Roth: I have a different solution that Iíve been using for the last 15 years. Probably 70% of my own fixed income is in certain CDs directly with banks and credit unions that have easy early withdrawal penalties, and that acts like a put. If rates do rise, you pay that small penalty and reinvest at the higher rate. I do have some bond funds and itís a complete myth that bonds are less risky than bond funds. The net present value of the decrease of the cash flow of holding a bond to maturity is equal to the amount that the bond fund falls when rates rise.
Orecchio: Can I argue that point? There is an additional risk in a bond fund that you donít necessarily have with an individual bond. With an individual bond, no one can force you to sell that bond, but in a fund if there is an exodus, a quick one, and thereís not enough cash on the sidelines, the fund manager may be forced to sell bonds at an inopportune time to create that cash. And we donít want our clients to be caught up in that.
Roth: I agree. You want funds like Vanguard bond funds where investors donít have a history of moving in and out like Pimco, which lost $41 billion when rates barely ticked up last year.
Blanchett: Regarding munis, they obviously can be an attractive investment for individuals based on their tax rate. Weíre more focused on corporates versus Treasuries, and we tend to shy away from corporates because, to everyoneís point, bonds are the safe part of your portfolio, so take risks in equities, not in bonds.
Foss: On the corporate side, we stay triple B or better because in a downturn you want to be sure the bonds are performing.
Orecchio: I may be a lone wolf here because we use junk bonds. We like them as an asset class in our bond portfolio. That said, we treat them more like equities than fixed income because of their volatility. But we like different dimensions of risk.
So youíre chasing yield but acknowledging thereís more risk?
Orecchio: I wouldnít call it chasing yield because weíre not as interested in the income that itís producing. We want different dimensions of risk in the portfolio because we donít know which risk will materialize when, and as a result we want to have broad diversification in all of our asset classes.
Blanchett: To me, itís paraphrasing Star Trek, where you have to boldly go where we havenít gone before. Given where rates are, given where the market is, you have to have a diversified portfolio. Adding high-yield is not chasing yield, itís just saying, 'Hey, whatís going to happen next? We donít know. Letís have a little bit of everything to have a diversified portfolio.í
Millions of Americans hold disproportionately large positions in cash following last decadeís financial crisis, the second market meltdown in less than 10 years. What talking points should advisors use with clients to get them to diversify?