The Biggest Investing Challenge Today
Posted: Brandon Arns
In almost any portfolio, for investors large and small, there are two primary parts. There is the side that should grow (almost always stocks), and there is the counterbalance that should give the portfolio safety (almost always bonds). This has been a fantastic strategy, especially for the last 40 years or so. So much so that any advice to stray from this balanced approach is often thought to be irresponsible.
These are unprecedented times however, as the safety side of this balanced approach yields almost nothing.
When you invest in bonds, there are two ways you get paid. The first is you earn the stated yield each year. A 10% coupon bond will pay you 10% per year for as long as you hold it, for example. In 1981, the 10-year treasury bond had a yield of about 15%. Today that yield is about 0.96%.
This starting yield explains most of a bonds return, so it’s immediately obvious why a starting yield of 0.96% is concerning.
Of course, rates have been low for several years now, and yet bonds have had a great return. In the last 5 years, the highest yield on the 10-year treasury was about 3.24% in 2018, yet the return has been close to 6% per year. How this happens is because of the second source of return.
The second source is price appreciation. When market interest rates go down, the price of the bond you currently hold go up, and vice versa. So when the 10-year bond yield goes from 3.24% in 2018 to 0.96% now, your return is high. In addition, interest rates often fall (bond prices go up) when stock markets do, which is why treasury bonds have been such great diversifiers.
Starting at 0.96% today however, how much more juice is there left to squeeze? Rates can fall to 0% and you’ll make a little bit of money, but then what? Looking at Europe and Japan, we’ve seen that rates can go past 0% and offer a negative yield. Will you still be willing to hold it then?
This is the biggest investing challenge today, and in fact it’s one of the hardest investing problems money managers have ever faced. Hold bonds that yield nothing for protection or take more risk and buy more stocks.
We believe it’s irresponsible to simply abandon a balanced portfolio and hold only stocks, as this can lead to financial ruin if you’re caught in a bear market. However, it’s not much of a choice to just accept no returns on the other half of the portfolio to maintain safety.
We’ve spent a lot of time and effort trying to figure out how best to navigate this environment. We’re always searching for alternative investments that can provide more return or more safety, as well as being tactical with the portfolio to avoid unnecessary risks.
If you’d like to understand more about how we’re positioning portfolios in today’s environment, please reach out to us by phone or email and we’d love to answer any questions you have.