks. Frequently, the performance of stocks and bonds are inversely related.

For instance, when the stock market suffered during the tech bubble crash of 2000-2002, the Barclays Long-Term Government Bond Index rose 20.28%, 4.34%, and 16.99% in those years, respectively.

Current Indices

More recently, when the S&P 500 lost -36.93% in 2008, the Long-Term Government Bond Index rose 22.69% during the year. This diversification benefit may prove useful when stocks ultimately cool off from the extended hot streak they have experienced since 2009.

In 2013, the Aggregate Bond Index decreased in value by -1.98%. Given the occasional negative correlation in performance between stocks and bonds, is it really surprising that bonds didn’t produce a positive return given the incredible year stocks had (S&P 500 up over 32%)? Additionally, held within a diversified portfolio, isn’t the -1.98% return produced by bonds during the recent equity surge a small price to pay for the additional security they are likely to provide when markets reverse?

Assessment

It doesn’t seem prudent to avoid bonds entirely during periods of expected interest rate increases.

First, forecasts of rising rates are far from certain.
Second, even if interest rates rise bonds are still likely to be far less risky than stocks.
Third, rising interest rates don’t necessarily mean declining bond values are a certainty – in fact, bonds performed quite well during the past two periods of rate increases.
Finally, bonds are a vitally important part of a diversified portfolio, and owning uncorrelated and negatively correlated assets will be critical when equities ultimately lose their momentum.

Conclusion

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Filed under: Investing, Portfolio Management | Tagged: Allen Roth, Barclays Long-Term Government Bond, bonds, Christopher Philips, Craig Israelsen, Lon Jefferies, Vanguard’s Investment Strategy Group, www.NetWorthAdvice.com | 2 Comments »

On Employer-Sponsored Retirement Plans

Posted on May 16, 2013 by Editor-in-Chief

Should I Stay … or … Should I Go?

By Guy P. Jones CFP® www.guypjones.com

Many ME-P readers may remember the song by the same name released in 1982 by English punk band, The Clash.

If you do and you were in your late 20’s or early 30’s then, you are probably asking the same question about your hospital, medical clinic or employer-sponsored retirement plans, 401k, 403b, 457b and the like, right now.

History

Since the 401k was introduced back in 1978, it has been promoted as the “holy grail” of retirement savings vehicles, mostly by the mutual fund companies that it favors. Since the introduction of the 401k, there has been a gradual, yet steady, decline in employer-sponsored pension plans by private sector employers to the point that they are almost nonexistent.

Unless you work for a very large company or work in the public sector, your pension plan was phased out a long time ago. This has thrust a myriad of decisions regarding retirement planning on a workforce that is ill prepared to make the proper choices as to appropriate investment options. They therefore have relied on their employer to choose for them. In doing so, we now have a retirement system that is fraught with poor performing, high-cost, limited-choice, loss-incurring investment options.

Another Option?

But, wait, what if there was another, better option for some of you? What would you do if you were suddenly handed a “Get Outta Jail Free Card” from your employer-sponsored retirement plan? Well, guess what, you just have! It’s called an “In-Service Distribution” or “In-Service Transfer” to an Individual Retirement Account (IRA).

So what exactly is an In-Service Distribution or In-Service Transfer?

An In-Service Distribution allows workers to empty their 401(k) accounts once they hit 59½. This means that they can take cash out, pay any ordinary income taxes due and spend what’s left. The same goes for participants in government and not-for-profit savings plans like 403b, 457b, and TSP accounts. Or, they can roll all the money into an IRA without paying tax now which is an In-Service Transfer.

Need to Know:

You first have to determine if your employer-sponsored plan even permits in-service distributions or transfers. It is determined by what was written in your company summary plan description.
Many plans permit workers to take out or rollover to an IRA when you reach 59½, but some plans also permit in-service distributions for those under the age of 59½. This permits them to get in-service distributions of money rolled over from previous plans, employer (but not employee) pretax contributions, employee after-tax contributions, and account earnings. If they spend the cash, instead of rolling it over, they will owe an extra 10% penalty on the taxable amount.
In doing an In-Service Transfer, you must make sure the rollover is to an IRA. In doing so, you avoid IRS taxation (and possibly penalties) on this money.
Some plans have already pre-approved this option and in many cases can process the in-service distribution or transfer to an IRA right over the phone. Other plans require the completion of some paperwork which then has to be signed by your employer.

[The Retired Doctor’s Lounge]

What Funds are eligible for In-Service Distributions or In-Service Transfers?

When you decide to rollover money from your current employer-sponsored plan to your own IRA while still employed, here are the funds that will be available, subject to the summary plan description:

Your employer contributions including match and profit sharing
Your personal after-tax contributions
Your pre-tax contributions when you reach age 59½.

