Compared to stocks, bonds can seem rather dull and uninteresting. But bonds can play an important role in your portfolio, as SMI executive editor Mark Biller explained yesterday on Moody Radio's MoneyWise Live. He also answered caller questions.
To listen, click the play button below — or, if you prefer, scroll down for a transcript. (And for more radio appearances by members of the SMI team, visit our Resources page.)
MoneyWise Live, with Rob West and Steve Moore, airs daily at 4:00 p.m. ET/3:00 CT.
To ask a question on a future MoneyWise program, call 1-800-525-7000 and mention you have a question for either Mark Biller or Matt Bell of Sound Mind Investing.
Steve Moore: During a 10-year bull market, bonds were banished from many portfolios, but December showed the wisdom of Ecclesiastes 11: "Divide your portion to seven or even to eight, for you do not know what misfortune may occur on the earth."
Well, Rob, with that verse — Ecclesiastes 11:2 to be exact — we're of course talking about diversification or asset allocation or not putting all of your golden eggs in one basket. And who better to talk about this than Mark Biller — no, he's not a chicken farmer. He's executive editor of Sound Mind Investing.
Rob West: That's exactly right. He does know a few things about golden eggs though. And, Mark, a delight to have you back on Moneywise Live.
Mark Biller: Thanks, guys. Good to be here.
Rob West: Do you make an allocation for golden eggs in the typical portfolio?
Mark Biller: Boy, I wish we could work that one in. That's a good idea.
Rob West: That would be nice. Hey, Mark, as we mentioned at the top, bonds really have taken a backseat in recent years. So why don't we start by you just setting the stage. Tell us a bit of the backstory on why that's been the case.
Mark Biller: Yeah, sure. So you can really trace that back to the financial crisis a decade ago. So coming out of that period, central banks all around the world, including the Federal Reserve here in the U.S., they were using their influence to push interest rates down to really unnaturally low levels, and then they just held them there for years. So here in the States, that meant that interest rates are near zero, whereas at one point I remember something like 60 percent of global government debt actually had a negative interest rate on it. It was just something that we've never seen anything like it before.
And the key to understanding this, Rob, is that bonds have this unbreakable mathematical formula that governs their returns. So anytime a bond's yield or interest rate is going down, that means its value or its price is going up and vice versa. So if a bond's yield is going up, that means its value is going down.
So to kind of tie this together, bond returns were great during that process when interest rates were being forced down a decade ago. But then once those interest rates were so low, everybody knew that bond returns were gonna stink when the rates eventually started rising again. And that's really what we've been working through these past few years — interest rates rising back to these more kind of historically normal levels. And that's really hurt bond returns. And, of course, in contrast, you've had stocks just ripping higher every single. So eventually a lot of investors ditched their bonds and piled into stocks.
Rob West: Yeah, well I want to talk in just a moment about how we should think about bonds and what place they should have in our portfolios today. You mentioned interest rates and it seems like so much focus these days is on the Federal Reserve, on the monetary policy. That is how central banks or our national bank manage liquidity to create economic growth, they control the money supply. But it seems like it's become a much larger piece of not only how the stock market moves, but how our economy reacts. Would you agree?
Mark Biller: Oh, absolutely. And it's really been that way for a couple of decades now. You know, the stock market, unfortunately, has gotten to the point where they really feel like the Federal Reserve has their back, and that impacts the amount of risk-taking that investors are willing to take. They take on way more risk now thinking that if anything bad happens, the Fed is going to bail them out. And you can see that so vividly in December. Investors were looking for that kind of reassurance from the Fed and didn't get it, and that's really when stocks fell off the table right before Christmas. Then, just a few weeks later, the Fed came back in early January and did reassure the market that actually we do have your back — and stocks immediately rallied.
Rob West: Explain for us the relationship between interest rates, stock prices, and bond yields because they're really all connected.
Mark Biller: Yeah, they really are, and it does get a little bit confusing, but we'll try to unpack that here. Rising interest rates are always gonna hurt bond returns because as interest rates go up, bond prices go down. But then at a certain point rising interest rates also starts to hurt the actual economy and that makes the prospect of a recession seem more likely. So whenever a future recession really starts to become a legitimate possibility and investors start to get worried about that, the stock market is always going to freak out about recession — especially so if the market is overvalued, which after a decade long bull market, that certainly has been the case now. So that's what we've seen the last few months of 2018.
So as those stock investors start to panic, well, what are they going to do? Almost always, as people rotate out of stocks and sell stock holdings, they're going to flee to the safety of bonds — and that's gonna push those bond prices up and interest rates back down. So there's almost a self-regulating mechanism here where interest rates tend to be the driver until the stock market panics — and then at that point those falling stock prices are going to benefit bonds. All of that, Rob, is why traditionally people have advised to own both stocks and bonds because stocks are going to do well most of the time, but when stocks panic — or when investors in stocks panic — then a lot of that money goes into bonds and pushes those bond prices up to help the portfolio.
