There is practically universal opinion that interest rates will rise in the future, and that bond portfolios will suffer painful losses when this happens. At Merriman, we think the financial news media has blown this story way out of proportion, with inflammatory headlines designed to capture attention. Narratives include “the coming bloodbath for bond holders” and “the imminent bursting of the 30-year bond bubble.”
Our Chief Investment Officer, Dennis Tilley, recently wrote an article detailing three reasons why we’re not worried about rising interest rates. Here’s a quick summary:
1. The Experts and Consensus Are Often Wrong
History provides countless examples of when experts and/or a super-consensus have been wrong about the future of stock and bond movements. This is why we don’t use market predictions to manage client portfolios.
2. A Portfolio Duration of Four to Five Years Is Optimal
The sweet spot duration for Merriman investors holding bonds is in the maturity range of four to five years. This intermediate duration provides a nice compromise of offering overall portfolio stability, market crisis/deflation/recession protection, a long-term real return above inflation and – perhaps most importantly – the ability to quickly adapt to a rising-rate environment. With this duration, we believe our clients don’t have to worry about rising interest rates. The article provides more detail and charts illustrating this point.
3. Rising Rates Signal an Improving Economy
Finally, rising interest rates are likely to coincide with an economy that is improving, which is generally good for stocks. Yes, temporarily, bonds will lose value due to rising yields. However, we expect only single digit losses from our bond portfolio, not the “bloodbath” that some pundits seem to think will happen.
Seattle is still reeling with excitement from the Seahawks winning the Super Bowl! Over 700,000 Seattleites celebrated downtown to welcome the champs coming home. No matter where your team allegiance lies, it’s easy to spot the strengths of the Seahawks both on and off the field. These lessons can be applied to multiple areas of life, including your finances.
Here are 12 things everyone can learn from the Seahawks:
1) It’s never too late: Russell Wilson was a third round draft pick but that didn’t determine his performance. No matter when you start saving and investing, there is always opportunity ahead of you.
2) Diversification is key: Every player on a team has a specific job to do, just as every investment in your portfolio has a unique purpose. It’s hard to win with a team full of quarterbacks! Design your portfolio with broad diversification to cover all types of positions.
3) Defense wins championships: There is a saying that “offense wins games and defense wins championships.” Many times it’s the team’s offense that gets all the praise and glory, but without a strong defense to hold back the competition, all of the points scored are for nothing. It’s easy to get caught up in short term performance chasing of stocks, but make sure to manage downside risk with bonds so that your returns won’t disappear in a down market.
4) Find a coach: Every team needs a coach to lead them to victory. Having a financial advisor will keep you on track toward achieving your goals.
5) Don’t compare your strategy to others: Every team has a different approach on how to win games. Your friends and family have their own ideas about investment that may be different from yours, and that’s okay. Stick with the plan you make with your financial advisor – it is unique to you.
6) Break expectations: Seahawks fullback Derrek Coleman is deaf. No one expected him to be able to play in the NFL but he didn’t let other people’s beliefs hold him back. Commit to success and don’t let others get in the way of what you want to accomplish.
7) Take a look back: Teams spend countless hours watching game footage to learn from their mistakes. Look back at historical investments to learn all you can about performance volatility throughout various market conditions.
8) Go all in: The Seahawks have an “All In” sign that they hit on their way to a workout. Often we don’t want to commit to a plan unless we know for sure it will work out…but a plan can’t work unless you commit. Go all in.
9) Never give up: Even when it looks like a team has lost, there is always a chance for a comeback late in the game. Sometimes when a portfolio is down, we are tempted to switch strategies or abandon hope. If you give up too early, you might miss the winning finish.
10) Have fun: Football is tough work but it is also a lot of fun. Always make time for the activities you enjoy with the people you love. As we say here at Merriman – Invest Wisely, Live Fully.
11) Give back: In the midst of practice, games, media interviews, and sponsor appearances, Russell Wilson still makes time to visit the patients at Seattle Children’s Hospital. Appreciate the gifts you have in your life and share them with others.
12) Identify your 12s: Seattle’s fans are known as the 12th man. Even though the fans aren’t on the field, they play an important role in the game. Find fans who will support you through all your wins and losses, and recognize their contribution to your success.
When you hear the term “umbrella insurance,” your first thought might be, “What do umbrellas have to do with insurance? Is this just another product the insurance industry is trying to sell me?” Actually, umbrella insurance has nothing to do with conventional umbrellas.