Reasons to Do an In-Service Distribution or In-Service Transfer

Unlimited Control — With an IRA, you are the account owner and have more control over your assets, more control over the investment choices, and are free from the restrictions of your employer-sponsored plan.
Diversification — Most employer-sponsored plans offer limited investment options. Conversely, IRAs enable you to choose virtually any investment option including individual stocks, bonds, ETFs, mutual funds, real estate and precious metals. This flexibility can help you better diversify your retirement assets to meet your individual investment goals.
Beneficiary Options — IRAs allow non-spouse beneficiaries to stretch distributions from an IRA over their lifetimes. This type of beneficiary distribution option not only results in greater distributions over their lifetime, but also enables the beneficiary to minimize the taxes owed on the distributions. This is not available in most employer-sponsored plans, which may limit distribution choices for your beneficiaries.
Income Tax Withholding — Employer-sponsored plans have a mandatory 20% withholding tax on any cash distributions from the plan whereas IRAs allow you to choose whether you want tax withheld or not.
ROTH IRA Conversion Option — Since 2010, any one regardless of their income can convert a Traditional pre-tax IRA to a ROTH IRA where future earnings are tax-free. In addition, you are now permitted to roll 401(k) money directly into a Roth IRA. Income taxes would be due, but not the 10% IRS penalty for pre-59½ withdrawals. If you want to do a gradual conversion of your traditional IRA to a ROTH IRA to minimize taxes, this would be another benefit to getting it out of the employer plan into an IRA now.
Required Minimum Distributions — By getting your money out of the employer plan, you can do a conversion to a ROTH IRA to eliminate having to take RMDs starting at age 70½. RMDs affect the taxability of your Social Security benefits and by eliminating them, the taxation on your social security would be reduced.
Protect IRAs from Investment Losses — Generally, what is offered in employer qualified plans are mutual funds which can and will lose money in the event of a market decline. By doing an in-service transfer to an IRA, you can choose options that will protect these funds from investment losses, lock in gains, and create an income stream that you can never outlive.

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[Physician Retirement Funds]

Drawbacks to doing an In-Service Distribution or In-Service Transfer

Age limitations — with employer plans, they allow participants who stop working at age 55 or older to take distributions without the 10% IRS penalty. In an IRA, you can’t take distributions until age 59½ without incurring the 10% penalty. If you plan to retire before age 59½, you may want to preserve penalty-free access to your retirement funds by not moving all of your 401(k) assets to an IRA before retirement
Net Unrealized Appreciation (NUA) — tax treatment is not an option for distributions from IRAs. Therefore, if you hold highly appreciated company stock in your employer-sponsored plan, the transfer of that stock to an IRA eliminates any ability you may have to take advantage of NUA tax treatment.
Creditor protection — while IRAs now have federal bankruptcy protection, other IRA creditor protection is still determined by state laws. Texas affords unlimited bankruptcy protection of IRA assets from creditors. Qualified plan assets continue to have broad federal creditor protection.
New contributions to your existing plan — taking an in-service distribution may affect your ability to contribute to your employer-sponsored plan. Be sure to consult with your plan provider or employer HR department before implementing this.
Cost — fees related to having your own IRA could be more costly than the investment options inside the 401k, although this can be controlled by careful selection of IRA options.
After-tax dollars — after tax dollars are generally segregated in a qualified plan, and can often be distributed separately. If you move after-tax money into an IRA, that money becomes part of the non-deductible “basis” of the IRA and will not be separately accessible. To avoid paying tax again on your IRA “basis” when you take an IRA distribution, you must maintain careful records of the “basis” in your IRAs. This can become more of an issue in regards to doing a Roth IRA Conversion.
Loans — loans are permissible through your employer plan, generally up to 50% of the account balance not to exceed $50,000. These loans can be paid back over a 5 year period or 10 years if used to purchase a home. Loans are not permitted in IRAs or ROTH IRAs.

Assessment

So, if this is so great then why doesn’t everyone take advantage of doing an in-service distribution or in-service transfer? The biggest reason is that employers don’t want plan participants to know about it or exercise this option. The second reason is that people don’t understand it or think that by transferring money out of their plan, they will incur tax and/or penalties. Make sure you go through the facts with a professional or your 401(k) company to understand the rules.

Nobody can be certain when the next market meltdown will be. With many Boomers now approaching retirement, you have to keep your eye on what will be the bulk of your retirement assets.

