What About Bonds?
Bonds will be a terrible investment over the next 10 years. That is the conventional wisdom in the investment community lately.
“Bonds are the worst asset class for investors,” says Professor Burton Malkiel, the author of A Random Walk Down Wall Street, in an opinion piece published in late March in The Wall Street Journal. “Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser.”
This prediction may or may not be correct; however it is important to review the reasons why investors should hold bonds in a diversified portfolio.
What Are The Risks of Owning Bonds?
There are 3 components of risk in owning bonds. Issuers of bonds (corporate or government) can default and not repay you. Default risk can be very low (U.S. Treasuries) or quite high (corporate junk bonds). As interest rates rise, the market value of your bond holdings will go down (interest rate risk). Over the past ten years bond returns have been very good due in large part to the increase in market value as rates went lower and lower. Inflation is a source of risk that greatly impacts an investor’s purchasing power in retirement. For retired investors, interest and dividends are an important source of income. If inflation outpaces interest rates, the bond investor’s purchasing power decreases.
It is likely that bond returns will not be nearly as good as they have been over the past ten years. So what should an investor do about it?
- Sell bonds and move into cash or CDs, waiting for interest rates to rise.
While it seems like a good strategy, it’s very difficult to predict when rates will rise. They may stay low for several more years. Inflation is likely to outpace interest payments from cash reducing their real value and purchasing power. - Sell bonds and re-invest in the stock market.
In addition to expected return, high quality government bonds are a low-risk way to diversify a stock portfolio. An investor would greatly increase portfolio risk using this strategy. Ask yourself if you can stomach the volatility of a 100% stock portfolio during a period like 2008. Most investors would be unable to ride out that storm. - Reach for higher dividends by reallocating to longer-term or corporate bonds.
This strategy will also increase risk in a portfolio. Longer-term bonds are more volatile and sensitive to interest rate changes. Corporate bonds increase default risk if the business offering the bond fails. - Do nothing.
Bonds are in a portfolio for good and valid reasons. Over the long term, interest income – and the reinvestment of that income – accounts for the largest portion of total returns for many bond funds. The impact of price fluctuations can be more than offset by staying invested and reinvesting income, even if the future is similar to the rising-rate environment of the late 1970s and early 1980s.
I don’t recommend selling bonds and buying either cash or stocks. However, there is merit in adding longer-term Treasury Inflation-Protected Securities, or TIPS, and short-term corporate bonds into a portfolio for investors willing to accept the additional risk. There is no way to reliably predict future interest rates or inflation, so most investors will fare very well by leaving their bond allocation alone and riding out the market cycle.
2011 Review and 2012 Plans
Over the holidays, many of our clients and friends asked how business is going. I thought it would be a good time to provide an update on Rockbridge Investment Management and what we are looking forward to in the New Year.
Financial Results
As a firm, Rockbridge continues to grow steadily. Over the past two years we’ve grown the amount of assets under management by 20% from $194 million to $232 million. While the markets have contributed to this increase, most of this rise is due to new clients who have discovered our firm via a referral from a current client or through our website.
Surprisingly, a significant number of our new clients have found us via our website after searching for a local fee-only advisor. We’ve invested in website improvements to bring our story to more people. We don’t have an advertising budget and rely on referrals as our main source of new clients.
Our Business Model is a Winner
While our clients know this, it’s worth repeating. Rockbridge is a fee-only Registered Investment Advisor (RIA). Our only source of revenue is from fees paid by clients. We have never accepted a commission from a product we recommend. The fee-only RIA business model has experienced steady growth while commission-based brokers continue to lose market share as individual investors discover the value of working with an objective fee-only investment advisor.
Our Fees Are Modest
Our mantra continues to be “costs matter.” The amount an investor pays in investment costs will definitely affect their standard of living. We continue to have a relentless focus on costs for our clients. Each year, Charles Schwab surveys the advisors they service. Rockbridge participates in order to benchmark our firm against others like us. The survey revealed that our management fees are less than our peers. Our fees for a typical client average .50% of assets managed versus our peers whose fees average .67%. Lower investment costs mean more money in our client’s pocket.
