Long Bonds Beating Stocks in 2019

Posted On September 2, 2019 By Scott Stratton, CFP(R), CFA In Portfolio Management /

Through August 31, the S&P 500 Index is up 18.34%, including dividends. Would it surprise you to learn that bonds did even better? The Morningstar US Long Government Bond Index was up 18.40% in the same period. Even with this remarkable stock market performance, you would have done slightly better by buying a 30-year Treasury Bond in January!

How do bonds yielding under 3% give an 18% gain in eight months? Bond prices move inversely to yields, so as yields fall, prices rise. The longer the duration of the bond, the greater impact a change of interest rates has on its price. This year’s unexpected decrease in rates has sent the prices of long bonds soaring. While bonds have made a nice contribution to portfolios this year because of their price increases, today’s yields are not very attractive. And longer dated bonds – those which enjoyed the biggest price increases in 2019 – could eventually suffer equivalent losses if interest rates were to swing the other direction. We find bonds going up 18% to be scary and not something to try to chase.

Today’s low interest rates are a conundrum for investors. The yields on Treasury bonds, from the shortest T-Bills to 10-year bonds are all below 2%. CDs, Municipal bonds, and investment grade corporate bonds have all seen their yields plummet this year. In some countries, there are bonds with zero or even negative yields.

What can investors do? I am going to give you three considerations before you make any changes and then three ideas for investors who want to aim for higher returns.

1. Don’t bet on interest rates. Don’t try to guess which direction interest rates are going to go next. We prefer short (0-2 year) and intermediate (3-7 year) bonds to minimize the impact that interest rates will have on the price of bonds. With a flat or inverted yield curve today, you are not getting paid any additional yield to take on this interest rate risk. Instead, we take a laddered approach. If you own long bonds which have shot up this year, consider taking some of your profits off the table.

2. Bonds are for safety. The reason why we have a 60/40 portfolio is because a portfolio of 100% stocks would be too risky and volatile for many investors. Bonds provide a way to offset the risk of stocks and provide a smoother trajectory for the portfolio. If this is why you own bonds, then a decrease in yield from 3% to 2% isn’t important. The bonds are there to protect that portion of your money from the next time stocks go down 20 or 30 percent.

3. Real Yields. Many of my clients remember CDs yielding 10 percent or more. But if inflation is running 8%, your purchasing power is actually only growing at 2%. Similarly, if inflation is zero and you are getting a 2% yield, you have the same 2% real rate of return. While yields today are low on any measure, when we consider the impact of inflation, historical yields are a lot less volatile than they may appear.

Still want to aim for higher returns? We can help. Here are three ideas, depending on how aggressive you want to go.

1. Fixed Annuities. We have 5-year fixed annuities with yields over 3.5%. These are guaranteed for principal and interest. We suggest building a 5-year ladder. These will give you a higher return than Treasuries or CDs, although with a trade-off of limited or no liquidity. If you don’t need 100% of your bonds to be liquid, these can make a lot of sense. Some investors think annuity is a dirty word, and it’s not a magic bullet. But more investors should be using this tool; it is a very effective way to invest in fixed income today.
Read more: 5-year Annuity Ladder

2. High Yield is getting attractive. Back in 2017, we sold our position in high yield bonds as rising prices created very narrow spreads over investment grade bonds. Those spreads have widened this year and yields are over 5%. That’s not high by historical standards, but is attractive for today. Don’t trade all your high quality bonds for junk, but adding a small percentage of a diversified high-yield fund to a portfolio can increase yields with a relatively small increase in portfolio volatility.

3. Dividend stocks on sale. While the overall stock market is only down a couple of percent from its all time high in July, I am seeing some US and international blue chip stocks which are down 20 percent or more from their 2018 highs. Some of these companies are selling for a genuinely low price, when we consider profitability, book value, and future earnings potential. And many yield 3-5%, which is double the 1.5% you get on the US 10-year Treasury bond, as of Friday.

