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Perceiving the Possible Evils of Bond Funds – Payne Capital Management
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Perceiving the Possible Evils of Bond Funds

Perceiving the Possible Evils of Bond Funds

 

 

 

 By Bob Payne, Managing Director and Chief Investment Officer (CIO)

As a young financial advisor working for Merrill Lynch in Philadelphia during the late 1970s, I remember selling a bond fund called a federal securities trust. It couldn’t have had a better marketing label: high-yield, government-guaranteed, diversified portfolio, and professionally managed. Around the same time, my first son Ryan was born. So I bought him a zero-coupon treasury bond that we locked in at 14.25% compounded.

Three Keys:
1

When rates go down, money pours into bond funds

The flip side is if rates rise, money flows out of bond funds

PCM counteracts this potential volatility by focusing on bonds with maturity dates

That was such a great investment. Not only did we make enough to pay for Ryan’s college tuition at Villanova, but there was actually money left over that we gave to him as a gift. However, I learned about the possible evils of bond funds two years into that investment. Ryan was up dramatically on the fixed income investment at the time, while my clients had only an 11% current yield and their portfolio was down. How ridiculous is that?

The reason is when rates go down, money pours into bond funds. Then the evil thing that happens is money will come flowing out if rates rise. There was a great article recently on CNBC titled “Check Your Bond Funds before Interest Rates Rise” that actually refers to bond funds as a ticking time bomb. It includes an interview with the Head of Fixed Income at AllianceBernstein, who says that if rates were to rise by just 1%, many of these funds could lose as much as 7.5% in one year.

Do you know what will happen if rates go up 1% and the portfolio declines 7.5%? You personally may not panic out, but millions of people who are invested side-by-side with you will. Then you’ll get penalized by the panic of those other people, because a bond fund is a collective investment of everybody’s portfolio.

How do you fix that? By having a fixed income portfolio with permanence and definition. It’s unavoidable that bonds will go down when rates go up. But every single one of the bonds that PCM owns has a maturity date, so by holding the bonds until they come due our clients will ultimately make more money and have a portfolio that gets reinvested at a higher interest rate.

IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Payne Capital Management, LLC), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Payne Capital Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Payne Capital Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Payne Capital Management, LLC’s current written disclosure statement discussing our advisory services and fees is available for review upon request.