Why the Bomb Proof Bond Portfolio Isn’t So Bomb Proof Anymore


Money magazine recently had an article on different investing strategies for those going into retirement.  One strategy they laid out was what they called the “bomb-proof bond portfolio.”  The idea there was to invest retirement money in bonds with the bonds maturing at different times throughout your retirement.   For example, you might start your retirement with a couple of years’ worth of cash and then buy bonds that mature in three years, five years, seven years, ten years, fifteen years, twenty years, twenty-five years.

The amount invested in each bond would be the amount needed to pay for expenses until the next set of bonds matured.  For example, If you needed $50,000 per year, you might have $100,000 in cash for the first two years, have another $100,000 each in the three and  five-year bonds, $150,000 in the seven-year bonds, and so on.  Note that $1.5 million would be needed to fund a 30-year retirement with this strategy.  The last quarter million dollars would be in the bonds that would mature in 25 years.

The type of bonds selected by the strategy was US Government Treasury bonds.  While the interest rates are low, the risk in the past has been almost zero (actually, the interest rates have been low because the risk has been almost zero).  The idea here was not to make a significant return on investment, but to just keep up with inflation.  The issue with applying this strategy today, however, is that these bonds are not as risk-free as they once were.

The debt load on the US Government is approaching unsustainable levels.  Debt has increased from less than $9 T in 2008 to over $17 T today.  Interest payments on the debt are still a relatively small amount compared to income from taxes and other sources, but this is largely due to low interest rates available to the US Government.  This could change quickly if creditors started to feel that there was a greater risk of default or a country such as China decided to stop buying new debt for strategic reasons.  Understand that government interest rates are reset constantly since debt must be refinanced regularly, so the low interest rates currently being enjoyed are not locked-in as would the interest rate on a home loan.

There are also several bills that are starting to come due for the US.  Many people are starting to receive Social Security and Medicare benefits as the Baby Boom generation retires.  This is coupled with declining revenues from new workers as young people increase the amount of time spent after high school before getting a significant job.  All of these factors together are going to lead to a situation where the debt service will become ever larger and start to compete with government employee salaries and benefits and the provision of government services for limited revenue dollars.  It is extremely likely that some sort of a default would occur if one were to set up a “bond-proof” portfolio at this point.

To find a way to provide retirement income in this environment, one needs to realize that a government default is not the same thing as an economic collapse.  While there are a lot of companies that depend on the government for revenue, there are a lot that do not. The US economy is not the same thing as the US Government.  A default would cause an immediate reduction in the goods and services provided by the government, and things like Social Security benefits would be cut since the government would not be able to spend beyond its revenues for a period of time, but critical services needed for businesses to operate like military protection and courts would be provided.  Retirement funds should therefore be spread out into a variety of assets, including corporate bonds, common stocks, real estate (or REITs), and foreign assets.  US Government securities should be viewed with a great deal more suspicion than in the past and should make up a limited portion of one’s retirement portfolio.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The SmallIvy Book Of Investing is Now Available!


BookCoverPreview

Finally, after a lot of writing and editing, the first SmallIvy Book of Investing is available for purchase.   They say that there is a state of purgatory between finishing the writing on a book and getting it published.  I can say that is definitely true from my experience.

The book covers a lot of the topics I cover on the blog.  The central theme of the book is the Serious Investing idea, where large numbers of shares of a select group of companies are purchased and then held for a long time.  The book also gives the basic on different types of assets, talks about how to set up your cash flow to get money to invest and grow wealth, and gives information on what you should be doing at different stages of your life to become financially independent.  I’m hoping to sell a few copies, but I doubt I’ll make even minimum wage for the hours spent writing and editing it.  My main goal is to help people learn to handle money and grow wealth.  It is really within many people’s grasp to retire wealthy and not need to worry about money – they just do the wrong things.

It will be available on Amazon soon.  Copies can be ordered currently from Amazon’s affiliate, CreateSpace for $14.99.  To order, please go to this link.

Here’s a sample from the book:

Introduction

Many people dabble in the stock market. Just like the gambler in Las Vegas, people spend their time tracking different stocks, buying and selling on the latest news, and generally not making much money at the end of the day. The 1990’s saw the rise of the penny ante day trader. These individuals would sit at home on their computers or go to rooms full of workstations where they would attempt to make money trading stocks as they went up or down by quarters or eighths of a dollar.

They had visions of trading during the mornings and then playing golf in the afternoons. It was shown that an individual would need to be right about 80% of the time to make a profit this way, after paying all the fees and commissions. Obviously very few people did well over time.

For some who have already made their fortune through running a business or other means, the stock market is merely a form of entertainment – a way to get a little excitement during otherwise bland days. These people are not investors and they will never really make much from their activities. It just gives them battle stories to tell at parties.

A true investor is like the fisherman on the American frontier back in the 1800’s. Unlike the modern angler who plays around with different lures and may throw back much of his catch, the frontiersman needed to catch fish to eat. He would do what was effective, like placing a net under a waterfall or building a fish trap, rather than what was sporting. He did what worked, even if it wasn’t particularly exciting.

