Bonds in 2022

Bonds in 2022

Resuming last week’s Investment Themes, today we consider Bonds in 2022. It is a challenging environment for bond investors. We are coming off record low yields and the yield on the 10-year Treasury is still only 1.5%. At the same time, yields are starting to move up. And since prices move inversely to yields, the US Aggregate Bond index ETF (AGG) is actually down 1.74% year to date. Even including the yield, you’ve lost money in bonds this year. With stocks having a great year in 2021, it is frustrating to see bonds dragging down the returns of a diversified portfolio.

Inflation Hurts Bonds

Inflation is picking up in the US and globally. Supply chain issues, strong demand for goods, and rising labor costs are increasing prices. The Federal Reserve this week said they would be removing the word “transitory” from their description of inflation. And now that it appears that Jay Powell will remain the Chair, it is believed that the Fed will focus on lowering inflation in 2022. They will reduce their bond buying program which has suppressed interest rates. And they are expected to gradually start increasing the Fed Funds rate in 2022.

It is difficult to make accurate predictions about interest rates, but the consensus is that rates will continue to rise in 2022. So, on the one hand, bonds have very little yield to offer. And on the other hand, you will lose money if interest rates continue to climb. Then, to add insult to injury, most bonds are not maintaining your purchasing power with inflation at 6%.

Bond Themes for 2022

There aren’t a lot of great options for bond investors today. But here are the bond investment themes we believe will benefit your portfolio for the year ahead. This is how we are positioning portfolios

  1. We will be increasing our allocation to Floating Rate bonds (“Bank Loans”). These are bonds with adjustable interest rates. As rates rise, the interest charged goes up. These are a good Satellite for rising rate environments.
  2. Within core bonds, we want to reduce duration to shorter term bonds. This can reduce interest rate risk.
  3. We continue to hold Preferred Stocks for their yield. While their prices will come under pressure if rates rise, they offer a continuous cash flow.
  4. Ladder 5-year fixed annuities. I have been beating this drum for years. Still, multi-year guaranteed annuities (MYGA) have higher yields than CDs, Treasuries, or A-rated corporate and municipal bonds. If you don’t need the liquidity, MYGAs offer a guaranteed yield and principal.
  5. I previously suggested I-Series Savings Bonds rather than TIPS. These are linked to inflation and presently are paying 7.12%. Purchases are limited to $10,000 a year per person, and unfortunately cannot be held in a brokerage account or an IRA. Read my recent article for more details. I personally bought $10,000 of I-Bonds this week.

Purpose of Bonds

Even with a negative environment for bonds, they still have a role in most portfolios. Unless you have the risk capacity to be 100% in stocks, bonds offer crucial diversification. When we have a portfolio with 60% stocks and 40% bonds, we have an opportunity to rebalance. When stocks are down, like in March of 2020, we can use bonds to buy more stocks while they are on sale. And of course, a portfolio with 40% in bonds has much less volatility than one which has 100% stocks.

Yields may eventually go back up to more normal levels. While it would be nice to have higher yields, the process of yields going up will be painful for bond investors. Our themes are trying to reduce this “interest rate risk”. We hope to reset to higher rates in the future, while reducing a potential loss in bond prices in 2022.

Inflation Investments

Inflation Investments

With the cost of living on the rise in 2021, many investors are asking about inflation investments. What is a good way to position your portfolio to grow and maintain its purchasing power? Where should we be positioned for 2022 if higher inflation is going to stick around?

Inflation was 5.4% for the 12 months ending in July. I share these concerns and we are going to discuss several inflation investments below. Before we do, I have to begin with a caveat. We should be cautious about placing a lot of weight in forecasts. Whether we look at predictions of stock market returns, interest rates, or inflation, these are often quite inaccurate. Market timing decisions based on these forecasts seldom add any value in hindsight.

What we do know for sure is that cash will lose its purchasing power. With interest rates near zero on most money market funds and bank accounts, it is a frustrating time to be a conservative investor. We like to consider the Real Yield – the yield minus inflation. It would be good if bonds were giving us a positive Real Yield. Today, however, the Real Yield on a 10-year Treasury bond is negative 4%. This may be the most unattractive Real Yield we have ever seen in US fixed income.