While we don’t have a crystal ball on what the stock market will do next, if I had to choose between owning a 10-year bond to maturity or a basket of companies with a long record of paying dividends, I’d pick the stocks. For investors who want a higher yield and can accept the additional volatility, they may want to shift some money from bonds into quality, dividend stocks. For example, a 60/40 portfolio could be moved to a 70/30 target, using 10% of the bonds to buy value stocks today.

When central banks cut rates, they want to make bonds unattractive so that investors will buy riskier assets and support those prices. When rates are really low, and being cut, don’t fight the Fed.

Long bonds have had a great performance in 2019 and I know the market is looking for an additional rate cut. But don’t buy long bonds looking for capital appreciation. Trying to bet on the direction of interest rates is an attempt at market timing and investors ability to profit from timing bonds is no better than stocks. If you are concerned how today’s low yields are going to negatively impact your portfolio going forward, then let’s talk through your options and see which might make the most sense for your goals.

Source of data: Morningstar.com on September 2, 2019.

A Bond Primer

Posted On January 13, 2019 By Scott Stratton, CFP(R), CFA In Portfolio Management /

We have been adding individual bonds and CDs across many accounts since December, as we looked to reduce our equity exposure and take advantage of higher yields now available in short-term, investment grade fixed income. When you are an owner of individual bonds, you are likely to encounter some terminology that may be new, even if you’ve been investing in bond funds for many years. Here are some important things to know:

Bonds are generally priced in $1,000 increments. One bond will mature at $1,000. However, instead of quoting bond prices in actual dollars, we basically use percentages. A bond priced at 100 (note, no dollar sign or percentage symbol is used) would cost $1,000. 100 is called its Par value. If you are buying newly issued bonds, they are generally issued at Par (100). This is called the Primary Market – where issuers directly sell their bonds to the public. We also buy bonds in the Secondary Market, which is where bond desks trade existing bonds between each other.

In the Secondary Market, bond prices are set by market participants. A bond priced at 98.50 would cost $985, and would be said to be at a discount to Par. A bond priced at 102 would cost $1,020, called a premium. As interest rates rise, the value of existing (lower yielding bonds) will fall. There is an inverse relationship between price and interest rates – when one rises, the other falls.

Bonds have a set Maturity date. That is when the issuer will return the $1,000 they borrowed from the bondholder and cancel the debt. Some bonds are also Callable, which means that the issuer has the right to buy the bond back before its maturity date. This benefits the company, but not the bondholder, because when interest rates are low, companies can refinance their debt to a lower rate.

Most bonds pay interest semi-annually (twice a year). We call this the Coupon. A bond with a 4% coupon would pay $20 in interest, twice a year. If the bond is priced exactly at Par, then the coupon is the same as the effective yield. However, if the bond is priced differently, we are more interested in its Yield to Maturity, commonly listed as YTM. This is very helpful for comparing bonds with different coupons.

Most bonds pay a fixed coupon, although some pay a step coupon, which rises over time, and others are floating, tied to an interest rate index, or inflation. When we purchase a bond between interest payments, the buyer will receive all of the next payment, so the buyer will also pay the seller Accrued Interest, which is the interest they have earned calculated to the day of sale.

For bonds which are callable, we also have the Yield to Call (YTC), which measures what your yield would be if the bond is called early. Generally, if we are buying a bond at a discount, Yield to Call is attractive. If we buy at 96 and they redeem at 100, that’s a good thing. But if we buy a bond at a premium, we need to carefully examine if or when it might be callable. Yield to Worst (YTW) will show the worst possible return, whether that is to maturity or to a specific call date.

Some bonds do not pay a coupon and are called Zero Coupon Bonds. Instead, they are issued at a discount and grow to 100 at maturity. Treasury Bills are the most common type of zero coupon bonds. US Government Bonds include Treasury Bills (under one year), Treasury Notes (1 to 10 years), and Treasury Bonds (10 to 30 years). There also are Treasury Inflation Protected Securities (TIPS), which are tied to the Consumer Price Index, and Agency Bonds, which are issued by government sponsored entities, such as Fannie Mae or Freddie Mac.

