Stocks and bonds are the basic building blocks of our portfolio. Think of stocks as the offense and bonds as the defense. Bonds are basically loans to a government entity or company that are paid back over time. Depending on how creditworthy the borrower is and how long the borrower will take to repay the loan, bonds can be relatively safe investments, or carry more risk. The two big factors that help investors classify bonds are referred to as quality and maturity. (more…)
What’s the best asset mix for you? You already know that your two major options are stocks and bonds. The choice between them represents a basic tradeoff: growth vs. stability. Investing in stocks is more likely to produce higher returns than investing in bonds, but with more volatility. (more…)
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.
Please share your view of convertible bonds as an asset class for folks entering retirement.
Convertible bonds are a unique asset class in that they have features of both stocks and bonds. They are often referred to as “hybrid” securities. This, along with their typically sub-par credit rating, is why they do not fit into our bond portfolio.
We prefer to keep the stock and bond components of our portfolios separate. Our bond portfolio is designed to buoy the allocation in times of stock market stress. The potential for convertible bonds to act like stocks does not jive with this logic. If convertibles – due to their hybrid nature – were showing stock-like tendencies when stocks were declining, your portfolio would have much less downside protection. As we have seen in the recent past, it is extremely important that investors maintain some level of protection in their portfolio. We do not believe convertible bonds are the solution. (more…)
At 61 years old, what is the best way to transition from an all stock portfolio to a 60% stock 40% bond portfolio?
This is a difficult question to answer without knowing your specific set of circumstances. To narrow the scope I will assume the following: 1) you will retire at 65, 2) you will take a 4% annual distribution from the portfolio upon retirement, and 3) you are using a globally-diversified portfolio like the one we outline in The Ultimate Buy-and-Hold Strategy.
Regarding the third assumption, it is extremely important to understand that different portfolios have different risk characteristics. A 60% stock 40% bond (60/40) portfolio allocated to the S&P 500 and high-yield junk bonds is entirely different and much riskier than the one discussed in the aforementioned article.
That said, I would make the switch immediately. With four years until retirement you cannot afford to subject the entirety of your portfolio to the risks associated with stocks.
For perspective, consider that the financial crisis cut the average stock portfolio value in half. Taking distributions from an all-stock portfolio during such a time period has disastrous consequences on the longevity of your assets. This is why, as investors near retirement (the distribution phase of a portfolio), they should – as you’ve indicated – consider adding a preservation component (bonds) to their portfolio.
If the goal is to achieve a 60/40 allocation by retirement, many people will initiate the transition process around the time they reach age 50. This longer time frame for transition allows the use of ordinary cash flows and rebalancing opportunities to make it a cost-effective and natural process. Your situation calls for a less subtle shift. Nonetheless, it is a shift in the right direction and, as mentioned above, I would proceed.