You Can’t Afford to DIY Investing

do-it-yourselfWith the proliferation of the Internet and continued expansion of online investment tools, the role of an Investment Advisor is now of crucial importance. Personal investors have access to more information than they ever have before, but wading through the data to find that path to success and discipline still requires the eye of a trained investment coach. Given the daunting amount of different investment advice, options, funds, accounts,  stocks, bonds, annuities, and timelines available to investors planning for your future is intimidating to say the least. When you take the inherent danger that follows bad investments into consideration , it quickly becomes clear your retirement isn’t worth that risk, and should instead be left to a professional. The following five points are some of the more common DIY investor mistakes that a qualified investment advisor can help you avoid, while better planning for your future.

1) Buying “cool” stocks, or giving too much attention to brand loyalty
This is one of the most common mistakes of beginning investors. Although you might feel a certain pull to invest in a company whose products you already support, it’s important to remember that you’re not buying their product; you’re buying their future performance as a company. In the long run the advantage of having a globally diversified portfolio is much bigger than the cool feeling you get when you buy your favorite companies stock.  Remember, your investments’ future earnings are more important to your well being than owning a fraction of a “cool” brand.  On top of this, usually the “cool” stocks that people buy are extremely massive companies, which have a lower expected growth rate than small cap companies.

2) Investing too conservatively
With the previous point in mind, it’s important to not be overly conservative when it comes to planning your future. Ever since the crash of 2008 new investors have been very skittish when taking on risk, many opting out of the stock market entirely. That being said, it’s important to remember the old adage that “without risk, there is no reward.” A financial professional can better assess the highs and lows inherent with ownership of  stocks. A more evenly balanced portfolio (that means one with stocks), while carrying an additional degree of risk, offers much greater rewards to the investor, and under a watchful eye it will continue to grow for years to come.

3) Hoping to beat the market “bad gambling”
This tip, more than almost any other, is extremely important to new investors. We’ve all seen a movie or heard a story with someone offering “a deal too good to be true,” and when it comes to investing that old cliché is worth its weight in gold. While we can all think of an example when a company’s stock value went through the roof seemingly overnight, it’s important to remember for every success story there are many more of failure and bankruptcy. Putting everything on a single stock or position is just as risky as taking your life savings to Vegas and hoping for the best at a roulette table. Any investment you care about should be made as part of a balanced portfolio and a long-term plan.

4) Thinking they are saving money by not having an advisor
This is a very common thought by most do it yourself investors.  They think with the advisor out of the picture they take out the middleman and thus lower their investment costs. The problem with this thinking, is that it is completely wrong in most cases.   Online, the extremely high fees for trading must be paid.  Depending on the website, they usually run $7 to $10 per trade.  If you are diversified like you should be, that would be hundreds if not thousands of dollars just to buy into all the stocks you should be holding.   The advantage to working with us is that there is no fee per trade.  You are no longer treated as an individual investor and thus you have a flat discounted fee no matter how many trades are made in your account.

5) Ignoring your investment horizon
To be frank, you need an investment coach to accurately accomplish your goals. Many new investors forget that investments are made for a purpose, and if you don’t have access to your money when you need it that investment has failed you. Different accounts have different tax implications that must be matched with your time horizon and age.  If you are putting away money for retirement that is not for 20 years, then you should not invest your money conservatively.  Your risk tolerance should be directly correlated with your time horizon for your investments.  You can be more conservative with investments that you will need in a short time frame.

By Jimmy Hancock

References

Do It Yourself Lobotomy. Digital image. Smithlhhsb122.wikispaces.com. N.p., n.d. Web. 21 Nov. 2016.

3rd Quarter Returns: I Told You So

making-moneyThe weather was not the only thing that was hot from July to September, but your investment portfolio most likely was as well.  Let’s just hope you stayed disciplined to receive the tough returns.  The following is an excerpt from the Matson Money quarterly statement.