For my part as a financial professional, if your plan allows in-service distributions or transfers and you were debating whether to get out of your employer plan, I would give you the same advice that Jennie gave Forrest Gump when he was being chased by the bullies: RUN FORREST, RUN!!

The Author

Guy P. Jones & Associates

21 Stone Creek Place
The Woodlands, TX 77382
832-677-1692
281-605-5370 fax

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Filed under: Retirement and Benefits | Tagged: 401(k), 403(b), 457b, bonds, Employer-Sponsored Retirement Plans, ETFs, Guy P. Jones, In-Service Transfer, individual retirement account, IRA Conversion Options, Mutual Funds, precious metals., real-estate, Required Minimum Distributions, stocks, TSP accounts | 1 Comment »

Are We in a Bond Market Bubble?

Posted on March 1, 2011 by Editor-in-Chief

Beware all Physicians and Investors

By Sean G. Todd, Esq., M. Tax, CFP, CPA

Investors have been pouring money into bonds. The Investment Company Institute statistics show that since January 2007, average net new money going into bond mutual funds each month has been roughly four times greater than net outflows from equity funds.* So does that mean we’re in the bond market’s equivalent of the late-1990s tech bubble?

What’s been driving interest in bonds?

There are several reasons why bond funds have been attracting investor interest.

First, in the wake of both the tech crash of 2000-2002 and the 2008 financial crisis, the Federal Reserve felt it needed to make credit more available by lowering interest rates. Over the last 10 years, the yield on the 10-year Treasury bond has fallen from 5% to well under 3% at the end of 2010.

And for the first time ever, 5-year Treasury Inflation-Protected Securities (TIPS) actually paid a negative yield when they were auctioned last October.

Because bond prices rise as interest rates fall, that has increased bond prices generally.

As a result, bonds have outperformed stocks in recent years. For the last 20-year period, total returns from stocks and bonds have been equal: 8.2%.

And during the decade between January 2000 and the end of 2009, bonds actually outperformed stocks; the S&P 500 saw a total return of -0.9%, while long-term government bonds returned 7.7%.

That outperformance has lured investors who may have forgotten that past performance doesn’t guarantee future results, and invest in an asset class based on its recent history rather than its prospects for the future.

The Demographics

Next, demographics also have played a role. Many aging baby boomers who became accustomed to investing much of their IRAs and 401(k)s in stocks are beginning to realize that their time horizon for retirement isn’t as long as it used to be, and that they should consider allocating an increasing percentage of their retirement portfolios to income-producing assets. The financial crisis also sent many frightened investors scurrying to put their money anywhere besides stocks.

Finally, diminished dividends from stocks have encouraged many investors to look elsewhere for income. During the tech boom, companies preferred to reinvest in growth or buy back stock rather than increase dividends, and according to Standard and Poor’s, 2009 was the worst year on record for dividend payments.

Though there has been some reversal of that trend in recent months, stingy dividends helped make bonds and their income more attractive.

What to Watch out For

No investing trend lasts forever without interruption. Here are some factors that could affect bond prices:

Signs that inflation is picking up: Higher inflation means fixed income payments will have less purchasing power in the future, diminishing bonds’ appeal as income vehicles.
Fed reversal on interest rates: As the economy recovers, the Federal Reserve will need to withdraw the support it has given the bond markets. As it gradually rachets up interest rates, bonds will begin to reverse their pattern of the last decade. Depending on the pace of the Fed action, that reversal could be swift. Rising interest rates typically mean falling bond prices, and longer-term bonds often feel the most impact because bond buyers are reluctant to tie up their money long-term if a better rate lies ahead.
Lack of overseas interest in U.S. debt: Foreign buyers have been large purchasers of U.S. government debt. If foreign buyers show signs of turning away from U.S. debt, it could send shivers through the bond markets.
Muni bond troubles: Some experts worry that defaults by cash-strapped state and local governments could become a problem.

Assessment

However, balance those factors against the possibility of further sovereign debt problems abroad. Several European nations are still struggling to deal with their debt problems; another bout of global jitters like the one in spring 2009 could remind investors that the United States has never defaulted on its debt. Also, if the potential for deflation that the Fed is so concerned about turns into an actual decline in wages and prices, that could be a positive for bonds, since the income they pay would be more valuable as prices fall. Either way, now is an especially good time to keep an eye on your bond investments.

Source: Average of monthly net new cash flows from January 2007 through September 2010 as reported in Investment Company Institute’s “Long-Term Mutual Fund Flows Historical Data” as of Nov. 20, 2010.

Source: U.S. Treasury historical data on daily Treasury yield curve rates.

Source: “Record Setting Auction Data,” http://www.treasurydirect.gov.

