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Friday, January 31, 2014

So much for the safety of bonds

Bonds had a lousy 2013.  Most investors think bonds are always safer than stocks, but it depends on what you are buying and the price you pay.  

Last year, the 1-3 year Treasury Bond ETF (SHY) generated a 0.23% return.  That's one-tenth of inflation.  

The 3-7 year Treasury Bond ETF (IEI) returned -1.95%.

The 7-10 year Treasury Bond ETF (IEF) returned -6.12%

The Treasury Inflation Protection Bond ETF (TIP) generated -8.65% return.

The 10-20 year Treasury Bond ETF (TLH) returned -8.48%.

The 20+ year Treasury Bond ETF (TLT) returned -13.91%.

Oh, by the way, the S&P 500 ETF (IVV) returned +32.31%.

What happened?  As has been long predicted, interest rates went up.  That's it.  When interest rates go up, bond prices go down.

When you buy bonds at high prices and low yield, you get return-less risk instead of risk-less return.

Bond yields are higher, but not high relative to history.  The bond bull market that began in the early 1980's saw yields in the teens.  Today long government bonds are yielding 2.6% to 3.6%.  I don't know which way they will go, but yields still have more room to go up than down.

Bonds are safe when they are priced to provide good returns, not at any price--just like stocks provide good returns when priced accordingly.

No financial instrument is inherently safe.  It depends on what you buy, and the price you pay.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Friday, January 24, 2014

In retirement: how much bonds and stocks?

Most people cling to the idea that people should invest in stocks when young and bonds when old.  

Specifically, many believe that young people can stand the risk of stocks and retirees can't, so you should start 100% stocks when young and gradually increase your bond percentage until you have 100% bonds late in retirement.  Sound familiar?

This advice tends to sound like:

  • own 100% stocks when you are 25
  • 80% stocks and 20% bonds when you are 35
  • 70%/30% at 45
  • 60%/40% at 55
  • 50%/50% at 65
  • 40%/60% at 75
  • 20%/80% at 85
  • 100% bonds in your 90's

Some provocative research indicates this may be the wrong way to think about asset allocation.  

The riskiest period for retirees is right before and early in retirement.  If they own a bunch of bonds or stocks that tank in that critical time period, it is hard for them to recover.

Added to this, as a retiree ages, their greatest risk is running out of money because their assets don't appreciate enough relative to inflation or how long they live.

Instead, the new approach indicates a U-shaped path, with lots of stocks early and late, and more bonds in the middle.  The idea is that you get lots of growth early, less right before and early in retirement, and then ratchet up the stocks to make sure you outrun your age and inflation.

Although I think that is better advice than just increasing bond holdings linearly over time, I think it may miss the risk of stocks and bonds at certain times.

Bonds had a lousy year last year, and stocks did wonderfully.  The extremely low rates on bonds should have been a warning, but many people think bonds are inherently safe and don't understand that bonds decline in price when interest rates rise.

Same with stocks.  Stocks are better investments when they are cheap than when they are expensive.  Knowing when to own one versus the other may mean the difference between collecting cans or enjoying retirement.

Having the right mix of assets before and during retirement is vital to successfully navigating retirement.  The task shouldn't be taken lightly or with imprecise rules of thumb that don't always work.

Fortune favor the prepared mind.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Thursday, January 16, 2014

2013: tough year for stock pickers

Research from S&P Dow Jones reported in Pensions& Investments shows that 2013 was a tough year for stock pickers.

The average variance in returns between stocks in the S&P 500 was at its lowest in more than 20 years!  That means for people making a living trying to pick the winners and avoid the losers (like, well, me), 2013 looked like a fruitless year.

This is great news for passive, index investors, and bad news for active investors trying to beat the market--at least in hindsight.

This last point is important.  Either the average variance is low and staying there or headed lower, or it will regress to the mean and stock pickers will be able to add value by picking winners and avoiding losers.

My experience is that years like 2013, where most investors are focused on government action, Federal Reserve policy, and international macro-economics, are lousy for stock pickers.  Instead of focusing on sales, earnings, profit margins and returns on capital, investors were trading stocks en masse based on the latest government report.

But, stocks aren't claims on future Federal Reserve policy or macro-economic output, they are claims on future earnings of specific businesses.  Unless you think all businesses are equal, then some will do better, some will do worse, and buying the ones that will do better will reward you as will avoiding their opposite.

I know what I'll do as always: spend all day researching specific companies to figure out which ones will win in the years to come.  At some point in the not-too-distant future, this will be profitable again.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.