In addition to Government Bonds, we also buy Corporate Bonds – those issued by public and private companies, Municipal Bonds issued by state and local governments, including school districts, and Certificates of Deposit (CDs) from Banks.

Most Municipal Bonds are tax exempt, at the Federal and possibly at the state level. If you live in New York, any Municipal Bond would be tax-free at the Federal Level, but only NY bonds would be tax-free for NY state income tax. In states with no income tax, such as Texas, a tax-exempt bond from any state will be tax-free for Federal Income Tax purposes.

To make their bonds more attractive, some municipal bonds are Insured, which means that if they were to default, a private insurance company would make investors whole. Those municipal insurers got in trouble in the previous financial crisis, and some are still weak today. My preferred insurer is Assured Guaranty (AGMC).

Please note that some Municipal Bonds are taxable; we sometimes buy these for retirement accounts. In addition to the types of bonds we’ve discussed, there are thousands of bonds issued outside of the US, in other currencies, but we do not purchase those bonds directly.

There are several agencies that provide credit ratings to assess the financial strength of the issuer. Standard and Poor’s highest rating is AAA, followed by AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-. These are considered all Investment Grade. Below this level, from BB+ to C are below Investment Grade, often called High Yield or Junk Bonds. D means a bond has Defaulted. Moody’s ratings scale is slightly different: Aaa is the highest, followed by Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, and Baa3 for Investment Grade. Junk Bonds include Ba(1,2,3), B(1,2,3), Caa(1,2,3), Ca, and C.

There are about 5,000 stocks issued in the US, but there are probably over a million individual bonds issued, each one identified by a unique CUSIP number. Every week, there are bonds which mature and new ones which are issued.

Our approach for individual bonds is to buy only investment grade bonds, and ladder them from one to five years with diversified issuers. We also sometimes invest in other types of bonds, such as floating rate bonds, mortgage backed securities, emerging markets debt, or high yield. For those categories, we will use a fund or ETF because it’s more important to diversify very broadly with lower credit quality.

Bonds for Safety in 2019

Posted On January 3, 2019 By Scott Stratton, CFP(R), CFA In Portfolio Management / 1 Comment

2018 saw rising interest rates, which hurt the prices of bonds. Most bond funds were flat to slightly down for the year. Rising interest rates also means higher yields, and we now see sufficient yields to justify buying short-term bonds. We have been reducing our equity exposure over the last few weeks, and have been using those proceeds to buy individual investment grade short-term bonds and Exchange Traded Funds (ETFs).

I wanted to share a couple of themes which will guide our investment process for fixed income in the year ahead. In general, this is not a great time to be taking a lot of risk with your bond allocation. We want to use bonds to offset the risk of stocks to dampen overall portfolio volatility. Thankfully, bonds can now also make a positive contribution to your return albeit in a very modest 2-4% range, and with low or very low risk.

1. Credit doesn’t pay. A credit spread measures the difference in yield between a high quality bond, such as a US Treasury bond, versus say a bond issued by a company which has lower credit. That spread remains very tight today, meaning that you are not getting much additional yield for accepting the credit risk of a lower quality issuer.

This has led us to be selective about which corporate bonds we buy, only buying issues which have enough spread to justify their purchase. In today’s market, this primarily leads us to financial companies, especially the large banks, and to municipal bonds, including the rarely-discussed taxable municipal bonds which are a good choice for IRAs or other non-taxable accounts.

Both Treasury and US Government Agency bonds still have lower yields than CDs. This month, we bought some one-year CDs at 2.70% to 2.75% while the one-year Treasury was around 2.50%. That spread widens as we look to two and three year maturities.

I should explain that we offer “Brokerage CDs”, which are a little different than your typical bank CDs. Brokerage CDs are FDIC-insured against loss and we can shop for the best rates available, from both top banks like Wells Fargo or JP Morgan Chase and from smaller local banks who want to compete for the best yield.