“The 3rd quarter of 2016 provided much smoother sailing for the equity markets as compared to the occasionally tumultuous quarters that preceded it. 2016 began with significant downside volatility in the early part of the year, followed by geopolitical uncertainty surrounding the Brexit referendum vote, and it seemed like choppy waters was the new norm in the global marketplace. However, despite the talking heads making dire warnings, Matson Money’s recommendation to practice prudence proved to be sage advice, with post-Brexit markets have providing consistent upward movement over the last few months, with the S&P 500 index gaining 3.85% for the quarter, and international stocks as represented by the MSCI EAFE index rising 6.50%.
Another shift began to emerge recently, while U.S. large growth stocks had been one of the higher if not highest performing equity asset classes for much of past few years, we began to see a reversal of this over the last few months. Compared to the 3.85% return of the S&P 500 index in the 3rd quarter, we saw a gain of 9.05% out of small stocks as represented by the Russell 2000 index. In addition, the Russell 2000 Value index which represents small value stocks gained 8.87% for the quarter and is now up 15.49% year to date, as compared to only 7.84% for the S&P 500. We have also seen a resurgence in international stocks, which had also lagged U.S. stocks in recent memory. The MSCI Emerging Markets Index rose by 9.15% for the quarter and is now up 16.36% for the year, while the MSCI EAFE and EAFE Small  Value – benchmarks for international large stocks and international small value stocks – had gains of 6.50% and 9.78% respectively for the quarter.

This recent shift can be a good lesson for investors. While we don’t know if or how long these trends will persist into the future, we do know that historically there have been premiums associated with holding small and value stocks, and there have been time periods in which international stocks have outperformed U.S. stocks. The recent occurrence over the last couple of years of large U.S. growth stocks being a great performing asset class can tempt investors to become myopically focused and assume that these familiar stocks will continue to perform well into perpetuity. This mindset can result in eschewing diversification and ignoring academically known premiums, which can lead them to make sub-optimal decisions within their investment portfolios. This can be a costly mistake. Diversifying beyond US large stocks has historically had a great impact on an investor’s performance. From 1/1979 – 09/2016, the S&P returned 11.68% a year. However, during this same time period, U.S. small value stocks returned 12.99% as shown by the Russell 2000 Value Index.

A seasoned investor is aware that perceived trends and market cycles come and go, and it is extremely difficult to know when it is happening. They know that staying invested in broadly diversified portfolios that are designed to take advantage of academically known premiums can result in a positive investing experience over a lifetime.

In the end, choosing a wise financial strategy – and sticking to it – can have tremendous impact on an investor’s long term financial health. Chasing performance through buying and selling is a risky game. Historically speaking, it will only reduce an investor’s real return. Relying on unbiased, non-emotional advice from a trusted investor coach to make good decisions can help an investor bridge that gap between what the average investor makes and the return of the market.”

By Jimmy Hancock

References

1. Matson Money. “Account Statement.” Letter to James Hancock. 17 Jul. 2016. MS. N.p.

2. How to Make Easy Money Online. Digital image. Fgfinder.com. N.p., n.d. Web. 11 Oct. 2016.

 

YTD Market Returns and Analysis

Idaho Falls Investment AdvisorReturns have been pretty bipolar thus far this year.  After a very bad start in January, the market was back up and doing well until turmoil hit with Brexit Vote, and now everything is good again.  As of the end of June, the Free Market US Equity Fund (diversified US Mix) was up 3.3%.  The Free Market International Fund (Diversified International Mix) was down just a tad at -1.93%.  Bonds have been solid as the Free Market Fixed Income Fund (Diversified Short Term Bond Mix) was up 2.56%.  If anything, we learned once again that you can never predict the market in the short term.

The following commentary on the second quarter market returns is from the Matson Money Quarterly Statement.

“The 2nd quarter of 2016 was dominated by headlines from across the pond. The impending European Union referendum vote was looming over European markets and across the globe for much of the spring, with the popularly coined “Brexit” seemingly leading every news cycle. Finally on June 23, the citizens of the United Kingdom voted, and in a surprise result, the majority decided for the UK to leave the European Union. This result sent ripples around the world, and fear and panic took hold in the stock market. Stock prices fell sharply immediately after the news came in; both US and UK large stocks fell over 5% in the 2 days following the vote, with the S&P 500 Index down 5.34% and UK Stocks as represented by the FTSE Index down 5.62%. In addition, the Nikkei 225 Index – a benchmark for Japanese stocks – plummeted 7.92% in one day. However, as we often see, these panic induced drops did not persist. In fact, by the end of the quarter just a week later, much of these losses had already been recovered; US and Japanese stocks were up 4.91% and 4.89% respectively, while UK stocks were actually trading higher than before the drop, up 8.73%.