Investing for growing wealth, what I refer to as serious investing, is not exciting. It is not the talk of cocktail parties and chit chat for the water cooler. It is doing what works and doing whatever is needed to put the odds in one’s favor.

A serious investor is not the favorite of the broker since he rarely trades. He builds up large positions in a few great companies and then holds for years or even decades. He buys companies, not stocks. The price patterns of stocks, e.g. trends, ceilings, floors, etc… are not important to him except perhaps as a way to get a better price on a purchase or a sale.

The serious investor saves and invests a portion of his income because he understands that it is worth the delay of gratification to have a steady stream of revenue that requires no additional labor. He understands compound interest and knows that to become wealthy, one must receive interest instead of pay interest each month. The serious investor first wants to use investing to grow wealth and thereby gain economic freedom. Once there, he then wants to be able to ensure a lifelong stream of income without losing the principle he worked so hard to build.

This book is for the small investor who is serious about growing and then maintaining wealth. It first presents a strategy for a young investor with a long time to invest (30-50 years) who has little money and wants to grow assets. This strategy is not the typical investment spiel about diversification, proper balances of stocks and bonds, etc… provided by many financial advisers. It is not that diversification is a bad thing, it is that diversification is designed to preserve capital, not grow capital. The goal of this book is to present strategies to beat the market, not just match it, at least while one is young and has little capital to protect.

The strategy presented for the new investor is to invest concentrated amounts in a few stocks that one believes are going to grow for years and years, and then hold them for years and years. One wants to catch the next Microsoft, IBM, or Cisco. One may get a few losers along the way, but one big winner will make up for a lot of losers. As gains are made, some of the money is diversified into mutual funds and spread among a greater number of stocks to preserve the gains.

The book then presents strategies for the investor later in life who has grown a substantial portfolio and would like to preserve it while gaining some income for living expenses. It is here that diversification is increased and cash is maintained to reduce the risk of market fluctuations affecting one’s income stream. Some exposure to equities is maintained even at this stage, however, as a hedge against inflation, but mutual funds are more important.

Information on stock picking is not included in this book, but will be included in a second book. Indeed, stock picking is worthy of its own book since there is a lot of information one must absorb before becoming a good stock picker. Even then it is a craft that is learned through experience rather than something that could be distilled down into a procedure.

Having dispensed with the preliminaries, let’s end this introduction with a brief summary of the reasons for wanting to become wealthy. It goes well beyond the superficial lifestyle portrayed by celebrities and rock starts. In fact, if the reader is looking to have lavish parties and buy tons of superficial things, he will be sadly disappointed. The lifestyle of celebrities is more due to their large incomes than their money management skills. People who attain and hold onto wealth have nice things but tend to be more frugal than the average NFL quarterback.

Instead, the reason for becoming wealthy is to have freedom and security. The ability to just pay for things when life’s little disasters happen. To have all the things that coworkers have, but to actually own them rather than rent them with a credit card and a home equity loan. To not always be living always on the edge of default if a paycheck is lost. To be able to choose a job you love, instead of working to support a lifestyle.

It is also ethical to live in an economically sustainable fashion. Indeed, there is virtue in the growth and maintenance of wealth and many benefits to society. In the very least, those who can take care of themselves don’t burden others. It is also those who are firmly on the shore who can best rescue others who are drowning. It is the people who have money who are able to support churches, charities, and neighbors.

An Easy Way to Invest $25,000


Investing need not take a lot of time or effort.  It also doesn’t take a great deal of learning (although a copy of the Small Investor Book of Investing wouldn’t be a bad idea if you wanted to learn more).  Mutual funds make it very easy.

The simplest way to invest is to buy a set of index funds.  With $25,000 I would buy a large cap fund, a midcap fund, and a smallcap fund.  I would put more in the midcap and the smallcap than the large cap.  For the simplest investment possible, just buy these funds and forget you have them (OK, you’ll need to pay some capital gains taxes, so remember to look at the 1099 the mutual fund company sends you watch year, but that is really about it.  As you near retirement, sell about 8% of the shares and continue to do this each year.

If you are willing to put a little more time in you can increase your return through one additional step.  Let’s say that you decided to put $10,000 in the smallcap index fund, $10,000 in the midcap index fund, and $5,000 in the largecap fund.  This would be a distribution of 40%, 40% and 20% in the small, mid, and large cap funds.

Let’s then say that after the first year you had $15,000 in the small cap, $20,000 in the midcap, and $5000 still in the large cap.  This would be a balance of 38%, 50%, and 12%.  You should rebalance the portfolio to return to the 40%, 40%, 20% distribution by selling some shares of the midcap fund and buying shares of the smallcap and largecap fund.  This will have the effect of selling the shares fo the fund that did well (selling high) and buying shares of the funds that didn’t do as well (buying low).  Note that this will result in realizing capital gains, so it is not worth rebalancing unless there is a significant difference between the current allocation and the targeted allocation.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.