While you can typically redeem a bank CD early, albeit with an interest penalty of a few months, with a Brokerage CD, you would have to sell the CD in the bond market. If interest rates continue to rise, you would likely have to sell at less than full value. While these CDs offer the excellent rates, they are best used when you can hold to maturity.

We use CD rates as the basis of our spread comparison, rather than the traditional Treasury bonds. If we can’t find an improvement of at least 0.35% to 0.50% for an A-rated bond, then it’s not worth taking even the small risk over the CD. We will still use Treasury Bills for maturities of 6 months or less.

2. 5-year Ladder. In larger accounts, our goal is to create a ladder of bonds and CDs that mature over the following five years (2019, 2020, 2021, 2022, and 2023). This gives us a nice diversification of maturities while still maintaining a low overall duration. When the 2019 bonds mature, we purchase 2024 bonds to maintain a 5-year structure. In a rising rate environment, we are likely to be able buy new bonds at a higher rate.

Besides being a sensible way to build a bond portfolio, a ladder also can be used to meet future needs for withdrawals or Required Minimum Distributions. Then instead of needing to sell equities or bond funds which could be down, we have a bond that is maturing to meet those cash needs. As a result, an investor might not need to touch their equities for the next five years. If or when their equities do grow, we can rebalance by selling stocks and buying new bonds at the top of the ladder.

While bond prices may go down if interest rates continue to rise in 2019, when you have an individual bond or CD, you know that it will mature at its full face value. So even if prices fluctuate, you will realize your stated Yield to Maturity when you do hold to maturity, which should be very possible with a 5-year ladder.

(Two notes: 1. While we can say that CDs and Treasury Bonds are guaranteed, other types of bonds do have some risk of default and cannot be described as guaranteed. 2. Investors who try to predict interest rates have as little success as investors who try to predict stock markets. We do not want to make bets on the direction of interest rates.)

3. Fixed Annuities. Annuities get a bad rap, but a Fixed Annuity is a third type of guaranteed fixed income investment. They deserve a closer look by investors as a bond substitute and work well with a 5-year laddered approach.

The current rate for a 5-year fixed annuity is 3.80% from one carrier I use. That compares to a 5-year CD at 3.35% to 3.60%. That’s not much of an improvement, however, the Fixed Annuity is an insurance product outside of our managed portfolio, so there are no investment management fees. Your net return is 3.80%. The insurance company will pay me a small commission directly, which does not impact your principal or your rate of return.

I think laddering fixed annuities can make sense for some, as a bond replacement, and more investors should learn about this before dismissing it as soon as they hear the word annuity. A 3.80% percent return on an annuity would be the equivalent of a 4.80% bond if you include a 1% annual management fee.

We wrote about doing a 5-year ladder of Fixed Annuities back in February 2016 in this blog, and I think it still makes sense for some investors. We would count this as part of your fixed income target for your overall portfolio allocation (60/40, etc.).

The stock market gets a lot of attention, but we don’t neglect fixed income in our portfolios. I do think there are benefits to managing your bond portfolio, and we spend as much time sweating the details of our fixed income selections as we do our stock market exposures.

Bye Bye High Yield Bonds

Posted On August 13, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management / 1 Comment

We’re making a trade in our portfolio models this week and will be selling our high yield bond fund (SPDR Short-Term High Yield ETF, ticker SJNK). The last 18 months have been excellent for high yield bonds; so excellent, in fact, that at this point the now lower yields don’t justify the risks. For those who might be interested in our process behind this decision, please read on.

High Yield, or “Junk”, Bonds are highly cyclical and go through wide swings up and down. They have much higher volatility than other types of bonds, and in spite of their higher yields, have the potential for negative returns to a greater degree than most other types of bonds. Additionally, they have a fairly strong correlation to equities, meaning that when stock markets plunge, high yield bonds – which are issued by lower quality companies – are also likely to drop in value. In times of recession, several percent of high yield issuers will default on their bonds and go bankrupt each year.