Rob West: Yeah, which would make the case for the idea that if you're properly allocated according to your age and risk tolerance and goals and objectives, then you stay the course. It doesn't mean you check out or just put it on autopilot, but you should keep the long view in mind, which is why we invest in stocks and bonds in the first place.
But with the recent market setbacks, Mark, a lot of folks are tempted just to park money on the sidelines. So perhaps is this a time to take another look at how bonds can, in fact, balance their portfolios?
Mark Biller: Yeah, for sure. And, like you said, the ideal really is to have that good mix of stocks and bonds before the crisis hits so that you do feel comfortable staying the course. Now, if somebody is in a position today where maybe they don't have that proper mix and they're feeling the pressure and feel like they need to take some risk off the table, then, of course, it might be appropriate to sell down some of the stocks and increase the bonds. You hate to do that after prices have already fallen, but it's better than not doing that if there's a big bear market in the future.
The one caveat that I would add to that is interest rates are still very low by historical standards and right now you can get pretty attractive interest rates on very, very safe investments like money market funds, which are less risky than bonds. So if you have access, maybe through your 401(k) plan or something like that, to a money market fund that's yielding 2–2.5%, that might be a good alternative to some of the bonds that you might be offered. But you definitely want to check what interest rate you're getting because a lot of those cash options are not very good right now still at your bank or broker — and in those cases, definitely looking at bonds.
Rob West: Mark, let's stay with the 401(k) plan holder — somebody who's listening to us today who has a typical 401k. If they're not in one of the "target" funds where they actually manage the allocation to stocks and bonds for them based on their age and prospective retirement date, and they're actually doing that themselves, what type of bond fund would you encourage them to be looking for? Should they be thinking about short term versus long term?
Mark Biller: Well, the principle here that people need to know is that the longer the term of the bond, the more violently it's going to react to interest-rate changes. So short term bonds are not going to react all that much to ups and downs and interest rates, whereas long-term bonds are going to react a lot. So with interest rates, still fairly low, rising interest rates are still a threat — less of a threat than they were, say two years ago, but still a threat. So being really overweighted in long-term bonds is probably not going to be a good idea over the longer term. Now again, in a panic situation — kind of like we saw in December — long-term bonds are going to do great. But if you're looking at how do I want to allocate for the next several years, then typically intermediate-term bonds are a good sweet spot where you get better returns with a little bit less risk, but kind of a blend of short- and intermediate-term are probably the way to go at this point.
Rob West: Yeah, Mark, we often talk about the allocation to stocks and bonds and there are some rules of thumb out there. Uh, one of the most common is you take 100 and you subtract your age and the resulting number, when you do that, is the portion you should have allocated to stocks and then the rest to bonds. So if you're 50 years old, 100 minus your age, you should have 50 [percent] in stocks and bonds. Do you subscribe to that? Is that an oversimplification, or is that rule of thumb actually helpful?
Mark Biller: Well, I think it is helpful. I think it is a little bit of an oversimplification, too. So ideally I think a little bit better approach would be to build in your risk tolerance because people are different and you know, also your stage of life, your age. But in the absence of somebody to help you with that process, then I think that that type of rule of thumb can be helpful because it'll at least get you in the ballpark. You might be able to fine tune it a little bit better with the help of an advisor or the tools at soundmindinvesting.org, but it's a good starting point at least.
Steve Moore: Mark Biller with us today. He's our guest for the first portion of the program. You'll find more information about Mark and the entire team at soundmindinvesting.org. It's also where you can purchase a copy of The Sound Mind Investing Handbook, which we always recommend. It's a great primer on how to invest in stocks and bonds.
But, uh, guys, let's go to something a little bit more basic other than specific questions about bonds. Paul is with us from Holly, Minnesota — and Paul, what are you looking for?
Paul: Well, I've just come into the ability here in the last year or so to start to invest — and so how do you find a good a counselor, an investment counselor, versus a bad one? What do you do?
Rob West: Mark, you want to start?
Mark Biller: Sure. Yeah. I think, Paul, you know, it's very important to find somebody that shares your values. I think that's a key first point — whether that's a place like SMI or a place like Kingdom Advisors — somebody that's going to share your Christian values is going to be very important.
And then you also have to account for the fact that there are going to be some personality types that you're just going to "click" with better than others. So I would definitely advise talking with more than one person. Don't necessarily assume that they're all alike. But if you can set up meetings with maybe two or three different advisors and just ask them basic questions about what they feel like is appropriate for your situation, and get a feel for both how you interact with them and the type of counsel that you're getting. I think that that's a great place to start, and I'm sure that Rob has some ideas on that as well.
