The Bond Conundrum

By now if you’ve planted a garden, you are likely reaping some of what you have sown. At our house, Steph “invested” in some fancy planter boxes, soil, plant starts of ALL SORTS, fertilizer, and dandelions (I’ll let you gardeners determine why that last one is a good idea.) 😉 Some of the plants were a huge success. In fact, we can hardly eat enough of our tasty little sunburst tomatoes to keep up with our supply. However, the raspberries sold to us with a tag that made them look SO EASY to care for were a disappointing mess in more than one way. They actually CRUMBLED to pieces when you pick them and they were infested with little mites of some sort. It was gross. Now, growing up we had great raspberries, so I know what’s possible with homegrown fruit. Our family loves raspberries so we will dig in our heels and try again next year.

As with our financial investments, we plant a seed and hope to reap a large healthy bounty. Right now, bonds are a bit like our 2019 raspberry harvest. They are marketed as the one thing, but presently they are something entirely different.

Let me try to lay out plainly the issue with Bonds right now and what we are doing about it. As of this morning, a 30-Year Government Bond is Yielding 1.94%. A two-year bond is yielding right around 1.46%. It’s important to note that these numbers literally change minute-to-minute.

So, what does that mean in English? It means, if you had $100,000 to invest today and you bought a 30- Year Government Bond, you would receive $1940 per year for the next 30 years and then you’d get your $100,000 back.

So, what’s the big deal? Well, if that $100,000 is in a Taxable account, you owe taxes on that $1940 every year. Inflation historically has averaged 3% per year, so using that number your $100,000 is losing, on average, $3,000 per year in spending power. At 3%, that $100,000 you get back 30 years from now will have that same spending power of $40,702 today.

We like to refer to this as GOING BROKE SAFELY. Bonds are terrible long-term investments and even more so right now, but………… and this is a big but…….Bonds, especially government Bonds, are a buffer in times of volatility. Bond prices have risen quite a bit during this recent bout of volatility, which is part of the reason that yields are so low and why our more conservative portfolios have held up pretty well recently despite the losses in the equity markets.

For those who need stability in their portfolio, there really isn’t a much better option than to have bonds as part of your portfolio mix, but it comes with the knowledge that adding them lowers the long-term expected returns.

So, what is an investor to do? Here are a couple of pieces of general advice to consider and then I’ll explain actions I’ve taken and future possibilities to improve your investing experience.

1. If you are under the age of 45, as a general rule, bonds probably shouldn’t be a part of your portfolio. Unless you can’t stomach the ups and downs of the market, you should be in a well-diversified equity portfolio. Please check your 401ks and retirement plans. I often see young people with bond holdings inside their plan. Also, I see them with Balanced Funds, which hold both equities and bonds. Don’t do it. It’s a great time to make the change because bonds are up and stocks are down. Sell your bonds and buy stocks.
2. If you have been feeling that maybe you are too conservatively invested, it’s a good time to revisit your asset allocation. Again, bonds are up and stocks are down, and now is a great time to make that transition.

Finally, here is what we’ve done in response to the current situation and what we are considering moving forward.

1. Over the course of the last 3-4 weeks, I have rebalanced the models twice. The impact of this has been to sell a small portion of bonds and buy into the equity side of the model. Essentially, we are leveraging the rise in bond prices to take advantage of the lowered average purchase price of stocks in our portfolios.
2. We are aggressively looking at Bond-like alternatives that offer more yield while not adding significantly to the risk. Finding alternatives with more yield is not difficult but doing so without ramping up the risk of the portfolio is difficult. For that reason, we will likely add a variety of options and only in minor increments to not increase the risk substantially. We are considering Dividend-paying stocks exchange-traded funds (ETF), Real Estate Investment Trusts (REIT) (again most likely ETF’s or Funds), Utility Company ETF’s (pay high dividends and often act more like a bond than a stock), High Yield Bond ETF’s, master limited partnerships (MLP) ETF’s (Pipeline Leasing Companies), Closed-End Funds, Covered Call Strategy ETFs, Government Bonds, etc. We will probably do a combination of these things in small increments in the models to reduce the straight bond exposure a little bit while enhancing the potential returns of the models.

I’d like you to note that I do not want to be reactionary and short-sighted but it’s important to adjust over time as the environment changes. Government Bonds may be a fairly safe place to put your money and offer stability in times of market upset but given the current yield environment, they offer almost no upside potential (especially after taxes and inflation). If rates do increase, bond prices will fall, which doesn’t make them a risk-free asset (especially at the current levels). We will continue to monitor the situation and keep you up to date on other changes we make moving forward. We will also send out updates, when and if, we make the actual changes to the models.

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