How can we determine if high yield bonds are a good value? One of then most common ways is through Credit Spreads. A Credit Spread is the additional amount of yield a high yield bond will provide over a safe bond like a US Treasury.

As recently as January 2016, high yield bonds were paying 6-7 percent over Treasuries. Today, that spread has shrunk into the 3% range, a level which is closer to the lows of the past 20 years. You can see a chart of US Credit Spreads on the website of the Federal Reserve Bank of St. Louis.

Investors today are not being sufficiently compensated for taking the extra risk of high yield bonds, and given the headwinds of higher interest rates and a late-inning stock market, we believe it is time to remove the high yield position from our portfolio. They’ve done their job. While no one can predict if or when these bonds will have their next downturn, we’d rather make the change now.

This is a small trade in most portfolios; our 60/40 model, for example, has only a 4% position in high yield. The proceeds will be reinvested into other bond funds which have lower volatility and also a short duration.

In the future, if yield spreads widen, we might buy back into high yield bonds. When pessimism is at its highest, low prices on high yield bonds can be a great value for patient investors. And that’s the time to be a buyer, not today. Credit spreads are a unique consideration for high yield bonds, but know that we look at each category within our portfolio models closely and will not hesitate to make adjustments after cautious and deliberate study.

If you have any questions about high yield bonds, fixed income, or any other aspect of portfolio construction, please give me a call!

TIPS: Not Attractive Yet

Posted On April 10, 2017 By Scott Stratton, CFP(R), CFA In Portfolio Management /

I love TIPS, but I’m going to tell you why you should not own them today. Treasury Inflation Protected Securities (TIPS) are government bonds, backed by the US Treasury. They pay two ways: a fixed interest rate (coupon) paid every six months, and an adjustment to your principal based on the Consumer Price Index (CPI-U). The dollar amount of interest increases when CPI goes up.

TIPS are considered by many to be a nearly “ideal” investment. Most traditional bonds have a set face value of $1,000, which creates inflation risk. The $1,000 you will get back 10 years from now will not have the same purchasing power as $1,000 does today. This inflation risk is nullified by TIPS. And it doesn’t even matter what inflation is: whether it is 1% or 10%, your purchasing power will be preserved by TIPS. It’s a remarkable benefit which makes TIPS “safer” at preserving wealth than a CD or savings account, while carrying none of the market risk of stocks.

At my previous firm, we had tens of millions of dollars invested in TIPS as a core fixed income holding. At my urging, we sold almost all of these bonds between 2012 and 2013. Why? As interest rates fell, the prices of TIPS skyrocketed. Yields on TIPS became negative; investors were willing to pay so much for these bonds that they were guaranteed to not keep up with inflation. Our clients had made a handsome profit in TIPS, but would have made less than inflation if we continued to hold. So we sold the TIPS and moved into other types of bonds.

The yield on TIPS are determined by auction, and the Treasury presently issues 5-year, 10-year, and 30-year TIPS. Institutional investors compare TIPS yield to fixed rate Treasury Bonds. For example, the most recent 10-Year TIPS auction on March 31, 2017 produced a yield of 0.466% (plus inflation). Compared this to the current yield on a fixed 10-Year note of about 2.3% and you get an inflation expectation of 1.8% over the next 10 years.

For big banks, this creates arbitrage opportunities if they think that the market inflation expectations are wrong. This arbitrage mechanism means that the rate on TIPS will likely be tied closely to regular Treasury Interest Rates.

For investors, if you think that we were going to have extreme inflation over the next 10 years, you would prefer to invest in the TIPS rather than the 2.3% fixed rate 10-Year note. But that is speculation, and I am not interested in speculating on inflation rates, thinking that we know more than all of Wall Street.

However, the forces which drove down interest rates and gave us a reason to sell our TIPS at high prices appear to be reversing. The Federal Reserve has started to raise interest rates, which may mean that last summer’s 1.6% 10-Year yield was the top of a 30-year bond Bull Market. As interest rates rise, the price of existing bonds will drop. And that will be painful for holders of 10 year and especially 30 year bonds, including TIPS.

