You know that checking and savings can make money management easier, but were you aware that you may be able to open an account with literally no cash deposited? Generally, the amount of money you’ll need to open a bank account is whatever the bank requires for a minimum initial deposit. Depending on the bank […]
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If youâre looking to stash some cash, itâs important to know that a certificate of deposit and a savings account are similar, but not the same thing! Both are probably a big improvement over keeping your hard-earned money tucked in a drawer at home, as they keep your money safe and grow it. But factors […]
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Interest rates are rising and stock prices are falling, so investors naturally start thinking about bonds. But be careful.
Peter Lynch, the manager of Fidelity Magellan fund during its spectacular run in the 1980s, once said, “Gentlemen who prefer bonds don’t know what they are missing.”Â
Generally, I agree. Dow 36,000, the book I coauthored, made the case that, because history shows that stocks and bonds are equally risky over the long term and that stocks return an average of four to five percentage points more a year, the obvious choice is stocks.
But there are reasons to own bonds. First, in the short term, bonds fluctuate much less than stocks, and you may need a reliable investment because you have a large outlay coming up â a college tuition bill or a down payment on a house, for example.
Second, bonds provide ballast for a portfolio. According to research by Russell Investments, since 1997 the correlation between stock and bond returns has been mainly negative. In other words, when one goes up, the other tends to go down, and vice versa. As a result, you get a smoother ride. Finally, bonds supply reliable income â though recently not much.Â
Over the past decade, bonds have been especially unproductive investments. Since 2012, the annual yield on a Treasury bond that matures in 10 years has averaged just 2% per calendar year and has never exceeded 3%.
The Vanguard Intermediate Bond Index Admiral (VBILX), a popular mutual fund that owns both government and corporate bonds and charges expenses of just 0.07%, has returned an annual average of just 3.1% over the past 10 years, including interest payments and gains and losses from selling assets. (Nonetheless, I’m a fan of this fund for the long term.)Â
Lately, rates have perked up. Moody’s Seasoned Aaa Corporate Bond yield for the safest debt jumped from 2.5% on Dec. 3 to 3.3% on March 3. That’s still only about half the average of the past 40 years.Â
A bond is an IOU, a promise by a business or government to repay an investor for a loan â typically on a specific date (maturity) and at a specific interest rate (coupon, or yield).
Bonds are actively traded, so a 10-year, $10,000 bond issued with a coupon of 3% might trade a few years later at $7,000. Why? First, the borrower might get into financial trouble, and investors doubt they will be repaid. This kind of credit risk applies mainly to corporations or state, local or foreign governments â not, so far, to the U.S. Treasury. Second, interest rates may rise after you buy your bond, so new, similar bonds are issued at higher coupons. Higher rates make your old bond less attractive, so its price on the market falls.Â
If you hold your bond to maturity, the lower price in the interim won’t matter; you’ll get the bond’s full face value when it comes due. But if you have to sell sooner, you’ll take a loss.Â
Bonds present one other kind of risk: Inflation diminishes the value of the dollar, so that even when you get your $10,000 at maturity, it will have the purchasing power of, say, $6,000. Some decline in value is inevitable, and that expectation is built into the bond’s yield, but inflation may be worse than the market anticipates.
Right now, long-term inflation expectations are extremely low, even though the consumer price index (CPI) soared 7.9% in the 12 months that ended Feb. 28. The St. Louis Federal Reserve Bank extrapolates from TIPS, or Treasury inflation-protected securities, that the annual increase in CPI over the next 10 years will be about 2.7%.Â
My view is that intermediate (five- to 10-year) rates will probably rise another two or three points in the next few years, making bond yields much more attractive.
The choices are vast, but, for many investors, buying individual bonds at the riskier end of the debt spectrum â high-yield or junk debt, for example, or bonds issued by shaky governments â is just too adventuresome. Unless you spend a lifetime examining the nuances of particular bond issues, you will probably get better returns at much the same risk with stocks. I am not fond of individual municipal bonds, either. Yes, interest is exempt from federal taxes, but munis, accordingly, have lower yields.Â
Buying individual government bonds through a broker or directly from the U.S. Treasury is a reasonable option. But owning a bond, or even several, locks you into todayâs rates or forces you to take a loss if rates rise.Â
The best alternative is a mutual fund, whose assets evolve. For instance, if a bond fund has an average maturity of five years, about one-fifth of its holdings will come due in any 12-month period. The fund manager (or the computer algorithm, in the case of index funds) will then decide to buy new bonds with the cash from its maturing bonds, and, if rates are rising, those bonds will have higher yields.