Rob West: Yeah, well, I think you're exactly right there. Paul, your next step is to find that investment professional that you really have a meeting of the minds with, that you feel like it's just a good match personally, that has the right experience and expertise you're looking for. But I would also encourage you to think about somebody who really understands the counsel of Scripture and can bring that into the equation. That's why we recommend the Certified Kingdom Advisor designation.
So your two next steps are probably, one to go to MoneywiseLive.org and search for a CKA in your area — just click on "Find a Professional" and you can put in your zip code. The other option is to go to soundmindinvesting.org. You can get some great information there on a biblical approach to money management and investing — and you'll also find some great mutual fund options there as well.
Steve Moore: Let's go to south Florida. Taylor, thank you for calling. Thank you for holding. How can we help you?
Taylor: Thank you for taking my call.
Steve Moore: Yes ma'am.
Taylor: My daughter is in PA school to be a physician's assistant. She graduates in August. She's taken out $50,000 in loans. When it comes time to pay it back — she does have over $100,000 that's invested right now — should she take the money from that, or should she just because she'll have a high income, should she start paying it back that way? And the caveat is she's not really a follower of Christ.
Rob West: Well, we'll certainly ask our Moneywise Live community to be praying for that, because that's paramount. Taylor, let me ask, what type of account is the 100,000 in, and what was the source of those funds?
Taylor: Half of it is in a Janus mutual fund that's, you know, pretty aggressive growth. So she's done well with that. And then the rest is divided with my financial advisor. She's got mutual funds and some stocks. It's kind of a mix.
Rob West: Okay. Are they in taxable accounts or is it in a retirement type of account, any of it?
Taylor: She has a little bit in a retirement account, but maybe only a couple thousand dollars.
Rob West: Okay. And what is the source of those funds? Was that a gift? Is that money she saved? How did she earn it?
Taylor: Oh, I see. So one of them, the one that's in the Janus is money that I put away for her for many, many years, and then we invested it. The other is, you know, when she was younger and she was Bat Mitzvahed and things like that. So she accumulated money.
Rob West: I see. Okay. Mark, 50,000 in student loans, 100,000 invested — what are your thoughts?
Mark Biller: Yeah. Well, I think along the lines of the questions Rob was just asking there — the retirement account money, I would not encourage her to take that money out to repay these loans. As a physician assistant, you would expect that she will be making a good income. There's really no reason to take money out of a retirement account where you're likely to get into interest and penalties. And, if nothing else, there are contribution limits that restrict how quickly you would be able to rebuild those funds. So I would take the retirement accounts off the table completely.
The rest of the investment money is a little bit more of an open question, and some of that might depend on how that money would be invested. If she's going to be investing, continuing to invest in stocks, of course that's going to be higher risk. The thing to keep in mind is every dollar that you use to pay off debt, you are essentially earning that rate of return, the rate of return of the debt. So if it's a loan at 5%, you're essentially earning a 5% return.
So the purely financial calculation is our, we're going to make more in the investment account then the interest rate of the loans. But of course that's unknowable, so you would want to lean toward trying to reduce that debt.
So that's kind of a long way around the answer, but I think that maybe even a blending of those two, um, of paying off some of the debt with that investment money might be appropriate — wouldn't necessarily have to be an all-or-nothing type proposition. Rob?
Rob West: Taylor, have you talked to her about this? What is her preference at this point? What is she thinking?
Taylor: Well, my ex-husband and I have different opinions. I mean, he wanted her to take the loan and I encouraged her to take the money that she has and use it for school. But, you know, she kind of went the way that he instructed her. I don't think that she's going to want to touch it to pay it back. So, you know, I just wanted to know what the biblical way, even though she might not care if I tell her what the biblical way is, I still want her to know.
Rob West: Well, I appreciate that. I mean, first of all, you've given her an incredible gift with this money and I think you need to talk through the implications. The good news is if she's able to control her lifestyle, if she is going to get a good paying job, she should be able to pay the debt without any problem, and she can keep this money invested. If it's weighing on her and she really wants to get out from under that, have the peace of mind and the freedom to know that she doesn't know anything and then build that back up — and can keep herself disciplined — there's nothing wrong with that.
But I think perhaps, you know, paying off a portion of it and then staying the course with these investments and prioritizing getting it paid off just as quick as she can will really serve her well in the long run. Hey, thanks for your call today, Taylor. It's a great question.
And, Mark, really appreciate your insights always when we have you, but today in particular on bonds.
Mark Biller: Absolutely guys. Good to be with you.
Steve Moore: Thanks, Mark. God bless.