Back when you could buy TIPS and earn 2%, 3% or more above inflation, that was a compelling return for a very low risk bond. Today, the yields on TIPS are less than 0.5% on the 5 and 10 year TIPS and below 1% on the 30 year TIPS. In 2 of the 3 auctions in 2016, the yields on the 5-year TIPS were negative. These rates are simply too low to include in our portfolios. Add in the risk of rising interest rates (= falling bond prices), and the appeal of 10 and 30 year TIPS are gone for me.

There is an alternative to TIPS which do not carry the risk of rising rates: I-Series Savings Bonds. Like TIPS, I-Bonds are linked to CPI-U and also carry a fixed rate of return. You purchase and redeem I-Bonds through TreasuryDirect.gov. They are issued as 30-year bonds, but you can redeem them anytime after 1 year (3 months interest penalty if redeemed in the first 5 years). Since you can redeem them directly with the government, you don’t have to worry about market losses caused by rising interest rates. If there are better alternatives in 5 years, you could simply cash out your I-Bonds and take your money elsewhere.

I-Bonds would be a logical alternative to TIPS, except for two big problems: 1) The current fixed rate is zero. Since 2010, it has been zero for most of the time, briefly reaching only 0.10% or 0.20%. 2) Each taxpayer is limited to buying $10,000 of I-Bonds a year and you cannot own them in an IRA or brokerage account. Still, if the fixed rate on I-Bonds were the same as TIPS, I would buy those first, before buying any TIPS.

There may come a time when it will be attractive to buy I-Bonds or TIPS. For now, interest rates are too low and inflation is not an immediate risk. Still, there are many appealing benefits to these bonds. While preserving purchasing power is the primary difference to other bonds, from a portfolio construction standpoint, there are other benefits, including extremely low default risk, relatively low volatility, and much lower correlation to equities than corporate bonds.

Today, I think we can get a higher return by taking on some credit risk versus government bonds, whose interest rates have been held down by central banks. It has been nearly 10 years now since the peak of the mortgage/financial crisis, but we are just now starting to emerge from a global Zero Interest Rate Policy. That unwinding will take many years and will have a big impact on fixed income for years to come.

Can You Be Too Conservative?

Posted On February 13, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

As you approach retirement, you are probably thinking quite a bit about making your investment portfolio more conservative. We generally recommend that investors start dialing back their risk five years before retirement.

However, it is possible to be too conservative. Retirement is not an single date, but a long period of sustained withdrawals. We typically think in terms of a 30-year time horizon, which is not unrealistic for a 60 to 65-year old couple, given increasing longevity today.

The old rule of thumb was to subtract your age from 100 to determine your allocation to stocks. For example, a 65-year old would have 35% in stocks and 65% in bonds. Unfortunately, this old rule of thumb doesn’t work for today’s longer life expectancies.

Researchers analyzing the “4% rule” used for retirement income planning, typically find that optimal allocation for surviving a 30-year distribution period has been roughly 50 to 60 percent stocks. For most new retirees, we generally suggest dialing back only to 50/50 or 60/40 in recognition that the portfolio still needs to grow.

We still need growth in a retirement portfolio to help you preserve purchasing power as inflation erodes the value of your money. At 3% inflation, your cost of living will double every 24 years. So if you are retiring today and thinking that you just need $40,000 a year, you should be expecting that need to increase to $80,000 or more, to maintain your standard of living.

Another reason retirees should not be overly conservative: interest rates are very low today. Bonds had a much better return over the past 30 years than they will over the next 30 years. That’s not even a prediction, it’s just a fact. When we use projected returns rather than historical returns in our Monte Carlo simulations, it suggests that bond-heavy allocations are not as likely to succeed as they were for previous retirees. See: What Do Low Interest Rates Mean For Your Retirement?