And a fund manager can shift to higher yields by deploying cash from new investors, who tend to flock to bond funds as rates rise. Some of the best funds leaven their safer holdings with riskier debt to boost yields.Â
When looking at specific funds, decide how much volatility you can tolerate by checking out the duration, a figure expressed in years that indicates the sensitivity of a fund’s portfolio to interest rate increases. For example, the Fidelity Long-Term Treasury Bond Index (FNBGX) has a duration of over 18 years, which means if rates rise 1%, the fund’s value will fall about 18%. That’s risky. (The value, of course, will shoot up if rates fall.)Â
Although I have been impressed over the years with many active bond fund managers, the expenses they charge can eat up returns when yields are low. For example, one of the largest funds, the Pimco Total Return (PTTAX), which owns a mix of high-quality government and corporate bonds, charges 0.8% and has had an average annual return over the past five years of 3.0%. In the same asset category, I like the Fidelity Investment Grade Bond (FBNDX) better. Expenses are 0.45% for a fund whose average annual return for the past five years is 3.6%.Â
By contrast, the Vanguard Long-Term Corporate Bond (VCLT), an exchange-traded fund based on an index, has an expense ratio of just 0.04%. It’s an excellent fund if you are willing to accept more risk. Holdings are investment grade, but just barely, with 88% of assets rated A or BBB. And the fund has a duration of more than 14, so it’s sensitive to rate swings. But more risk, more reward: The fund has returned an annual average of 5.4% over the past five years.Â
Also recommended is the T. Rowe Price Total Return (PTTFX), which has about one-fourth of its assets rated below investment grade. With an expense ratio of 0.46%, the mutual fund has returned a five-year average of 4.0%. Its bonds mature in an average of eight years, so if rates rise, the portfolio’s yield will rise, too.
Another way to protect against rising interest rates is the SPDR Bloomberg Barclays 1-10 Year TIPS (TIPX), an ETF with expenses of 0.15%. TIPS become more valuable as inflation and interest rates increase. Technically, TIPS can have negative yields, as some do now, but the income from the bond gets enhanced when inflation rises by adjustments to the principal.Â
If rates do rise, returns may soon reach the 5% range for many bond funds. But higher rates, remember, also have the effect of depressing economic growth, which in turn can force borrowers into default. Bond investing is always a matter of balance: long versus short maturities; risky versus safer credits. No more so than now.
James K. Glassman chairs Glassman Advisory, a public-affairs consulting firm. He does not write about his clients. He owns none of the securities mentioned. His most recent book is Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. You can reach him at [email protected].
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With the swings weâve seen in the stock markets lately, investing can feel like a risky venture. We all want to reduce risk in our lives, but many people don’t think about diversifying their portfolios and how it relates to risk reduction. Some people may think that they are diversified, but in reality they hold a basket of similar stocks or bonds that all react in the same way to market events.
So, what is proper diversification, and how does it reduce risk? This article will discuss what a diversified portfolio should look like and how it reduces risk to help you reach your financial goals.
The concept is simple enough, yet many people fail to diversify their portfolios properly. Some people may receive stock options at work, and others may have a high conviction in a particular company. Still, the result creates an overly concentrated portfolio exposed to a high degree of risk entirely based on one or a few companies. Failure to properly diversify can cause many portfolios to have a much higher risk than an investor is comfortable with or even aware of.
For an investor to truly have a diverse investment collection, they need to invest in several different asset classes and sectors that will react differently to market events.
These asset classes and sectors will have moments when they are performing better than other categories, but no asset class or sector remains at the top forever. By spreading out your risks, market anomalies will have less of an impact on your portfolio. Think of it as betting on multiple horses in the race rather than just one.
Just because a portfolio is diversified doesn’t mean it is guaranteed to go up in value. Some events will impact the broad financial market. For instance, during the 2008 financial crisis, only bonds and cash had positive returns for the year. Large-cap growth stocks fell by more than 38% in that year, and international stocks lost more than 41%. A well-diversified portfolio would’ve had negative returns in that year between 20% to 30%, but it still would’ve had better returns than the worst-performing categories of the market.
