Most investors today believe in asset allocation, which usually helps reduce risk and provides our return a smoother ride to the market finish line.
As we all know, asset allocation begins with placing a percentage of our portfolio into equities. The majority of us have our equity portions designed for growth. Additionally, we place another portion of our assets into fixed income, which consists mostly of bonds. Applying allocations to our investments has consistently helped to reduce risk, notwithstanding the minor ups and downs of market gyrations.
Because of today’s economic good news environment and a record setting ten-year bull market, we have become complacent. You may be unaware of specific problems that could directly affect your investments going forward.
Woloshin Investment Management (WIM), is an institutional professional money management company with over 60 years of combined investment experience. We build and manage growth as well as growth and income investment portfolios for our clients. We would like to share some of our findings.
Many are worried about the overachieving stock market. Yes, the markets have run strong and delivered wonderful returns for over a decade. But there are unknown problems out there lurking and can potentially cause problems.
Our research points to RISK on the fixed income side of your portfolio!
We allocate our portfolios having a percentage in equities and a percentage in bonds, also referred to as fixed income. Many of us position our savings and investment assets in a 60-40 allocation, meaning 60% of our portfolio is invested in stocks and 40% is in bonds. We invest in bonds in our portfolio to generate income and add stability by reducing the potential fluctuations occurring in tumultuous markets. It’s the 40% portion that might be quite troubling for people once they realize the risks associated with bonds and their prices today.
Investing in bonds is for seeking safety, but because of today’s state of affairs, to our surprise, fixed income investing today may not be completely safe after all.
Let me explain!
The 10-year treasury benchmark has fallen nearly 50 basis points (one half percent) this year, while the longer duration bond rate has also plunged by about the same magnitude. You may not realize this, but if you want to invest for 30 years in a guaranteed AAA-rated government treasury bond, the yield is under 2% to 1.50%. Yes, that’s right, 1.50% return annually locked in for 30 years. An unbelievably low interest rate.
Guess what the 10-year government AAA treasury bond is yielding today?
Even worse, under 1.20%….
Yes, imagine locking up your hard-earned savings for ten years and earning under 1.20% interest per year. Not very exciting is it?
Yields today are shockingly low. But that’s not the only surprise you’re about to realize.
Most of us today invest the fixed income portion of our portfolios in bond mutual funds or exchange traded bond funds ETFs, not “the actual” treasuries or bonds. However, the mutual funds and ETFs we invest in need to invest in “the actual” treasuries and bonds to create their fixed income portfolios for you to invest in. And this is where the scary part occurs.
The bond portfolio managers are tied to the same constraints that you and I are, but on a much grander scale. Not all fixed income funds and ETFs are created the same way. Many are allowed to enhance their yields and their performance and they are increasing risk three different ways:
There are funds that are buying riskier bonds in emerging markets such as China and Indonesia. Yields might be more, but liquidity might suffer, credit ratings are most likely lower and so to the credit quality we would like, and there might be much more extreme volatility in the value of these bonds. In down markets, the price of the bonds might slide dramatically when trouble lurches its head.
Instead of investing in high-quality companies or government treasuries with lower interest rates, bond fund and ETF managers may be investing in lower rated companies in underperforming industries, looking for bargain prices and higher rates, but potentially creating more risk to their bond portfolios in their hunt for higher returns.
Lastly, we all like to buy low and sell high. This old adage applies not only to stocks but fixed income investing as well. Today, bond prices are at an all-time high forcing yields to an all-time low. Many foreign countries’ government bonds are yielding under 1%, while a few countries’ bonds actually have negative yields. It’s been reported that there is over $13 trillion of negative yielding bonds in the world. The collapse in yields means that massively more dollars are needed to generate the income we need and to which we American individual investors have become accustomed.
Are your bond funds and ETFs at risk? How are they invested? What emerging markets are they invested in? How risky is YOUR fixed income portfolio?
Perhaps it’s time to have your investments reviewed. We would like to offer you a free analysis of your portfolio. Do you have a written retirement income plan yet?
Retirement is quite complex, because there are so many moving parts. Don’t leave your retirement to luck. Reach out to us and we would be delighted for you to come in for a complementary visit. We have helped hundreds of people just like you to have a fabulous retirement providing income they can count on!