The other side of today’s low interest rates is that some investors are reaching for yield and investing in much lower-quality junk bonds. While retirees often focus heavily on income producing investments, financial planners and academic researchers prefer a “total return” approach, looking at both income and capital gains.

We don’t want to take high risks with the bond portion of our portfolios, because we want bonds to provide stability in the years when the stock market is down. High Yield bonds have a high correlation to equities and can have significant drops at exactly the same time as equities.

We manage to a specific, target asset allocation and rebalance annually to stay at that level of risk. That gets our focus away from stock picking and looking at the primary source of risk: your overall asset allocation of stocks, bonds, and other investments. While no one can predict the future, a disciplined approach can help avoid mistakes that will compound your losses when market volatility does occur.

Bonds at a Discount: CEFs on Sale

Posted On November 21, 2016 By Scott Stratton, CFP(R), CFA In Portfolio Management /

Since the election, bond yields have risen and prices have fallen in anticipation of increased government spending and an uptick in inflation. The yield on the 10-year Treasury was 2.33% on Friday, almost a full percent higher than the all-time low, set only a few months ago in July. When bond prices fall, many investors will sell their funds at the end of the year to harvest losses and redeploy their capital into other bond funds.

The annual tax-loss harvesting creates a unique opportunity for investors to look at Closed End Funds. Closed End Funds (CEFs) are an alternative to bond mutual funds. They are similar to mutual funds in that they are diversified, professionally managed baskets of stocks or bonds. In a regular mutual fund, you buy and sell shares directly from the fund company, whereas with a CEF, you buy or sell shares on a stock exchange with other buyers or sellers. There are a fixed number of shares, so a CEF manager can focus on managing their portfolio without the impact of money flowing in or out of the fund.

This works very well for bond strategies, and indeed many CEFs have an income focus and pay dividends monthly or quarterly. Today, there are many CEFs that pay 4-6% tax-free, or 5-10% taxable. They range from high investment grade credit ratings to junk bonds. Some have been around for decades.

Here is a comparison of Closed End Funds with Mutual Funds:

Closed End Funds	Mutual Funds “open end”
Professionally managed basket of stocks, bonds, etc.	Professionally managed basket of stocks, bonds, etc.
Fixed number of shares	Unlimited number of shares
Buy/sell on an exchange	Buy/sell from the fund company
Price may be at a premium or discount to NAV	Price equals net asset value (NAV)
Manager does not need to buy or sell securities; fixed pool of money	Manager must buy or sell to meet inflow or outflow of cash
May use leverage	Typically not leveraged

Many people have not heard of CEFs because they generally don’t advertise. The managers cannot raise new money, and their management fee is fixed, usually around 1% of assets. The fund manager has no incentive to advertise, so CEFs remain a secret of the investment community. When these CEFs trade at a discount to the underlying value of the assets, you may be able to buy the equivalent of $1,000 of bonds for $950 or $900 dollars. And that is what is happening right now – tax-loss harvesting is widening the discounts of many bond CEFs.

We generally don’t use CEFs in our portfolio models because they tend to have more price fluctuation than mutual funds. Besides the change in NAV, the discount or premium can change by as much as 10% or more in any year. But when that discount widens to 10% plus, that is often a good entry point for investors who are willing to hold the funds for long-term and who don’t mind a bit of additional volatility.

However, not all CEFs are created equal! There are many different strategies, and they have many more moving parts than mutual funds. We have an in depth process for choosing our CEFs and have been investing in these for more than a decade. If you are looking to increase your portfolio income, let’s talk about if Closed End Funds might be a good fit for you.

The Safest Way to Beat Inflation

Posted On March 21, 2016 By Admin In Portfolio Management /

With interest rates so low today, investors wonder where they can keep their money safe both in terms of their principal and purchasing power. We recently discussed Fixed Annuities as one substitute for CDs or bonds, with the conclusion that Annuities are best for investors over 59 1/2 who don’t need liquidity for at least five years. For others, one often overlooked option is Inflation-linked Savings bonds, officially known as Series I Bonds.

What Do Low Interest Rates Mean For Your Retirement?