This Brexit-mania can be a good lesson for investors. Especially in the modern era of 24 hour news cycles and social media, it is easy to fall prey to the fear mongering of these platforms talking up the geo-political disaster du jour that will bring the global economy to its knees. In the last year alone we’ve seen Brexit, Grexit, and Chinese asset instability all highlighted in the media as the next calamitous event that will sink the economy. Although these types of events can often result in short term volatility, those that have not let it affect their investing strategy have noticed that these events have come and gone without the disastrous results that many predicted. If one had simply turned off the news and tuned out the noise, they would have seen that the S&P 500 Index had a solid quarterly return of 2.46% during the 2nd quarter.

Acting on impulse as a result of a scary event in the news is not a new thing, and unfortunately it has been detrimental to investors throughout history if they panicked and sold out of equities as a result. Over the last 90 years, investors have seen The Great Depression, World War II, the Cold War, and 9/11, and through it all had they stayed invested in a simple 50/50 mix of the S&P 500 index and 5-Year Treasury notes, they would have experienced zero 10 year periods in which they suffered a loss, and an average annual return of 8.69%. Although past performance is no guarantee of future results, historically, those that have stayed disciplined have been rewarded.

In the end, choosing a wise financial strategy – and sticking to it – can have tremendous impact on an investor’s long term financial health. Chasing performance through buying and selling is a risky game. Historically speaking, it will only reduce an investor’s real return. Relying on unbiased, non-emotional advice from a trusted investor coach to make good decisions can help an investor bridge that gap between what the average investor makes and the return of the market.”

By Jimmy Hancock

 

References

 1. Matson Money. “Account Statement.” Letter to James Hancock. 17 Jul. 2016. MS. N.p.

2. Up Down Icon. Digital image. Commons.wikimedia.org. N.p., n.d. Web. 9 Aug. 2016.





Do You Have the Investor Instinct?

choose instinctsMany investors and young potential investors are still scared out of their minds because of what happened to a lot of innocent investors in 2008.  I have heard a few horror stories of people who supposedly lost all of their retirement money because of the crash.  Many young professionals are scared of the stock market because of the stories they have heard from their parents and grandparents.  But is the stock market really the issue, or is bad decision making also involved?

The Horror Story known as 2008

This is what happened to the average investor in 2008, instincts kicked in.  What I mean by that is that the average investor thinks that when the stock market is headed downward, it is going to keep going downward in a never ending spiral until the world ends.  That is just our instinct as human beings.  So as an investor, the obvious thing to do if you believe that, is to take your money out of stocks and put it in bonds, a bank account, or even under your mattress.  But the term that I use for that is selling low.  By the time most investors could get their money out of the stock market in 2008-2009,  it was already down 20 maybe even 40%.    Let’s take a look at the numbers.

Pain and Pleasure

On your statement at the end of 2008 you see that your small US stocks were down 38.67%.  You lost almost half of your hard earned money!  You also notice on the news that long term bonds were up 25.8% during 2008.  What does instinct tell you to do?  It tells you to leave the pain that stocks are inflicting upon you and go to the pleasure of bonds.   But is that really the best decision?

Regardless of what we know happened after the crash, it is ALWAYS a bad decision to sell low, and buy high.  But in the moment it doesn’t seem like that is what you are doing.  So let’s say you sold out of stocks and bought into bonds at the beginning of 2009.  Then at the end of 2009 you get this horrifying statement.  Long term bonds are down 14.09%.  What?  How could this happen?  You then search online and see that small US stocks were up 47.54%!   You managed to lose half of your money while those stock investors who didn’t do anything during this time did twice as good and made their money back.