Let’s look at inflation’s impact on stocks and bonds and then discuss three alternatives: TIPs, Commodities, and Real Estate.

Inflation and Stocks

You may hear that inflation is bad for stocks. That is partially true. Rising inflation hurts companies’ profitability and consumers’ wallets. In the short-term, unexpected spikes in inflation seem correlated to below average performance in stocks.

However, when we look longer, stocks have done the better job of staying ahead of inflation than other assets. Over five or ten years, stocks have generally outpaced inflation by a wide margin. That’s true even in periods of higher inflation. There are always some down periods for stocks, but as an asset class, stocks typically have the best chance of beating inflation over a 20-30 year horizon as an investor or as a retiree.

We can’t discuss stocks and inflation without considering two important points.

First, if there is high inflation in the US, we expect that the Dollar will decline in value as a currency. If the Dollar weakens, this would be positive for foreign stocks or emerging market stocks. Because foreign stocks trade in other currencies, a falling dollar would boost their values for US investors. Our international holdings provide a hedge against a falling dollar.

Second, the Federal Reserve may act soon to slow inflation by raising interest rates. This would help slow the economy. However, if the Fed presses too hard on the brake pedal, they could crash the economy, the stock market, and send bond prices falling, too. In this scenario, cash at 0% could still outperform stocks and bonds for a year or longer! That’s why Wall Street has long said “Don’t fight the Fed.” The Fed’s mandate is to manage inflation and they are now having to figure out how to keep the economy growing. But not growing too much to cause inflation! This will prove more difficult as government spending and debt grows to walk this tightrope.

Inflation and Bonds

With Real Yields negative today, it may seem an unappealing time to own bonds, especially high quality bonds. Earning one percent while inflation is 5% is frustrating. The challenge is to maintain an appropriate risk tolerance across the whole portfolio.

If you have a 60/40 portfolio with 60% in stocks and 40% in bonds, should you sell your bonds? The stock market is at an all-time high right now and US growth stocks could be overvalued. So it is not a great buying opportunity to replace all your bonds with stocks today. Instead, consider your reason for owning bonds. We own bonds to offset the risk of stocks. This gives us an opportunity to have some stability and survive the next bear market. Bonds give us a chance to rebalance. So, I doubt that anyone who is 60/40 or 70/30 will want to go to 100% stocks in this environment today.

Still, I think we can add some value to fixed income holdings. Here are a couple of ways we have been addressing fixed income holdings for our clients:

  • Ladder 5-year Fixed Annuities. Today’s rate is 2.75%, which is below inflation, but more than double what we can find in Treasury bonds, Municipal bonds, or CDs.
  • Emerging Market Bonds. As a long-term investment, we see attractive relative yields and improving fundamentals.
  • Preferred Stocks, offering an attractive yield.


Treasury Inflation Protected Securities are US government bonds which adjust to the CPI. These should be the perfect inflation investment. TIPS were designed to offer a return of inflation plus some small amount. In the past, these may have offered CPI plus say one percent. Then if CPI is 5.4%, you would earn 6.4% for the year.

Unfortunately, in today’s low yield environment, TIPS sell at a negative yield. For example, the yield on the Vanguard short-term TIPS ETF (VTIP) is presently negative 2.24%. That means you will earn inflation minus 2.24%. Today, TIPS are guaranteed to not keep up with inflation! I suppose if you think inflation is staying higher than 5%, TIPS could still be attractive relative to owning regular short-term Treasury Bonds. But TIPS today will not actually keep up with inflation.

Instead of TIPS, individual investors should look at I-Bonds. I-Bonds are a cousin of the old-school EE US Savings Bonds. The I-series savings bonds, however, are inflation linked. I-bonds bought today will pay CPI plus 0%. Then your investment is guaranteed to keep up with inflation, unlike TIPS. A couple of things to know about I-bonds:

  • You can only buy I-bonds directly from the US Treasury. We cannot hold I-Bonds in a brokerage account. There is no secondary market for I-bonds, you can only redeem at a bank or electronically.
  • I-Bond purchases are limited to a maximum of $10,000 a year in electronic form and $5,000 a year as paper bonds, per person. You can buy I-bonds as a gift for minors, and the annual limits are based on the recipient, not the purchaser.
  • I-bonds pay interest for 30 years. You can redeem an I-bond after 12 months. If you sell between 1 and 5 years, you lose the last three months of interest.