Posted On March 7, 2016 By Admin In Retirement Planning / 1 Comment

A 2013 study from Prudential considered whether a hypothetical 65-year old female retiree would have enough retirement income to last her lifetime. In their scenario, they calculated a 21% possibility of failure, given market volatility and longevity risk. When they added in a third factor of “an extended period of low interest rates”, the failure rate rose to 54%.

What To Do With Your CD Money

Posted On February 1, 2016 By Admin In Portfolio Management / 1 Comment

If you’ve had CDs mature over the past several years, you’ve faced the unfortunate reality of having to choose between reinvesting into a new CD that pays a miniscule rate, or moving your money into riskier assets and giving up your guaranteed rate of return and safety. Although you can earn a higher coupon with corporate bonds than CDs, those investments are volatile and definitely not guaranteed. I understand the desire for many investors to keep a portion of their money invested very conservatively in ultra-safe choices. So, I checked Bankrate.com this week for current CD rates on a 5-year Jumbo CD and here is what is offered by the largest banks in our area:

Bank of America 0.15%
JPMorgan Chase 0.25%
Wells Fargo 0.35%
Citibank 0.50%
BBVA Compass 0.50%

While there are higher rates available from some local and internet banks, it is surprising how many investors automatically renew and do not search for a better return. Others have parked their CD money in short-term products or cash, hoping that the Fed’s intention of raising rates in 2016 will soon bring the return of higher CD rates.

Unfortunately, it’s not a given that the economic conditions will be strong enough for the Fed to continue to raise rates in 2016 as planned. This week, the 10-year Treasury yield dropped below 2%, which is not strong endorsement of the likelihood of CD rates having a major rebound in 2016.

This is the new normal of low interest rates and slow growth. While rates could be nominally higher in 12 months, it seems very unlikely that we will see 4% or 5% yields on CDs anytime in the immediate future. Waiting out in cash is a sure-fire way to not keep up with inflation and lose purchasing power.

What do I suggest? You can keep your money safe – and earn a guaranteed rate of return – with a Fixed Annuity. I only recommend Fixed Annuities with a multi-year guaranteed rate. Like a CD, these have a fixed interest rate and set term. At the end of the term, you can take your investment and walk away.

Today, we can purchase a 5-year annuity with a rate of 2.9% to 3.1%, depending on your needs. I know that’s not a huge return, but it’s better than CDs, savings accounts, Treasury bonds, or any other guaranteed investment that I have found. Since an annuity is illiquid, I suggest investors set up a five year ladder, where each year 20% (one-fifth) of their money matures. When each annuity matures, you can keep out whatever money you need, and then reinvest the remainder into a new 5-year annuity.

The beauty of a laddered approach is that it gives you access to some of your money each year and it will allow your portfolio to reset to new interest rates gradually as annuities mature and are reinvested at hopefully higher rates. In the mean time, we can earn a better return to keep up with inflation and keep your principal guaranteed.

Issued by insurance companies, Annuities have a number of differences from CDs. Here are the main points to know:

Annuities typically have steep penalties if you withdraw your money early. It’s important to always have other sources of cash reserves for emergencies. Consider an annuity as illiquid, and only invest long-term holdings.
If you take money out of an annuity before age 59 1/2, there is a 10% premature distribution penalty, just like a retirement account. A 5-year annuity may be best for someone 55 or older.
Money in annuity grows tax-deferred until withdrawn. If you rollover one annuity to another, the money remains tax-deferred. Most annuities will allow you to withdraw earnings without penalty and take Required Minimum Distributions (RMDs) from IRAs. Always confirm these features on an annuity before purchase.
While CDs are insured by the FDIC, annuities are guaranteed at the state level. In Texas, every annuity company pays into the Texas Guaranty Association, which protects investors up to $250,000. If you have more than this amount to invest, I would spread it to multiple issuers, to stay under the limit with each company.

If you have CDs maturing and would like to learn more about Fixed Annuities, please contact me for more information.