I personally know people who did this, and their families are now forever afraid of the stock market.   These people blame the stock market when it was really their own emotions and fear that was the problem.   The stock market is way higher than it was before the crash in 2008 and continues to reach new highs as usual.

The Success Story known as 2008

Those investors who saw the largely negative numbers and heard the panic throughout the world, yet stayed disciplined made out like a bandit.   The best investors did exactly the opposite of what instincts told them to do, that is they bought more into stocks when the crash was happening and the prices were discounted, and sold some bonds while they were high.  Those people especially have been rewarded for their discipline.

The Next Crash

We all know crashes are a part of the stock market and are a regular thing.  The stock market has always come back lightning fast after a crash.  So are you going to go with your instinct and panic, or are you going to stay disciplined.

By Jimmy Hancock

References

1. Matson Money. Mind Over Money Powerpoint. Mason, OH: Matson Money, 2 Aug. 2016. PPT.

2. Graphic Design Schools. Digital image. Practicalpedal.com. N.p., n.d. Web. 2 Aug. 2016.

 





Don’t Sell International Stocks, Here’s Why

internationalToday I would like to tackle the question, why should I be invested internationally?  This question has been asked by investors more frequently after the horrible year’s international stocks had in 2014 and 2015.  So lets look at the data and see if there is any reason to keep international stocks in your portfolio.

International Stocks in 2014-2015

Every sector of international stocks lost money in 2014.  In 2015, International Large sector lost about 3% and international large value sector lost over 6%.  The Emerging Markets sector (stocks in countries that are “emerging”) was down almost 16%.  *1.  Meanwhile the S&P 500 (US Large companies) was positive in both 2014 and 2015.  You are probably wondering why everyone doesn’t just invest in Large US companies?

International Stocks 2000-2015

2000 through 2015 was not necessarily a great time period for any sector of the market, but international stocks definitely held their own.  US Stocks are in blue, International Stocks are in green.

Category                           2000-2015 Annual Return

S&P 500 Index                           4.03%

Intl Large Value index                5.03%

Intl Small index                           8.38%

Intl Small Value                          9.91%

Emerging Markets Value           7.04%

Emerging Markets Small           8.55%

*1. Obviously this chart doesn’t include every sector, but it illustrates a very important point.  International stocks are extremely valuable in your retirement portfolio, but you also have to be diversified in your international stocks and not just own international large stocks, like most of the population.  Most retail investment advisors cannot get you into categories like international small value and emerging markets small.

International Stocks From the Beginning

Accurate records for international stock data goes back only to the 1970’s, but lets take a look at the data going back to then.  International Large stocks return from 1973 to 2015 was 8.92% per year.  International Small Stocks during the same time period had a jaw dropping return of 12.84% per year.   *2.   This further proves that there is a long term advantage to having a diversified mix of international stocks in your portfolio.

 

A lot of investors get caught up in what is happening in the market over the last minute, day, month, or year.  It is important to keep the long term perspective and stay diversified no matter how hard it is to not drop out of sectors that are under performing in the short term.

by Jimmy Hancock

References

1. Matson Money. Investor Jeopardy Powerpoint. Mason, OH: Matson Money, 19 Jul. 2016. PPT.

2. Matson Money. Portfolio MRI. Mason, OH: Matson Money, n.d. PDF.





Post Brexit Positivity?

Ever wonder if there is anything on the news media that wasn’t focused on negativity, fear, and panic?  Lucky for us when Mark Matson, CEO of Matson Money, goes on the news media he takes a very different approach.  He focuses on real long term investing principles rather than what investors should do based on the big fear of the moment.

So the Brexit vote happened, and there has been a lot of discussion about the downward spiral it would send the world into.  This video clip is via Fox Business and is Mark Matson’s take on the stock market and world after the Brexit vote.

Instead of a regular blog this week, I want you to watch this quick 3 minute video that teaches quite a few good investing principles.

http://markmatson.tv/brexit-on-fox-business/

(note: you have to click on the link to view the video, not the picture)

 

mark fox business brexit

By Jimmy Hancock

References

Brexit on Fox Business. Perf. Mark Matson. N.p., 1 July 2016. Web. 1 July 2016.