Because inflation means that the cost of materials is rising, owning commodities as part of a portfolio may offer a hedge on inflation. Long-term, commodities have not performed as well as stocks, but they do have periods when they do well. While bonds are relatively stable and consistent, commodities can have a lot of volatility and risk. So, I don’t like commodities as a permanent holding in a portfolio.

The Bloomberg Commodities Index was up 22% this year through August 31. Having already had a strong performance, I don’t think that anyone buying commodities today is early to the party. That is a risk – even if we are correct about above average inflation, that does not mean we are guaranteed success by buying commodities.

Consider Gold. Gold is often thought of as a great inflation hedge and a store of value. Unfortunately, Gold has not performed well in 2021. Gold is down 4.7% year to date, even as inflation has spiked. It has underperformed broad commodities by 27%! It’s difficult to try to pick individual commodities with consistent accuracy. They are highly speculative. That’s why if you are going to invest in commodities, I would suggest a broad index fund rather than betting on a single commodity.

Real Estate

With home prices up 20% in many markets, Real Estate is certainly a popular inflation investment. And with mortgage rates at all-time lows, borrowers tend to do well when inflation ticks up. Home values grow and could even outstrip the interest rate on your mortgage, potentially. I’ve written at length about real estate and want to share a couple of my best pieces:

While I like real estate as an inflation hedge, I’d like to remind investors that the home price changes reported by the Case-Schiller Home Price Index do not reflect the return to investors. Read: Inflation and Real Estate.

Thinking about buying a rental property? Read: Should You Invest In Real Estate?

With cash at zero percent, should you pay off your mortgage? Read: Your Home Is Like A Bond

Looking at commercial Real Estate Investment Trusts, US REITs have had a strong year. The iShares US REIT ETF (IYR) is up 27% year to date, beating even the S&P 500 Index. I am concerned about the present valuations and low yields in the space. Additionally, retail, office, apartments, and senior living all face extreme challenges from the Pandemic. Many are seeing vacancies, bankrupt tenants, and people relocating away from urban development. Many businesses are rethinking their office needs as work-from-home seems here to stay. Even if we do see higher inflation moving forward, I’m not sure I want to chase REITs at these elevated levels.

Inflation Portfolio

Even with the possibility of higher inflation, I would caution investors against making radical changes to their portfolio. Stocks will continue to be the inflation investment that should offer the best chance at crushing inflation over the long-term. Include foreign stocks to add a hedge because US inflation suggests the Dollar will fall over time. Bonds are primarily to offset the risk of stocks and provide portfolio defense. We will make a few tweaks to try to reduce the impact of inflation on fixed income, but I would remind investors to avoid chasing high yield.

As satellite positions to core stock and bond holdings, we’ve looked at TIPS, Commodities, and Real Estate. Each has Pros and Cons as inflation investments. At this point, the simple fear of inflation has caused some of these investments to already have significant moves. We will continue to evaluate the inflation situation and analyze how we position our investment holdings. Our focus remains fixed on helping clients achieve their goals through prudent investment strategies and smart financial planning.

Preferred Stock Dividends

Preferred Stock Dividends

As part of our Core and Satellite portfolio models, our investors have received Preferred Stock Dividends for several years. Preferred Stocks are different from Common Stock as they are a hybrid security which combines the features of a stock and a bond. Like a stock, preferreds trade on an exchange and pay a quarterly dividend. Like a bond, preferreds are issued at a Par Value ($25) and can be called or redeemed by the issuer in the future for $25.

If you’d like a primer on Preferred Stocks, check out my previous article, Preferred Stocks Belong In Your Portfolio. Or check out Forbes, What is Preferred Stock?

