Fixed-Income

Imagine a title:  "FIXED-INCOME:  Mr. HYDE becomes Dr. JEKYLL".   Or another sub-title could simply be, “Don’t lose our money!”  ...because that is exactly what can be at risk now with fixed-income investing.  Don't use the last thirty years as your guide because the rear view mirror is a dangerous guide to the road ahead.  Even text books on fixed-income are out of date, and too many advisors are unprepared for risks hitting fixed-income markets over the next 3-to-15 years.

Growth-Investors could get a free ticket on this because you’re already confident when markets rise, fall, and rebound over time.  But fixed-income is altogether different, yielding NEW RISKS OF CONSERVATIVE INVESTING particularly for income-investors who want to avoid risk.  Maybe this isn't you!  But if it's your parents or grandparents – holding money in term deposits, certificates or bonds that pay nothing today – you need to be aware of two devastating risks.  #1 earning nothing means you can run out of money.  #2 rising interest rates can quickly hasten your money’s demise.

Quick tidbits, then we start.

#1 We all know people needing a strong and rising income for Life!  Is there someone you know who may need help in this area?  Where would you recommend they find help?

#2 Guide me if you see a way to write even more clearly here.  This is a challenging subject and I want to make this as simple and direct as can be.

#3 To learn if or how Life Annuities may fit your needs for Fixed Income ... see HERE.

FIXED-INCOME:  HYDE INTO JEKYLL.

Fixed-income investing will impact your life and family over the years ahead.  Wrong choices can steal your wealth and security – for years or even for life!

What is fixed-income?  This includes cash which pays nothing, and government or corporate bonds which pay a percentage or coupon (income).  Not long ago 30-year bonds paid over 8%;  10-year bonds paid over 6%;  5 year bonds paid over 4%.   Today these bonds are paying < 2% which can’t even keep up with the price of cat food.  Worse to come, see below “demonstrating a bond”.

How big is the problem?   While stock-losses hopefully recover in 4-7 years, bond markets follow cycles that may take 30 or more years to recover.  33 years ago interest rates reached 20%.  As I write this even 10-year rates are < 2%.  Some countries today even pay “negative interest” (charging you to deposit).   This cannot last.  It’s a dead-end.  Surely we know rate will rise.  4%, even 6%, someday 8%.  It’s a massive shift that can hit like an exploding IED -- destroying peoples' money without further warning!

Pic _ fan of paper currencyDemonstrating a Bond.

I have a simple story to help demonstrate bonds and how they work for (or against) you.  So wherever you are right now, reach over and pull out a drawer.  Any drawer.  Let's say it’s your desk drawer.  Every year this is the drawer that opens to pay you $30,000 …and you’re happy!  If rates are 3% and the drawer is paying $30,000 per year, your desk is worth $1Million!   (This analogy would refer to a million dollar bond.) 

But what happened when rates fell to 1.5%?   You kept getting $30,000 but the paper-value of your drawer or bond doubled to $2Million(How? … because 1.5% interest rates suggest a bond paying $30,000/year is worth $2Million.  Lucky you!)

Sadly though, if you still own that bond and rates return to 3% (getting $30K/year) your bond shrinks back to its value of $1Million(Unlucky if you still own that!)

What’s worse is as rates rise to 4%, 5%, your bond’s value diminishes further.  At 6% it drops to Million.  Remember the 1990s when 9% seemed happy?  …getting to 9% in the future puts your bond value at only $1/3M thus stealing so much of your prized wealth as your bond only pays 3% when the world is expecting 9%.  And can you recover?  Maybe in 35-60 years if rates again plummet to all-time historic lows.

Can it be that bad?

There were 8 weeks between May and June 2013 when the federal reserve raised interest rates 3/4 of 1%  …( 77 bps ).   Would you have thought bonds could lose 3% to 11% that quickly?  Here’s what happened in different sectors of the bond market:

  • FTSE TMX Canada Corporate-Bond Index (CAD) dropped 2.91%.
  • FTSE TMX Canada All-Government Bond Index dropped 6.85%.
  • FTSE TMX Canada Real-Return Bond Index dropped 11.35%.
  • FTSE TMX Canada High-Yield (Junk Bond) index lost 0.29%.
  • C.S. Leveraged-Loan Floating-Rate index gained 4.15%.

After a restless 2013, the world economy crawled through 2014 with ever lower rates …even hitting 0% or negative rates (Europe/Japan/etc).  From 0% today, which way will they go next?  ... They’ll have to rise!   And with rates rising, most fixed-income securities will lose value (as you’ve seen above).

HOW TO GET THE RESULTS WE WANT

As part of our planning -- and included in your certified financial plan if you and I are working together -- you’ve told me the results that are most important to you or for your family.  You said:

  • “don’t lose my money!”  
  • “an active lifestyle – never fall back.” 
  • “live and travel, and see my money grow.” 
  • “to help my children, and my grandchildren.”  
  • “if I need a retirement home, ensure it’s a better one.”
  • “confidence and dignity, for life, for our estate.”

Our plan and process together can assure strong and vital results through “Life Income Mandates”.   This means Inflation-Indexed Income for Life.   Modest risk, speedy recoveries, this strategic income supports Life and Lifestyles as we’ve discussed in your planning.  (See page 95-99 in my book “A Lifetime of Wealth” – also expanded in this website as Global Income ...use the search-bar above and tour through Dividends, Real Estate, Infrastructure, Fixed-Income, Life Annuities.)  Combining these mandates into a rigorous plan can guarantee you’ll always have money.  And you can outpace results (measured by risk/return) of many of the major pensions and stock/bond indices as well.

FIXED-INCOME.   REAR-VIEW, FORWARD-VIEW.