Education Never Ends
Our firm is part of a study group of likeminded advisors committed to the passive investment philosophy. We meet quarterly in New York City to discuss investment strategies or products and compare notes on our business practices. The insight we get from these meetings makes us better advisors. We also continue to be a member of The National Association of Personal Financial Advisors (NAPFA). NAPFA is the country’s leading professional association of fee-only financial advisors—highly trained professionals who are committed to working in the best interests of those they serve. NAPFA holds several training events throughout the year that we are proud to be a part of.
Plans for 2012 and Beyond
We will continue to meet with clients to review their investment plans. There is no way to predict future returns; however, we are confident that markets will reward investors for taking investment risk over the long term. Expected future returns may not be as high as in the past, as articulated in Craig’s accompanying article, so we will continue to help clients determine the right amount of risk to take in order to meet their financial goals.
Changes in technology and new investment products are introduced at an ever increasing pace. We take time to evaluate new technologies and products on a regular basis. We spend money on technologies that make us better, more productive advisors. We are slower to make changes involving new investment products since many are designed to maximize profit for their own companies, not necessarily for their investors.
Our strategic plan for the next three years calls for modest growth both in new clients and firm revenue. Our five professional fee only investment advisors have capacity to help more individual investors. As the baby boom generation is poised to start retiring, we look forward to referrals from our clients and professional networks.
Recent regulatory changes to be enacted in 2012 will shine a light on the abuses in the 401(k) marketplace, especially for small employers. At Rockbridge, 31% of our revenue comes from managing 401(k) plans for small business owners. We are poised to be an objective partner for other small firms who care about their employees and their retirement goals.
In conclusion, we continue to be passionate about our investment philosophy and thoroughly enjoy working with and educating our clients. Personally, I enjoy coming to work every day surrounded by smart, confident, passionate people.
Schwab Index Fund Changes
Many of our clients will be receiving a notice from Charles Schwab regarding a recent change in investment policy for two funds that we use in portfolios. The Schwab Small Cap Index Fund (SWSSX) and the Schwab International Index Fund (SWISX) are affected.
Here is the communication from Schwab to advisors:
We want to make you aware that the indices for the Schwab Small-Cap Index Fund® (SWSSX) and the Schwab International Index Fund® (SWISX) will be converted from Schwab’s propriety indices to the Russell 2000® Index and the MSCI EAFE Index, respectively. Although these conversions will not happen until December 14, 2011 and December 20, 2011, we are required to mail a 60-day notification to your clients invested in either fund as of October 14, 2011. Additionally, as of November 1, 2011, the Schwab Small-Cap Index Fund’s expense ratio will decrease from 19 basis points (bps) to 17 bps. You may review a copy of the prospectus supplements here and here.
The Russell 2000 Index is an established index that measures the performance of the small-cap sector of the U.S. equity market. The Russell 2000 is a subset of the Russell 3000, representing approximately the 2000 smallest issues and approximately 10% of the total market capitalization of the Russell 3000.1 The MSCI EAFE Index is an industry-recognized index composed of MSCI country indices representing developed markets outside of North America—Europe, Australasia, and the Far East.
Converting to these indices from Schwab’s proprietary indices offers more transparent fund management for all segments of investors, plus better tracking and comparison data from third-party providers. Lowering the expense ratio of the Schwab Small-Cap Index Fund offers a better investment value for your clients.
Both funds have performed as expected against their respective benchmarks in the past. We believe these are positive changes and both funds will continue to be excellent representatives of their respective market segments.
Please give us a call if you have any questions or concerns about the changes.
Social Security and Medicare Decisions on the Horizon for Baby Boomers
Two of the biggest concerns for aging baby boomers are longevity risk (i.e., not outliving your money) and rising healthcare costs. Social Security and Medicare are programs that we all pay into and expect to partially address these concerns. Social Security is often a cornerstone of a well thought-out retirement plan. It is adjusted for inflation, is tax-advantaged, will continue as long as you live and is backed by a government promise.
Social Security
Deciding when to start Social Security benefits is one of the most important decisions aging baby boomers will make. The Social Security Administration www.ssa.gov/ has a wealth of resources available online. And the local office representatives can provide the facts given your own personal circumstances. However, they will not give you advice on when to start taking Social Security. Our firm took a look at the options and summarized the information in a recent blog post on our website www.rockbridgeinvest.com/medicare-etc-cost-emphasis/. While we are not experts on all aspects of Social Security, we can help evaluate your options and provide excellent resources to assist you with making this very important decision.