Umbrella insurance is “extra insurance,” like an umbrella is extra protection against the rain, even though you have a raincoat on. Think of your regular car and homeowners insurance as the raincoat, and the umbrella insurance as the “umbrella” you carry for torrential downpours. (more…)
With the recent tornado in Oklahoma we are reminded of the importance of charitable giving. In fact, since the tornado, over $15 million has been donated to the American Red Cross. According to the Giving USA Foundation, individuals gave over $217 billion dollars to charitable causes in 2011, a 3.9% increase over 2010. As charitable giving increases, I want to make sure you know not only how to maximize your charitable contributions from a tax standpoint (see my post about using the donor advised fund), but also that you are informed about the effectiveness of the charities you choose.
There are a couple resources available now to help understand how effective a charity is with the money you donate. Charity Navigator has been around since 2001 and now assesses over 6,000 charities. Its goal is to provide one overall rating based on two areas of effectiveness: 1) their financial health and 2) their transparency and accountability. For example, the American Red Cross, a popular one at this moment, shows a total score at 59.64 out of 70 as of fiscal year end in June of 2011.
Another website, CharityWatch.org, also rates different charities’ effectiveness. While they rate only 600 or so of the largest charities, they tend to dig much deeper into the inner workings of the organization than Charity Navigator. They study the individual finances of every charity to give a clear picture on what the money is actually being used for. Instead of taking the information at given at face value, they try to determine if the donors’ objectives are actually being met. Because their analysis is more in-depth, Charity Watch charges $50/year for access to their Charity Rating Guide, which provides financial data and a rating from “A+” to “F” for each charity.
We all want to make sure the money we give generously is used effectively. Whether you’re giving funds to aid with large natural disasters or donating to your local food bank, donations are needed and greatly appreciated. Now, in addition to maximizing the tax effectiveness of your charitable donations through donor advised funds, these tools can help you choose organizations that will help your dollar have maximum impact.
I recently had the pleasure of sitting down with a client’s daughter. She’s in her twenties, just finished up her nursing degree six months ago and is working the night shift at a local hospital. She is living with a couple of roommates and is finally in a position to save some money after being a very broke college student. She now faces the question posed by many young people who are starting their first “real” jobs. (more…)
The return-centric environment in which we live too often gives little credence to an equally important measure – risk. Professionals and individual investors alike can often quote the return of a given stock or index, followed by silence when asked to recite its relative measure of risk. The financial crisis shouted to us the importance of understanding and controlling risk. If you did not hear the call – and hopefully you did before the fall – it’s not too late to answer it.
Two quantifiable means of controlling risk are diversification and asset allocation.
Proper diversification stretches well beyond your region and your country of residence. It has little to do with individual stock positions or individual sectors. It consists of all types of stocks – large, small, value, growth, etc., which are located all over the world. Global diversification is the goal.
Diversification is equally important for bond allocations. A bond portfolio consisting of high-yield bonds differs from one invested in U.S. treasury bonds. Obtaining an adequate amount of diversification on both sides of your portfolio is essential in controlling your risk.
Asset allocation speaks to the percentage of stocks and the percentage of bonds in your portfolio. While the specific mix has many variables, age and retirement goals are often large factors. Each investor’s situation is unique and there is no “one size fits all” solution. A good place to start is by answering the following questions:
At what age do I begin adding bonds? 40? 45?
How often do I add bonds and how much do I add?
What is an appropriate allocation once I am retired?
If you are struggling to answer these questions, it may be time to seek professional guidance. The answers are essential to your long-term investment success.
Investor discipline is a less tangible but equally important component of risk mitigation.
As stocks outpace bonds, a portfolio’s risk increases. At some point, there will be a need to sell the stocks to buy bonds and maintain the target allocation. In essence, this follows the golden rule of investing – that is to sell high and buy low. The same logic holds within each asset class of the portfolio, such as when international stocks outpace domestic stocks or small cap stocks outpace large cap stocks.
I can almost guarantee that when the time comes, rebalancing will not feel like the natural thing to do. Why, for example, would you want to buy into an underperforming asset class? Despite our rational brain, loading up on the winners will feel like the right thing to do at that moment. There are two questions you must ask yourself:
Do I have the discipline to rebalance my portfolio?
What mechanical process will I use to rebalance?
Your long-term investment success hinges on your answers to these questions. If you do not know how to answer them, seek guidance.
Investing is about risk and return. Understanding how much risk you can afford to take and how much risk you’re willing to take is the key. Quantitatively, two ways in which we control risk for clients is through diversification and asset allocation. Keeping clients disciplined in their goals and executing on a well thought out rebalancing process is another, less tangible means of controlling risk.
As Warren Buffet famously said, “It’s only when the tide goes out that you learn who’s been swimming naked.”