Below is a picture you could use to optimize fixed-income returns over the past ten years from 2005 to 2014.   With thanks to RBC GAM for this, freely expand the view (or click) to a comfortable size and then ponder the following questions.

Pic _ Bond Graphic

  • Which areas do you understand best? …cash? …govt bonds?
  • How often did cash actually pay the least (appear at the bottom)
  • How often do domestic govt bonds compete in the top two rows? 
  • Would you ever know in advance which sector will do best, or least?
  • Would you know – could you guess – how/when to shift categories? 
  • If you were doing it yourself for 10 years, would you have been ok?
  • What would you do now if rates double or triple in the next 10-15 years?  

As Mark Twain famously said, forecasting is difficult, especially about the future.   But FUTURE is exactly where our fixed-income teams must achieve strong returns for you.  And it’s why we generally have two or three teams expertly guiding our clients’ fixed-income needs.   With 5 foremost levers to fixed-income investing, if one team is out of step for a year, the other team can be stronger.  Each team will have its time at the top, but looking ahead over 5, 10, 15, 25 years, we must Reduce Risk and support endless and inevitable Income for Life!

                     LIFE INCOME MANDATES  ==> INEVITABLE INCOME FOR LIFE

Five Keys to Fixed-Income Decisions include:

   1. DURATIONif rates are rising, 2-to-5 year duration become safer;  10 to 30 year duration adds risk.

   2. CREDIT QUALITY:  governments can tax; corporations provide earnings; can they keep paying?

   3. CURRENCY:  Canada, USA, European or other – will currency shifts raise or shrink your value?  How will you adjust or manage such currency risks?

   4. YIELD:   may range under 0% to well over 10%  (Canadian or foreign, triple-A to lower-quality and "junk" status).

   5. GEOGRAPHY:  Canada or U.S. bonds, or world benchmarks (which typically are 93% US/Europe) are offering rather meagre returns.  Might you want to strengthen this by exposing your investment to high-growth economies & currencies, younger populations, such as Mexico, Malaysia, Indonesia, India, Chile, Poland…?

PUTTING THESE 5 KEYS TOGETHER

To optimize these keys, most people are not in a position to choose their own bonds (as they come in units of $100,000 or $1Million or more).  Even ETFs generally fail to optimize these 5 levers I’m sharing with you.  And frankly, four or five years ago we too advised fixed-income differently than we do today.  Times have changed – most especially now for fixed-income!  So what we can do - as soon as possible - is either confirm your fixed-income holdings as a strong and lasting reservoir for Life-Income …or adapt your plan now to reduce risks and sustain your wealth and wellbeing forever!

Brian Weatherdon,  MA. CFP. CLU. CPCA. CRC. MDRT. 
627 Guelph Line, Burlington, Ontario. L7R 3M7.   905-637-3500 x 223. 
Ret.Coach SEALCertified Financial Planner.  Certified Retirement Coach.
brian@SovereignWealth.ca 
Amazon: “A Lifetime Of Wealth — And How Not To Lose It.”
To explore Life Annuities visit HERE.
AND SEE:   "STICKY MONEY"introducing the total Life Income Mandates.
 
 

5 comments

  1. Thanks for the newsletter Brian. I read your illustration of a bond and while I understood the notion of the value of the bond rising or diminishing as interest rates changed, I don’t understand the premise of investing in the bond in the first place. Specifically, purchasing a $1 million bond paying 3%, I get $30,000 annual income. Would the bond not still be worth $1 million at maturity? …recognizing that if I tried to sell it before maturity the value would depend on the prevailing interest rate.

    • Yes you’re right – holding a bond to maturity you’d receive the full face value of the bond then (and without any loss). This also means that along the way, the dedicated bond owner must ignore the rise and fall of market-values associated with their bond holdings. We know however that Human Beings may smile brightly at seeing higher account values, and worry themselves when values head downward. If the next ten years were to see interest rates jump from 2% to 6% or beyond, our theoretical example would see values fall considerably, leaving a frown on face of the bond-owner.

      Solving this prudently today requires that we diversify our fixed-income (as suggested in the 5 keys above) and engage other vital mandates for steady and rising yield over the years (see “Life Income Mandates”).

      Thanks for asking; excellent question. 

  2. Nicely written Brian you’ve highlighted some very important points. In today’s environment where borrowers are rewarded at the expense of savers – fixed income investors are waking up to the sobering reality that safety is indeed risky. I believe in order to generate respectable yields in retirement one must either: invest more money in the market; invest for a longer priod of time; or invest differently. I believe a combination of the first two would br helpful but not as feasible as the last option. There’s no telling how long rates will remain low or even how much lower they will go (Sweden, Switzerland, Denmark, and the European Central Bank are all currently paying negative deposit rates) – but if events in Europe spill over on this side of the Atlantic we could be in for a long ride before we see any moderation in rates which ultimately means more painful times ahead if new income approaches aren’t considered.

  3. According to Bloomberg May 5/15, “It’s taken just two weeks for U.S. government-bond investors to lose $195 billion.” Two interesting quotes appearing on Bloomberg that day are worth considering if you want to reduce the escalating risks that are peculiar to fixed income:

    “Billionaire Warren Buffett said this week that “bonds are very overvalued,” and he’d short-sell 30-year debt if he could.” … “Bill Ackman has piled on, too. ‘I don’t like fixed income as a category, particularly at today’s interest rates.’”

    All the more caution, to ensure we bring effective strategies for fixed-income investing (alongside other global sources of life-income).

  4. May 15/15 Globe and Mail: “These days, with interest rates so low, money market funds have become an outstanding way to erode your purchasing power, while Canada bonds aren’t offering a much better deal.”

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