A diversified portfolio will likely have a better risk-adjusted return over a long period. While the diversified portfolio will never have returns as high as the top-performing sector, it will also never be at the bottom. A diversified portfolio will achieve the average returns of all the sectors invested with lower volatility along the way.
For example, in 2020, due to a decline in oil and gas consumption, energy companies lost 33%, making that sector the worst-performer in the S&P 500. All the while, the broader index rose over 16% for the year. However, as the COVID 19 lockdowns came to an end, energy consumption returned strong, causing energy to be the highest performer of 2021, with a 54% return. A broadly diversified portfolio across the S&P 500 would’ve seen an 18% gain in 2020 and a 29% gain in 2021, resulting in more than 52% return over two years. An investor solely concentrated in the energy sector would only be up 2% after recouping from their losses in year one.
Another example that spans an entire decade would be the 1970s. This decade experienced stagflation due to high unemployment, high inflation and low economic growth. The Dow Jones Industrial Average began the decade at 800 and closed it out at 839 points. Bonds had a negative real return after inflation. However, real assets like commodities and real estate did well due to higher-than-average inflation. Gold had a 10x return, while silver had a 15x return over the decade. REITs generated an annual return of 16.3%. Someone broadly diversified across multiple asset classes would’ve seen a better return than someone solely invested in stocks and bonds.
Diversification is an essential element to minimize the risk of investing. Allocating investments across different asset classes and sectors can help stabilize your returns because no single sector or class will have as much impact on the overall performance of the entire basket.
Over time, even if some assets perform poorly, others should offset them so that you don’t see too significant an effect on your overall performance.
While most of us start our banking journeys with one checking and one savings account, as our financial lives get more complex, having more than one checking account can make sense. Especially because having more than one bank account can make it easier to manage the comings and goings of funds. Keep reading for insight […]
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At a time when many Americans are paying more for everything from gas to ground beef, tax refunds will provide much-needed cash for many families. And this year, those refunds could be particularly generous.
Through the March 4, the average federal tax refund was $3,401, up 13.7% from the same period last year, according to the IRS. In 2021, the average refund was $2,815.
People who expect a big refund tend to file early, so the average for the 2022 tax season may be lower. Still, there are several reasons many taxpayers could get a larger refund this year. Taxpayers who were eligible for a third Economic Impact Payment and didn’t receive a check, or received less than the full amount, will have the opportunity to claim the recovery rebate credit when they file their 2021 tax return. The credit is worth up to $1,400. Likewise, taxpayers who were eligible for the expanded child tax credit, worth up to $3,600 in 2021, will have an opportunity to claim it when they file their 2021 tax return.
The IRS sent out advance child tax credits in six monthly payments last year, but not everyone who was eligible for the payments received them. If you had a newborn last year, for example, you didn’t receive the advance credits because the IRS didn’t have a record of the addition to your family. But when you file your 2021 tax return, you’ll be able to claim the credit.
Young adults may also receive a larger-than-expected refund this year because of a provision in the American Rescue Plan that expanded the earned income tax credit, which is designed to help low- and moderate-income workers. The legislation expanded eligibility for the credit to include workers between age 19 and 24 who don’t have children.
Nearly 60% of taxpayers expect to receive a refund this year. If you’re interested in investing all or part of your money, many brokerage firms will allow you to open an account for less than $500, and some have no minimum requirements. Coinbase, an online platform for cryptocurrency investors, says taxpayers who file their returns using TurboTax can have their refunds converted into Bitcoin, Ethereum or one of the other cryptocurrencies the company supports.
Cryptocurrencies are extremely volatile. Risk-averse investors may want to invest their refunds in Series I bonds. I bonds issued from November 2021 through April 2022 yield a composite rate of 7.12%. You can buy up to $10,000 each year in electronic I bonds and apply your tax refund to purchase up to $5,000 in paper bonds.
Finally, although it’s nice to get a check from the IRS, there are more-effective ways to use your money than giving the government an interest-free loan. The IRS offers a tool on its website that you can use to adjust your withholding.