The Role of Preferreds

The preferreds we own have yields from 4-6% or more. Today, with the yield on 10-year Treasury Bonds around 1.25%, preferred stock dividends offer a nice rate of return compared to bonds but without all of the volatility of common stocks. And with the current high valuations on US Stocks, Preferred Stocks offer us an alternative that complements our stock and bond holdings. It’s a nice way to diversify our holdings, but preferreds remain a small, niche investment that most people have never owned.

Presently, our Premiere Wealth Portfolios have between 7-11.5% in Preferred Stocks. In our Defensive Managers Select portfolio, we have a 20% position in Preferred Stocks. Those are significant weights for a satellite position, but it remains a small piece of our overall allocation.

We buy a basket of individual Preferred Stocks. For each client, we will own a minimum of 5 and as many as 15 individual Preferred Stocks. As of today, our largest holdings include Capital One, Wells Fargo, Regions Financial, JP Morgan, and Brookfield Finance. Most preferreds are issues by financial companies, although there are some issued by real estate and utilities, too.

I prefer to own individual preferreds to have better control over the portfolio and keep costs down. Generally, I like to buy Exchange Traded Funds. And there is an ETF for preferreds: PFF from iShares. Two problems. First, the ETF owns many preferreds trading at a very large premium to Par. That means you would be buying a preferred at $27 that could be redeemed at $25 within 5 years. We have to look at the Yield to Call to understand this. Second, the ETF has an expense ratio of almost half a percent (0.46%), and that would reduce investors’ return. In a sector where the expected return is only 4-5%, that expense ratio would be a big drag on returns.

Managing Preferreds

Within our baskets of preferreds, we’ve had quite a few trades this summer. Generally, for most of my clients, we own preferreds in IRAs, since they create taxable income. In an IRA, we can trade without any capital gains impact. With yields falling this year, there has been a high demand for Preferred Stock Dividends. And this has pushed up the price of many Preferred Stocks. This is not a good time to just blindly buy any Preferred Stocks – many are very expensive.

So, we have been rotating from preferreds with higher prices to those with lower prices. In some cases, a Preferred with a high dividend payment actually has a low Yield to Call. If you are paying $27 for a preferred that is callable for $25, you are paying an 8% premium. And that premium will decline to the call date, creating a loss of capital that will eat into your total return. I am finding opportunities to improve our preferred stock dividends with some careful trades.

Trading and Upgrading

There are a couple of scenarios where we have placed trades to replace one preferred with another.

  1. Price comparison. Here are two preferreds with the same coupon of 4.45% and similar credit ratings and call dates. The Schwab (series J) is trading at $26.57, while Regions Financial (series E) is at $25.60. This is an opportunity to sell an expensive share and use the proceeds to buy more shares of the lower priced preferred.
  2. Same company, different series. Capital One’s series L has a coupon of 4.375% and the series N is at 4.25%. Both have the same call date of September 2026. There is a one-eighth of a percent difference in coupon. So, when the L’s were trading for 2.5% more than the N’s, that is too big of a difference. We sold the L’s and bought the N’s. Then this week, the prices swapped and we were able to sell the N’s and buy back the higher yield L’s for less. Many companies have multiple series of preferred stocks. Sometimes one is more expensive and the other is less expensive, for no logical reason. We’ve also swapped between the Goldman Sachs series C and D, which both have a 4% coupon.
  3. New issues. We can buy IPOs of Preferred Stocks. We’ve bought a new JP Morgan preferred at $25 this summer and it is now up to $25.56. Other times, we have been able to buy preferreds for below $25 for a few days after the IPO, when the issue was undersubscribed. We’ve bought shares of Regions Financial and Texas Capital Bancshares at a discount this way. Over a few weeks, new issues usually move to where similar preferreds are priced.

Long-Term Outlook

I’ve been looking at all types of income securities for the last 17 years. Not just Preferred Stocks, but Closed End Funds, MLPs, REITs, and individual corporate and municipal bonds. It’s a lot of time to manage individual securities correctly, and it takes skill and knowledge that takes years to develop.

I like the idea of Preferred Stock Dividends to add income to our portfolio models. And that’s the purpose behind our Alternatives sleeve to the portfolio: to seek investments with a better return than bonds, and lower correlation and volatility compared to stocks.