 





Picking Winning Stocks

buy sellYou think you can pick winning stocks consistently, and I’m here to tell you that you can’t.   But even if I cannot convince you that you can’t pick stocks, I hope to at least convince you that it is not in your best interest to try.   We look at examples like Warren Buffet and see how much success he had “stock picking”. But the funny thing is that Warren Buffet believes that the best strategy for most investors is to buy low-cost index funds.

Bad Advice

The most dangerous advice in investing is often that which seems most practical, which is why the worst investing advice you will likely ever receive is that you should try to pick “good” stocks and sell “bad” ones. Yes it seems very sensible and almost too obvious that you should try to do this.  You will get this advice like this from innumerable sources, including a lot of investment advisers, friends, work associates, and most especially Wall Street/investment media. But…You should ignore it.

If you pursue a stock-picking strategy, you are almost certain to lag the market.

Stock pickers always underestimate the number of variables that are involved in the pricing of stocks.  There are literally trillions of variables that could occur on any given day that could change the price of a stock instantly.  Stock prices are based on every single investor which all have different feelings about companies, reasons for investing, and regional bias.

The big problem for investors is that even though stock-picking usually hurts returns, it’s extremely interesting and a makes for a great conversation. If you are wanting to wean yourself of this bad habit,  the first step is to understand why it’s so rarely successful. The quick answer is that the overall market provides most investment returns, not particular stock picks, so stock pickers get credit for gains that came merely from being invested in stocks generally.

Although it is relatively easy to pick stocks that beat the market before costs (just like a monkey you have a 50% chance), it is much harder to do so after costs are added in. So lets say you happen to pick stocks well enough to boost your return by a couple of points, the expenses you rack up along the way (ie. research, trading, taxes) will usually more than offset your gain.

Most stock pickers believe that they are among the 1% of investors who happen to beat the market after costs, and, for inspiration and encouragement, they point to legends such as Warren Buffett and Benjamin Graham. But as I mentioned before, such investors often don’t know that even Buffett has said that the best strategy for most investors is to buy low-cost index funds and that the great Benjamin Graham eventually changed his mind to advocate a passive approach to investing.

Stock picking is not only a dangerous activity for you to be involved in as an individual investor, but it is also dangerous to invest in mutual funds that employ stock picking strategies.  These stock picking strategies are used in most of the mutual funds out there, also known as active investing.  These mutual fund managers think they have a crystal ball and can predict the best stocks and drop the worst ones.

The Opposite of Stock Picking

Instead of stock picking, invest in a globally diversified portfolio managed by a low fee investment coach that will help to educate you on the investing process.  Instead of constantly turning the portfolio over by stock picking and active trading, buy and rebalance when necessary.  Long term you will see the fruits of your decision.

By Jimmy Hancock

References

1.Blodget, Henry. “Why the World’s Greatest Stock Picker Stopped Picking Stocks.” Slate Magazine. N.p., 22 Jan. 2007. Web. 28 Jun. 2016. http://www.slate.com/articles/arts/bad_advice/2007/01/stop_picking_stocksimmediately.html.

2.Stock Market People. Digital image. Opinion-forum.com. N.p., Aug. 2012. Web. 28 June 2016. <http://opinion-forum.com/index/wp-content/uploads/2012/08/stock_market.jpg>.





What is a Wall Street Bully?




wall street bullyWall Street Bullies are not just found in New York City, they are found in investment brokerages throughout the country.  In fact, your investment guy, might just be a wall street bully.

I explain a Wall Street Bully as an individual or institution that uses fear, greed, intimidation, and misleading information to get an investor to act in a certain way.

The core issue behind all of this is that people that work on wall street make money every time there is a trade made on stock or other security.   Acting like any salesman, it is in their best interest to get people to buy and sell every week, every day, every hour.  But the problem is, actively trading by buying and selling on impulse is not in the best interest of the long term investor.

