Professional financial advisers know that high quality bond interest rates are historically low. And that can be a disaster for some customers.
When retired or retiring clients understand the current and likely future state of bond investing, and how it has changed in a way that will deprive them of the benefits their parents enjoy, it will be up to their financial advisor to decide. to advise.
What you do during this discussion just might be the difference between your practice of growing, swimming in water, or sinking.
Here’s how to explain the realities of today’s bond markets to your clients and help them adjust to the new realities of bond investing.
The risks your clients run by holding bonds today
The bond market was once a way to balance your clients’ equity portfolios. Now, that looks more like a proverbial chicken game, which makes it similar to the stock market with its sky-high valuations.
Yields on high-quality US Treasuries and corporate bonds – those rated A or better – have been low for some time.
The 10-year Treasury bill has yielded well over 4% for decades. Over the past decade, it has rarely exceeded 3%. One of the reasons was low inflation, but inflation, as measured at the government level, is accelerating. While Federal Reserve Chairman Jerome Powell likes to call inflation “transient,” that word only means “not forever.” Your customers don’t plan to live forever. Their concern is the coming decades, a period in which higher inflation is an obvious possibility.
This reality has probably caused some players in the financial planning industry to seek yield by holding lower quality bonds. But these financial products are only worth the implicit support of the Fed.
The number of companies issuing lower quality bonds that cannot make their payments has increased, thanks to the removal of rates for so long. This might not be a reason to avoid junk bonds, but it should be a reason to change the way you rank them for customers. These are not so much bonds as equity instruments, with the potential for volatility similar to that of stocks and a bit more yield.
There may come a day when the market feels that the Fed cannot save BBB-rated bonds and below, preferred stocks and convertibles. Then, as in past credit market crises, they will explode without much warning.
Why you should care, even if your customers don’t
When clients find out that the fee percentage rate they pay represents most or all of the return they earn on the bond portion of their portfolio, how will you react?
In recent years, financial advisers have been able to hide behind the rate cut, which has added a price return to these paltry returns, producing decent total returns for bonds. And inflation was low, so advisers could position bonds as a value-added part of their investment work for clients.
But now, with rising inflation and falling bond rates, what explanation do you have?
This bond situation may have crept into clients. After all, the performance of the popular Barclays Aggregate Bond Index has fallen over the past decade. In addition, many bonds held by active bond managers are rated BBB-, the lowest investment grade level.
Imagine the chaos that would ensue if Fed support waned and some of those BBB bonds fell to BB +, the highest junk level, forcing funds that track the benchmark bond to sell off much of the market. their holdings, probably without much interest from buyers. This is just one of the potential victims that the state of the current bond market has put on the table for clients.
Create a potential alternative solution
Before you decide to simply turn your 60/40 portfolio into a 100/0 portfolio, made up of all stocks, consider that there are other ways to replace what used to be your market balance. It starts with the concept of tactical management alongside your major long-term investments.
Tactical management is now a more viable consideration for advisors. Simply put, tactical investing is all about making profits over shorter periods of time, such as weeks or months. This offers the possibility of generating a return on investment through a wide variety of asset classes other than bonds. It can also help stem large declines in value, as tactical investors don’t aim to hold their investments through ups and downs like a long-term investor would.
Customers are starting to learn more about the demise of bond investing. But the other major change in today’s markets is how increased volatility and expanded opportunity creates more ways to seek out low volatility non-cash, non-cash, and non-bond investments that could beat bond yields. . For example, innovation in exchange-traded funds now allows skilled tactical managers to build and rotate portfolios, seeking small amounts of gains and proactively managing risk.
While advisers have traditionally used this 60/40 framework to buy and hold stocks and bonds, they can decide to allocate based not on the type of asset, but on the relative speed at which holdings are renewed. In other words, a balanced portfolio becomes an allocation based on the expected holding period of investments rather than stocks versus bonds. You split between long term investments and shorter term investments.
If you’ve ever spoken to clients about the “bucket” approach to investing, this is just a different version of it. But instead of the first compartment being just cash equivalents, which is a loss for your clients, your short-term compartment contains investments which can be more volatile if you hold them for the long term. But you reduce that volatility a lot by setting loss thresholds.
Transmit the message
Once you’ve created your answer to the bond quagmire, you can celebrate by describing it to your clients.
If you offer an alternative to standard bond strategies, chances are they will be receptive to it. Bull markets tend to trick investors into thinking that all advisers are the same. This is your opportunity to stand out at a time when they need you.