Conclusion

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Filed under: Investing | Tagged: bond bubbles, bonds, interest rates, Investment Company Institute, Sean Todd | 5 Comments »

The “Life Cycle Investment Hypothesis”

Posted on August 16, 2010 by Editor-in-Chief

Physicians Returning to Zero?

[By Somnath Basu PhD, MBA]

How have your investments done over the last three years? If you were to ask doctors, or the myriads of people who are or even pose as professional financial advisors, they would generally say that it would depend on how well your portfolio was diversified. By this jargon, they would mean how your money (in what proportions) was invested among various asset classes such as stocks, bonds, commodities, cash etc. The more it was spread out around various asset classes, the safer they would have been.

To see how safe (or how risky) your portfolio was over the last few years, it’s useful to view how these asset classes themselves fared over this time period. That is what is shown in the next chart where the following asset class performances over the last few years are shown. The chart shows the performances of stocks (S&P 500 shown by the symbol ^GPSC, in red), bonds (symbol IEI, Barclay’s 3-7 Year Treasury Bond index etf, in light green), Commodities (DBC, Powershares etf, in dark green), Long dollar (UUP, Powershares long dollar etf, in orange; this fund allows speculating on the dollar going up against a basket of important currencies; whenever the world financial markets are in turmoil, this index generally goes up as investors around the world seek the “safe haven” status of the dollar.

Alternately, note that this index value will also typically rise when the domestic economy is in a sound condition and both domestic and international investors favor the U.S. financial markets) and the short dollar (UDN, the Powershares inverse of UUP). Note that the “Cash” asset class has been left out and returns on cash (or money market funds) have been close to zero the whole time.

There are a few startling observations from this period. The first part that arrests the eye is how commodities performed over this time period. If your portfolio was heavy in this sector, you had a heck of a ride these last three years. If you had a lot of stocks as well, heck, your ride just got wilder. As can also be seen from the picture, healthy doses of bonds and currencies would have made your ride that much smoother.

On the other hand, what is additionally startling to observe is that we all started this period close to zero returns in the beginning of 2007 (around March 2007) and in June 2010, we are all converging back to zero returns. No matter how you were diversified, you either took a smooth ride (well diversified portfolio) from a zero return environment to a zero return environment or a wilder ride. That is why diversification is so important. Another way to gauge your diversification benefit is to use a two-pronged system.

The first is what I refer to as the “monthly statement effect”. When your monthly financial statements come in, you first observe the current month’s ending balance, then the previous month’s ending balance and then have a great day, a lousy day or an uneventful day. Depending on how good or bad (how volatile the ride) the monthly effect is, it may last for much more than just a day, maybe days. The second piece is your age.

Life Cycle Investment Hypothesis

As you grow older, you ask yourself how wild a ride can you tolerate at this point in your life? Hopefully, as you age, this tolerance level should show significant declines. If it does, you are then joining a rational investment group practicing a “lifecycle-investment hypothesis” style. Finally, did anything do well during this time? Yes, and surprisingly from an asset class whose underlying asset is shaped too like a zero – mother earth and real estate. Having some real estate in your investment basket (another important diversification asset) would not only have smoothed your ride but would have made your financial life so much more pleasurable. Just take a look at this picture below (FRESX, an old Fidelity’s real estate index fund) which says it all.

Assessment

Even in the darkest days of falling real estate markets of 2008, this fund produced a positive return. Of course many other real estate indexes lost their bottoms; thus finding these stable indexes in all asset classes are well worth their salt. That is, if it is time for you to diversify.

Conclusion

OUR OTHER PRINT BOOKS AND RELATED INFORMATION SOURCES:

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ADVISORS: www.CertifiedMedicalPlanner.org
FINANCE: Financial Planning for Physicians and Advisors
INSURANCE: Risk Management and Insurance Strategies for Physicians and Advisors
Dictionary of Health Economics and Finance
Dictionary of Health Information Technology and Security
Dictionary of Health Insurance and Managed Care

Filed under: Financial Planning, Investing, Portfolio Management, Research & Development | Tagged: bonds, CASH, commodities, FRESX, Life Cycle Investment Hypothesis, real-estate, Somnath Basu, stocks, UDN, UUP | 5 Comments »

Physician Investing and Management

Posted on August 4, 2009 by Editor-in-Chief

Completing your Portfolio

By Sean G. Todd, Esq; M. Tax, CFP^©, CPA

I hope this post finds all ME-P readers well. Last month I focused on tax efficiency, and the culinary arts. This month the focus is on completing your portfolio. The economy is going through some trials and tribulations as of late. The markets are hitting 2009 highs despite the continued rise in unemployment and continued strain in the residential and now what appears to be the next sector under strain – commercial real estate.