Wall Street Bullies try to take advantage of under educated and uninformed investors by instilling fear in them and getting them to become short term focused even when they are long term investors.  They create the illusion that they are genius’s that can outsmart the market with little to no risk if you just trust them.  There are 3 main types of Wall Street Bullies as stated by Mark Matson in his book “Main Street Money”.

The 3 types of Wall Street Bullies

The Conman

This is the easiest one to identify, at least after they have been convicted.  Think of Bernie Madoff.  These people gain your trust with a great reputation and promise you great returns with no risk or downside.  If it seems to good to be true, it probably is.  Often times these con men send out false statements showing growth when in reality they are stealing your money.

The way to protect yourself from a con man is to never allow someone to manage your money that does not use a third party custodian to hold the money.  Without a third party custodian, the fox is guarding the hen house.   There were a lot of so called “sophisticated” investors who got caught up in the Bernie Madoff scheme and lost millions of dollars.

The Prognosticator

There is no shortage of self proclaimed genius fortune tellers who will convincingly claim that they know exactly what is going to happen in the stock market in the short term future.  They pull out charts, graphs, economic theories and data galore.  Investing in the stock market would be a whole lot easier if these “experts” really could predict the short term future.  Ultimately they are trying to sell newsletters or get media attention for their hedge fund or alternative strategy they are selling.

If your portfolio needs a prediction about the future to be successful, it is already broken.  If anyone tells you they know what the market is going to do in the next few days, or next few months, don’t walk, run away.

The Guru

These are the sharply dressed people you see on the front cover of any investment magazine.  They are the ones have beaten the market in the past and think they can continue to do it forever.  They are reported to have amazing insights into which stocks are undervalued and which stocks to stay away from.  But the issue here is, there is ZERO correlation between a Guru’s market beating performance in the past and his ability to do it in the future.

Guru’s are the most common form of Wall Street Bully.  Many investment advisor’s, Brokers, and money managers claim to be guru’s who study and pick the best stocks that will beat the market as a whole.  Staying away from them can be hard, but instead, you should work with a investment coach who educates you on why stock picking is not necessary to have a successful long term portfolio.

What should you do?

At Preferred Retirement Options, we call it Bully Proofing Your Portfolio.  Not all investment professionals are Wall Street Bullies.  We help our investors follow the simple rules of investing, which are own equities, diversify, rebalance.  No crystal ball is necessary.

By Jimmy Hancock

References

  1. Wall Street Wolf Cast. Digital image. N.p., n.d. Web. 20 Nov. 2016. <http://tse1.mm.bing.net/th?&id=OIP.M1ee62057658b9c97e8d311a77a7a7d78o0&w=300&h=204&c=0&pid=1.9&rs=0&p=0&r=0>.
  2. Matson, Mark E. “1.” Main Street Money: How to Outwit, Outsmart & out Invest the Wall Street Bullies. Cincinnati, OH: McGriff Pub., 2012. 3-5. Print.



Value Stocks vs Growth Stocks: Which is better?

Value and growth are a little bit more technical terms than most investors understand, but what I want to teach today is how investing in stocks can be a science rather than a guessing game or a luck game. We have looked at Nobel Prize winning data to figure out exactly what type of stocks have the highest expected return based on history of the last 80 plus years.  Today we are going to tackle one small section of what type of stocks you should be investing in.  The Value Stocks vs. Growth Stocks discussion.

Value Stock– A stock that has a low price compared to it’s financial data, usually because investors don’t “feel good” about that company.

Growth Stock – A stock that has a high price compared to it’s financial data, usually because investors expect that company to grow very fast.

Which one is better?

You might think that growth stocks (S&P 500) might have more long term “growth” potential, but you would be wrong.  Check out this chart that proves exactly the opposite.

 

value vs growth

The chart is showing 2 examples of value beating growth.  First the green example with the first bar being value and the 3rd bar being growth.  Then identical with the blue bars.  As you can see on this chart, whether with large stocks or small stocks, there is a premium when you invest in value companies.  And it is not just a little difference.  Over 2% difference in large stocks, and over 6% in small stocks.  That is huge.   Did you know that the historical return for small value stocks is almost 15% per year.  Does that blow your mind?  Many surface investors miss out on this investing “secret” because this is not in the news or media.  Value companies are not popular and are rarely if ever talked about.  It is not cool to invest in value companies.

