I am considering buying bond funds and would welcome your recommendations. I recently read in Time magazine that you could get hurt if you’re invested in a bond fund. How can I get hurt holding bonds?
Many people think bonds are risk free, but that is not actually true. There are multiple risks associated with bonds, but they can be an extremely important component of a portfolio despite those risks. And, if properly allocated, they can provide a level of security above and beyond the equity markets. Of course there is no free lunch, and the added stability of bonds requires a tradeoff. Namely, you are foregoing the equity premium associated with stocks.
We recommend using a mix of high quality short- and intermediate-term government and Treasury issues. For tax-deferred accounts we include Treasury Inflation Protected Securities (TIPS). This allocation is purposefully designed to be very conservative. Nonetheless, it is still subject to certain risks. Interest rate and inflation risk make the top of the list. You can alleviate the risk of inflation through the use of TIPS. Interest rate risk is somewhat of a different story.
There is an inverse relationship between bond prices and interest rates. As rates rise, bond prices fall and as rates fall, bond prices rise. Longer-term bonds are hit hardest in a rising rate environment; short-term issues are hurt the least. Of course shorter-term issues generally pay less interest. If you want an appreciable return – especially in today’s low rate environment – you need to extend beyond extremely short-term debt. Our solution is to limit risk exposure and also gain some additional yield by using high quality short- and intermediate-term US government and Treasury debt.
I have 5 nieces ranging in age from 2 to 14. We want to give them money instead of toys for birthdays and Christmas. We are talking about $25 each for birthdays and Christmas for now. That’s only $50 per year until we can increase it. Where is the best place to put that money?
The ability to delay gratification goes hand in hand with long term success. Not only will your gift help provide financial security but it will set an important example. Sure, every kid would love to have the latest and greatest toy. But – at least to us boring adults – the prospect of an extra several thousand dollars for college, retirement, or a down payment on a home is much more appealing. Granted this is not as tangible and doesn’t present as well to a 7 yr. old as a box of Legos, for example.
The option you choose depends upon the circumstances of each child. If the goal is to fund college my first recommendation would be to use the West Virginia Smart 529 Select plan. This plan has a low minimum initial investment and offers age-based portfolios that allocate amongst stocks and bonds based upon the beneficiary’s age. As the child approaches the distribution phase (college) the portfolio automatically adjusts to a more conservative allocation.
However, the West Virginia does assess a $25 annual maintenance fee for smaller accounts. The details of which can be found in the aforementioned link. In your case it may be best to explore the 529 plan associated with your state of residence. When the account meets one of the exceptions for the $25 West Virginia plan fee you can roll the assets into it.
Another option would be contributing to a custodial account such as a UTMA or UGMA. The downside to a custodial account is that there are no real tax advantages. However, if the child is not going to go to college it may be a sensible option. Unlike 529 plans the only restriction for a custodial account is that the money must be used for the presumed benefit of the minor. As mentioned above this would be an appropriate vehicle to save for something such as a down payment on a home.
Finally, once the kids begin to earn income you have the option of helping them set up an IRA. What I love about this option is the time horizon and the shared responsibility. Not only could you contribute $50/year, but you could encourage them to do the same. Again, this is setting an example that will help shape their perspective and increases their chances, in this case for retirement success.
At the end of the day the foregone toy will be a distant memory. More importantly, you will have made a lasting contribution to the financial security and education of your nieces.
Is it a smart bet to reduce European exposure? It seems certain that these markets will continue to underperform for the next one to two decades.
Based on recent political and economic events we understand the skepticism surrounding the long-term growth prospects of European markets. However, we do not feel it is a foregone conclusion that European markets will produce sub-par returns over the coming decades. In its simplest form I see three potential outcomes:
1) European markets underperform
2) They keep pace with other financial markets
3) They outperform.
Under scenario one you are correct and moving out of European markets would have been a good move. “Would have” being the operative phrase. There is certainty in the past not in the future. On the flip side there is the chance that European markets outperform in the coming decades. Under this scenario we should have increased the European exposure. Again, should have – past tense.
We are not making tactical bets based on current political and economic circumstances. Rather, we are using historical data in conjunction with decades of academic research to build well-diversified portfolio designed for the long-term.
I use your investment strategy for my Roth IRA and Rollover IRA. My current employer uses Prudential for my company’s 457 plan. Looking at the options, I cannot seem to use your allocation strategy due to a lack of choices. Do you have any suggestions?
A recurring theme in most plans is a limited number of investment options. This restricts your ability to properly allocate and diversify your account.
If you find yourself in this situation the allocation tactic described below is a simple and practical way to get your portfolio on track.
I have read Paul Merriman’s book, Live It Up Without Outliving Your Money and watched some of Paul’s videos and listened to his podcasts. I have a question that hasn’t been addressed: What’s the best way to transition a portfolio from individual stocks to index funds and ETFs?
I would like to make the change quickly, but I’m worried that my timing might turn out to be all wrong. Should I do it all at once, or gradually over a period of time?
We believe that the move you are describing is a good way to reduce your risk and potentially improve your return, because index funds and ETFs will give you much greater diversification. I recommend you follow the recommendations that you’ll find in Paul Merriman’s article “The Ultimate Buy and Hold Strategy.”
Once you have made this decision, I cannot see any good reason to spread it out. If you do it all at once, you will get it over with quickly so you can focus on other things. I recommend you sell all the stocks in a single day. Stock trades typically take three business days to settle, so there will be a short delay before you can reinvest the proceeds.
During that brief period while your money is in cash, the market may go up or it may go down – or it could remain largely unchanged. You can’t control that, so you will have to accept it as an unknown price you’ll have to pay (if you must reinvest at higher prices) or an unknown bonus you receive (if you reinvest at lower prices). Either way, make the change and get it over with.
If you try to control this, you’ll have to predict or guess future stock prices, and that’s likely to lead to second-guessing your plan and not getting it accomplished.
There’s an exception to that advice. If the stocks you own are in a taxable account, it’s important that you consult your tax advisor before you move forward. Tax consequences in some cases should dictate the timing of your sales.
I am a buy and hold investor, but two recent lectures by Niall Ferguson, a Harvard Economic-Historian, make a strong case for the impending economic collapse of the United States. He predicts default and/or rampant inflation and suggests re-allocating one’s portfolio to a mixture of gold and foreign investments. I can already hear you saying “no, this time won’t be different, America will recover”, but I suppose I just wanted to hear it straight from the source. Any words of wisdom would be most appreciated.
At any given time, it is not difficult to find somebody professing to know the short term future of the economy or the capital markets. Quite often these people are highly regarded professionals armed with plenty of data to support their claims. And quite often they are wrong. History is replete with examples of how investors made wholesale changes in their portfolios based on excessively optimistic or pessimistic predictions, only to regret it deeply after the opposite occurred.
We believe that the future is fundamentally unknowable, and thus cannot be predicted with any precision. We believe investors could use their time and energy and brainpower much more effectively by controlling what they can control instead of trying to predict what cannot be predicted. We do this for our clients and with our clients by maintaining portfolios that are designed to address a wide range of economic and market climates, including inflation.