The Recession Has Ended?

As I have indicated before, I’m not convinced this recent rally is sustainable for several reasons. The investing environment is a bit different this time and I believe that we are still in what is now being labeled as the “Great Recession” despite reports that the “recession has ended”. Have you made adjustments to your portfolio? If not, let’s move to the real reason you continue to read these ME-Ps; to be able to make the right long-term decision during these difficult times. Last month I focused on the importance of Tax-Efficient Investing. This month let’s look at the importance of Completing Your Portfolio.

Diversification

We all understand that the best way to manage risk in your portfolio is to diversity your investments across multiple asset classes, styles, geographies and sectors. In doing so, you have to optimize the balance between risk and return.

Taxable Assets

Within your taxable accounts, it’s always a good idea to minimize the impact of tax consequences. But, are you taking the right steps to reduce the effect of the capital gains distribution often associated with traditional mutual funds? When it is time to reallocate the portfolio; be sure not to violate the 30-day wash sale rule.

Fixed Income Assets

Fixed income securities are a key component of many physicians’ well-diversified portfolios. When making an investment in fix income instruments, be sure to pay attention to duration and credit quality. You should be able to adjust a tolerable balance between credit quality and yield to achieve your investment objectives.

For example, be sure if you are investing in any fixed income funds they have the following three characteristics: 1) the fund is diversified, 2) the fund is transparent and 3) the fund is highly liquid.

Liquidity

Liquidity is the key during this volatile market and you should not be subject to any redemption fees associated with your investment. If a redemption fee is being imposed, I’m confident of a better alternative available to you.

UITs

What about a unit investment trust [UIT] investment? Here is one reason to shy away from them: they must deposit the income in a non-interest bearing account and distribute it periodically to the trust shareholders. This restriction results in a dividend cash drag, which can affect your investment return.

Bond Premiums

Have you recently been solicited by a broker to purchase an individual bond at a premium? If the bond is trading at a premium – then you are paying over the face amount for the bond. If you are investing in fixed instruments – wouldn’t it make sense to pay the market price and not a premium?

Conclusion

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Filed under: Alerts Sign-Up, Financial Planning, Investing, Portfolio Management, Taxation | Tagged: asset classes, bond discounts, bond premiums, bonds, fixed income investments, liquidity, Mutual Funds, porfolio management, recession, risk and retun, Sean Todd, tax efficient investing, taxable assets, UITs | Leave a comment »

Broker Compensation for Debt-Based Securities

Posted on April 15, 2009 by Editor-in-Chief

Understanding Commission Methods for Selling Investments

By Staff Reporters

Brokers earn commissions on debt instruments based on the spread, or markup, between the price at which the broker can secure the bond and the price at which it is sold.

Bond Funds

In the case of bond funds, the fund charges a management fee and/or an expense fee. There may or may not be a load, or commission, paid to a broker.

Assessment

For more terminology information, please refer to the Dictionary of Health Economics and Finance.

www.HealthDictionarySeries.com

Conclusion

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Filed under: Financial Planning, Investing, Portfolio Management | Tagged: bond brokers, bond fees, bond funds, bond price, bonds, broker, commissions, debst instruments, debt based securities, load, markup, sales load | Leave a comment »

Understanding Managed Bond Funds

Posted on March 29, 2009 by Editor-in-Chief

Considerations for the Physician-Investor

By Staff Reporters

Proper diversification among types of bonds is an important investment objective. The maturity schedule and the number of issuers are often very important, along with the issuers’ creditworthiness.

Individual Constraints

The constraints on purchases of individual bond issues often put the physician-investor at a disadvantage. Minimum amounts of investments are imposed by the marketplace or the issuer. Many doctor-investors find it impractical to meet these requirements and also obtain proper diversification (the amount of portfolio funds committed to debt-based securities simply is not large enough to obtain diversification and at the same time meet the other limitations). Accordingly, many investors find mutual funds devoted to debt-based securities most effective in achieving diversification.

A Large Marketplace

The mutual fund marketplace has many types of bond funds, and diversification can be obtained quite easily. The investor with a relatively reduced amount to invest in debt-based securities should consider using mutual funds.

Assessment

For more terminology information, please refer to the Dictionary of Health Economics and Finance.

www.HealthDictionarySeries.com

Conclusion

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Filed under: Financial Planning, Investing, Portfolio Management | Tagged: bond funds, bond insuror's, bond rating, bonds, credit, credit rating, credit rating agency, creditworthiness, debt securities, debts, junk bonds, municipal bonds, mutual bond funds, Mutual Funds, revenue bonds, treasury bonds | 3 Comments »

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