For now it’s working as I had hoped. What might change this? If we see the Federal Reserve start to raise interest rates and see the long-end of the yield curve move up, this would be negative for preferreds. That’s why this is a Satellite holding and not a Core. There may well come a day that we liquidate the preferreds for another asset class with better prospects. Even though we are buy and hold, long-term investors, by no means is the approach a purely passive portfolio. Rather than looking in the rear view mirror, we construct portfolios looking forward at the challenges we see facing markets today.

Have a question about Preferred Stock Dividends? Curious about your Retirement Income? Let’s talk about our portfolios and how they might work for you. Click Contact on the top of this page to get in touch!

10 Year Expected Returns

10 Year Expected Returns

With the market rising so fast in the past year, investors are wondering if the 10 year expected returns are still attractive. Are we in a speculative bubble? Other investors see certain stocks soaring and are driving prices even higher. Will recent returns continue? While it’s natural to fret about the future of the stock market, we suggest investors resist the temptation to try to time the market.

It may be helpful, however, to evaluate current valuations and consider how to weight a diversified, buy and hold portfolio. Based on present levels and projected growth, the Vanguard Capital Markets Model calculates the 10 year expected returns for various asset classes. We use this information both in our portfolio construction as well as in our financial planning calculations.

Expected returns today are lower than historical returns. The stock market has risen much faster than corporate earnings. Now, companies need to catch up with their stock valuations. Dividend Yields are lower than historical, as well as economic growth and inflation. All of these are components of projected future Equity returns.

Vanguard recently updated their 10 year expected returns, based on market levels on December 31, 2020. You can compare these figures to six months ago, when I last wrote about Vanguard’s estimates.

Vanguard’s 10 Year Expected Returns

  • US Stocks: 3.0% to 5.0%
  • International Stocks: 6.1% to 8.1%
  • US Growth: -0.1% to 1.9%
  • Value: 4.4% to 6.4%
  • Large Cap: 2.9% to 4.9%
  • Small Cap: 3.2% to 5.2%
  • US REITs: 3.0% to 5.0%
  • US Aggregate Bonds: 0.8% to 1.8%
  • International Bonds: 0.6% to 1.6%
  • Emerging Markets Bonds: 1.5% to 2.5%

These estimates are 10 year annualized projections and are not guaranteed. There will undoubtedly be down years and this is not meant to suggest returns over the next year or in the short-term. Investing involves risk of loss of capital. Source: Vanguard Market Perspectives, March 2021.

Key Takeaways

  1. 10 year expected returns are lower than historical returns. I have cautioned in the past about using historical returns in financial planning projections. We use projected returns. Based on the midpoint of Vanguard’s figures, a 60/40 portfolio with 30% US Stocks, 30% International Stocks, and 40% US Aggregate Bonds has a projected return of 3.85% a year. This may cause some investors to rethink their allocations.
  2. US Growth Stocks are overvalued. US Value is more attractive for a long-term investor today. Be careful of chasing 2020’s hot stocks! We have already built a sizeable position in Value stocks in our models.
  3. International Stocks are more attractive than US Stocks. Be diversified and don’t invest in just US companies. Presently, International Stocks make up 43% of the World Index. If you don’t have at least 43% of your equities in International, you have a Home Bias. This may have worked well in the past decade, but appears less likely to be the case for the next 10 years.
  4. US Small Cap may offer a diversification benefit to Large Cap. REITs on the other hand, have the same return profile as US Stocks, but are riskier (higher volatility). So, we are avoiding REITs in our models.
  5. Bonds and Cash serve primarily as portfolio defense today. They offer little return potential. Vanguard projects inflation will be 1.1% to 2.1% over the next 10 years. Bond and cash returns may be less than inflation, which means you are losing purchasing power. Still, fixed income offers some benefits to rebalance when things are volatile. On their own, bonds are not making much of a positive contribution to portfolio returns.
  6. Preferred Stocks, Convertible Bonds, and Emerging Markets Bonds offer an attractive return potential compared to expected returns on core categories like US Stocks or US Aggregate Bonds. We have expanded our Alternative holdings in 2020 and again in 2021. Read more: Investment Themes for 2021.

