Written by Jason Hiley
Written by Andrew Hunt
Anyone who is keeping even a casual eye on financial headlines is aware that fixed income returns are a bit topsy-turvy these days. With bond prices reacting negatively to uncertain economic news, investments that are supposed to be our reliable safety net and income stream during troubled times are experiencing uncertain times themselves. Many investors are abandoning their existing plans (or had none to begin with), and are selling off their bond funds. To cite a June 28, 2013 column in The New York Times, “Taking a Cue From Bernanke a Little Too Far,” the month’s outflows neared $77 billion, handily exceeding the last high-water mark of nearly $42 billion bond-fund outflows in October 2008.
That’s too bad. None of us can forecast the future, but we see no strong evidence that the overarching laws of the investment universe have suddenly changed. As the New York Times columnist said: “The rush for the exits really means one thing: investors are betting that interest rates are about to begin their upward trajectory, something that’s been expected for several years now.” While this news may be important – maybe even good – for our economy, we would not advise joining those who are betting their life’s savings on outcomes that are yet to unfold.
Guiding Rule #1: Invest According to a Sensible, Customized Plan.
When Hiley Hunt Wealth Management initiates a relationship we begin by exploring our client’s personal circumstances, to determine the levels of investment risk they could or should accept in pursuit of financial goals. Next, we crafted an Investment Policy Statement (IPS) to guide our way. Only then do we make specific, customized investment recommendations for your portfolio, including building – and maintaining – an appropriate balance between stocks and bonds.
As a result, our client’s stock-bond allocations are closely tied to their specific needs. Our portfolios are also based on the available evidence on how markets are expected to deliver their long-term returns. In contrast, current headlines are based on predicting events over which we have no control. While there is no guarantee that an existing portfolio will deliver the outcomes for which it’s been designed, we recommend that our client’s stick with it, ignoring the temptation to react to near-term news. We believe that each carefully crafted portfolio continues to represent the client’s best interests for achieving their personal goals.
Guiding Rule #2: Bonds are safer; they’re not entirely safe.
Many have already heard repeatedly advise to “stay the course” during troubled times. Still, it is easy to wonder whether, this time, it’s different. In our collective past memories, when market uncertainty has appeared, it’s usually been within stock holdings. We’ve grown used to thinking that bonds will keep plodding along, reliably if unspectacularly.
This is close to, but not quite accurate. Compared to stocks, bonds have historically exhibited lower market risk (uncertainty) along with commensurate lower returns. But they have exhibited some market risk, along with some expected returns.
Consider the roles for which each asset is intended. We employ stocks to help build new wealth over time. Bonds are meant to help dampen the bumpier ride that stocks are expected to deliver over time, while contributing more modestly to your portfolio’s overall expected returns. In the face of inflation, cash is expected to actually lose buying power over time, but it’s great to have on hand for near-term spending needs.
|Expected Long-Term Returns||Highest Purpose|
|Stocks (Equity)||Higher||Building wealth|
|Bonds (Fixed Income)||Lower||Preserving wealth|
|Cash||Negative (after inflation)||Spending wealth|
Thus, in performance and predictability, fixed income is meant to be “cooler” than stocks, but “warmer” than cold, hard cash. Based on its in-between role, we actually expect fixed income to periodically deliver disappointing returns, sometimes even for extended periods. These periods are expected to be less severe and less frequent than what is seen in stock holdings … but as we’re seeing right now, they exist. They need to, for fixed income to fulfill its intended role.
In other words, based on the long-term evidence on market performance, we see no compelling reason to abandon our existing plans at this time, at least not due to market forces. Our position is substantiated by a July 2013 article by DFA Australia Ltd.’s Jim Parker. In it, he observed: “We are seeing a classic example of how markets efficiently price in new information. Prior to Bernanke’s remarks, markets might have been positioned to expect a different message than he delivered. They adjusted accordingly.”
Guiding Rule #3: Act on What You Can Control
So, where does that leave the long-term investor who is diligently adhering to a carefully wrought strategy? Is there really nothing to be done? There are some possibilities we can help you explore at this time.
Guiding Rule #4: Be Brave.
More than four centuries ago, Galileo Galilei is attributed to have said: “All truths are easy to understand once they are discovered; the point is to discover them.” He also was accused of heresy and placed under house arrest for the remainder of his life after he observed that the earth revolves around the sun.
Galileo’s experiences offer an early illustration that there’s a big difference between understanding and accepting best available evidence in an uncertain world. In many respects, investing is a scientific endeavor. But there are times when it requires courage and perseverance to remain confident about that evidence, particularly when others are succumbing to irrational doubts.
We would love to invite you to learn more about Hiley Hunt Wealth Management and who we serve in Omaha, NE –Financial Planning and Investment Management.
 Jim Parker, Outside the Flags, “Second-Guessing.” DFA Australia Limited, July 2013.