Why is that?

Because there is a greater risk involved in investing in these value companies, there is also a greater reward.  Value companies have low earnings and shaky financial health, thus they are riskier to invest in.  Just like banks would charge these companies a higher rate on loans, you the investor can expect a higher rate of return from investing in their stock.

Most financial advisors stay away from value companies because they are uninformed about how to prudently invest in these companies.   If you invest in widely diversified portfolio with at least some portion in bonds, you can increase your long term growth immensely by investing a greater percent of your portfolio in value and less in growth.

by Jimmy Hancock

References

1. Matson Money. Understanding the Dimensions of Risk and Return. N.p.: n.p., n.d. PPT.



Bonds 101

Bonds can be extremely difficult to understand at a deep level, but today we are going to discuss the basics of bonds and how they can help you achieve success in your retirement portfolio. 

Bond- “A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.” 1

Short term quality Bonds (matures in 10 years or less) should make up a percentage of your total retirement portfolio.  What percentage of bonds you have compared to stocks is up to you and should be planned according to your age and risk preference.

The Benefit of Bonds

Bonds are much less risky than stocks generally speaking, especially short term Triple A quality bonds.  A bond will give you a set rate of return each year.   Putting bonds in your portfolio helps to lower the overall standard deviation, thus helping to smooth out the performance.

Another advantage of having bonds in your portfolio is that they are not correlated with the price of stocks.  Often times bond prices and stock prices move in opposite directions although not always.  This means that bonds can give you big downside protection in case there is a big down turn in stocks.

Because bonds are not highly correlated with stocks, this makes it a huge rebalancing advantage to have both stocks and bonds in your portfolio.  If stocks crash, you can pull some money out of your fixed income portion of your portfolio, and buy stocks at 20 to 50% off.  Thus you are able to buy stocks at a discount without even putting new money into your portfolio, and your portfolio goes back to your original risk preference of stock to bond ratio.

The Risk of Bonds

Default risk is the main risk that comes along with bonds.  If you own a bond that defaults, you lose all of your money including the principle.  To reduce this risk you can diversify by not buying individual bonds, but investing in a bond mutual fund.  Some bonds, like long term (10 to 30 years) junk bonds can be extremely risky and lose their value quickly.  Long term junk bonds can give you a slightly higher rate, but have a much bigger chance of being defaulted and you losing your money.   Investing in long term bonds can also be dangerous especially in a time like now.  The current rate for a 30 year bond is about 2.63%. 2   That is extremely low and most people expect that to increase dramatically in the future.  If you get stuck in a 30 year bond at that rate, and the rate jumps to 5%, then the price value of your bond has dropped by an extreme amount.  You can either sell the bond at a big loss, or suffer the consequence of receiving 2% per year while everyone else is getting 5%.  

Bonds Vs. Stocks

To finish off, I will explain why bonds should not be used as your main source of portfolio growth.  The historical return for Bonds are minimal compared to a diversified group of stocks.  Check out the chart below. 3

  • Hypothetical US Stock Mix
  • S&P 500
  • Long Term Bonds

bond trap
This chart shows 30 year rolling returns of these 3 asset categories from 1927 though 2014.  You can see that long term bonds have never had a better 30 year return than a diversified stock mix.  Bonds have lost to stocks over the long term no matter what period of time you look at.  This is important to know as you decide the percentage of bonds you want in your retirement mix.

Short term quality bonds should be a part of your portfolio, but make sure you work with an investment coach to decide exactly how much.

By Jimmy Hancock

 

References

1. Investopedia. “Bond Definition | Investopedia.” Investopedia. Investopedia, LLC, 23 Nov. 2003. Web. 31 May 2016.

2. Yahoo! “Bonds Center.” – Bond Quotes, News, Screeners and Education Information. Yahoo!, 31 May 2015. Web. 31 May 2015.

3. Matson Money. The Long Bond Trap Presentation. N.p.: n.p., n.d. PPT.