Stay Diversified, Don’t Speculate

While we do tilt portfolios towards areas of relative value, it is important to remain diversified. Don’t put all your eggs in the one basket with the highest expected return. There’s no guarantee that Vanguard’s projected returns will become reality. Regardless of short-term market movements, our investment strength comes from keeping costs low, using Index strategies, staying diversified, and tax-efficiency.

The stock volatility over the past 12 months has been remarkable. But, it’s not unprecedented, though. I remember the Tech Bubble in 1999 and the rebound 12 years ago, from March of 2009. Both of those created rampant speculation, which we see today in certain growth stocks, cryptocurrency, and in the options market. Have we not learned the painful lessons of previous day-traders and those who gambled on stocks? Recently, individual investors have been asking me about trading options, Penny Stocks, and day trading stocks with the money they have set aside for a house down payment in one year.

Even as Vanguard is lowering its 10 year expected returns, people are getting greedy, with the fear of missing out on their chance to get rich. They know someone who got lucky over the past year and made a great trade. The lesson from the past is that everyone is a genius in a Bull Market. You could do no wrong in the past year, as long as you did something. Things won’t always be that easy, and that’s why you need a plan. Please make your investment choices about the next 10 years, and not the next 10 hours or 10 days.

Investment Themes for 2021

Investment Themes for 2021

Today we are going to discuss our top Investment Themes for 2021. I’ve stated that predictions are generally worthless, and 2020 certainly proved this point. 12 months ago, no one anticipated the massive impact of the Coronavirus. And the lightning speed of the stock market recovery remains shocking.

From its highs in February, US Stocks fell 35% to March 23. The recovery saw a 65% rally, with the S&P 500 Index ending the year up 17.6%. It was a mind-boggling year for investors, but I think we can count our blessings. This was the fastest Bear Market and recovery in history. Compared to the previous two Crashes, investors felt compelled to stay the course this year. And this proved wise.

(Here’s what I wrote to investors on March 21: Stock Crash Pattern.)

So, where do we go from here? Will 2021 unwind all the gains of 2020? My philosophy remains that we do not need to predict market movements or time the market to be successful. As a long-term investor, my approach to tactical investing is based on over-rebalancing. Think of rebalancing – trimming categories which rose (and became expensive) and adding to what became cheap. We overweight the assets which are cheaper.

We remain fully invested in our target allocation, but the weighting of funds can change from year to year. In some years, we own assets which lag other categories. That’s okay. That’s part of being a diversified investor. We want to avoid chasing performance.

Trades for 2021

  1. US large cap growth has become very expensive. For 2021, we are shifting some of our large cap growth to a mid cap growth fund. The valuations there are not as elevated.
  2. US small cap appears to have turned. Q4 of 2020 was the best quarter for small cap in 30 years. We added to small cap in our Growth and Aggressive models.
  3. Emerging Markets have a high expected long-term return. We remain overweight in EM.
  4. Value stocks lagged growth names again in 2020. (Growth stocks performance was highly concentrated in a small number of tech stocks such as Facebook, Amazon, Alphabet, and Tesla.) We are committed to our Value Funds and believe that they are compelling today.
  5. Bond yields fell in 2020 to all-time lows. The US Aggregate Bond Index had a return of 7.4%, but most of that was from prices increasing. Less than 2% came from yield. So, we finished 2020 with terrible yields – less than 1% on a 10-year Treasury bond.
  6. Yields were up in the first week of 2021, and bond investors are seeing falling prices. We are positioned towards the short-end of the yield curve and want to avoid chasing high yield today.
  7. Fixed Annuities remain a good substitute for CDs and Bonds for investors who don’t need liquidity. We can get a 5-year annuity at 3.0%.
  8. There are relative values within municipal bonds and Emerging Markets debt. Other than that, we expect very low returns from bonds. Own them for diversification. They provide ballast if your stocks are down and give you the ability to rebalance.
  9. We trimmed some short-term bonds and added to Preferred Stocks. Although many are priced at par today, we can get yields of 4-6%. This is an attractive middle ground between the volatility of stocks and the 0-1% yields of bonds.
  10. Both stocks and bonds are at all-time highs right now, and that makes alternatives compelling. In ad