Medicare
Retiree healthcare costs are also a major growing concern for baby boomers. Many will delay retiring to age 65 when they become eligible for Medicare health benefits. Our resident expert, Dick Schlote, has been navigating the Medicare maze for the past few years and has agreed to write a series of blog posts on the subject. You can find his first Medicare blog post on our website www.rockbridgeinvest.com/medicare-etc-cost-emphasis/.
Our main job at Rockbridge is to prudently manage our clients’ investment portfolios. We also strive to expand our knowledge in other important areas of financial planning, such as Social Security and Medicare. We continue to develop our website into an excellent resource for our clients and friends of the firm.
Mint.com – The Evolution of Personal Financial Software on the Web
Most successful investors start out as diligent savers. Saving is the tried and true path to reach your financial goals. For young people, the goal may be a car, a trip or an education. As we get older our goals expand to include buying a home, starting a family, paying for a child’s education and saving for retirement. Achievement of any savings goal is dependent on your ability and willingness to spend less than you make.
After my first full time job in 1990, I had to take responsibility for managing my own finances. My first budget was quite easy to write since I made very little income and had very few expenses. However, the act of writing down my goals was profound. As life got more complicated I continually searched for easier ways to keep track of my income, expenses and savings goals. Early spreadsheets led to the personal finance software Microsoft Money. Soon, Microsoft and its main rival Quicken dominated the personal finance software market. I spent many hours entering my growing number of transactions. The software became increasingly complex by adding features that I rarely needed or used. Ease of use was not a top priority for either company.
My frustrations were shared by a young engineer from Duke University named Aaron Patzer. In 2005 Patzer was inspired to create Mint.com as an alternative to the frustrating and difficult Quicken product.
Patzer created a simple and easy to use online interface for keeping track of financial transactions. His timing was perfect as online banking had exploded across the country. Patzer leveraged the availability of all that online data to bring the consumer a free resource that could easily and intuitively track all of your transactions electronically. By 2009, the company had 1.6 million users and was quickly bought by Quicken for $170MM. Today, Mint.com boasts about 5 million users. Some of the most impressive features of Mint.com are:
Tracking expenses – When you log onto Mint.com all of your transactions from your various accounts are immediately imported into your Mint.com account. The transactions are categorized for you automatically or you can enter your own categories which will be recognized going forward for future similar transactions.
Overview page – Once your accounts are synced online, you have a quick look at the current balances of all your accounts on one page. Scroll down to see the sum of all your assets, your current liabilities and net worth.
Budgeting – You can create your own budget or let Mint.com do it for you by tracking your expenses over time. It uses inertia in your favor by building a budget based on spending history.
Goal setting – You can set your own savings goals. Mint.com has 10 savings goals that span a saver’s life cycle. Use the ones that most interest you and ignore the others.
There are a few drawbacks to consider. The business model for Mint.com relies heavily on advertising and promotional offers from various sponsors. For example, if Mint.com records a transaction fee in your checking account you may see an ad for a “free checking” account from XYZ Bank. It’s not clear that such a business model is sustainable, but Quicken clearly saw the future of personal finance being on the web.
I am currently a devoted user of Mint.com. At first I was apprehensive about this online startup having access to my online banking, credit and investment information. I tested the waters with one checking account. Slowly I began to see the power of consolidating all of my accounts in one easy to use online location. My Mint.com account now keeps track of 2 checking accounts, a health savings account, 3 credit cards, a mortgage, a brokerage account and several IRA accounts at Charles Schwab.
I do not believe anything can be 100% secure online, but Mint.com does boast bank level encryption to secure your information. It’s a “need only” connection, meaning they cannot access your accounts online to perform actions such as an unauthorized withdrawal or transfer.
I would highly recommend Mint.com for anyone who wants to track their expenses or transition from one of the PC based software options like Quicken.
Please note that Rockbridge Investment Management has no affiliation with or financial interest in Mint.com and accepts no liability arising from the use of their services.
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