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The question of the quarter has been “Why do you suggest I add bonds to my portfolio when CD’s and Money Market yields are fine – I lost money in Bonds”!
As 2023 hits the final weeks of the year it has become clear that interest rates are driving market sentiment. Worrying about the Fed’s next rate hike seems to have become yesterday’s concern. So, what’s next and what is a conservative / income-oriented investor to do given the current interest rate environment.
(Above picture taken in Ravenna, Italy at the shop of a famous local artist known for her work with mosaics)
Determine how much Stock risk you are able to emotionally handle!
Sounds simple…..but this decision drives a number of outcomes….emotional as well as financial. We have long written that stocks will regularly test your emotions with their constant fluctuation of value and patience and discipline is needed to hold on and weather the downturns. However, over the long term, even with the constant volatility stocks have offered the best return for investors. Stock volatility may take a few years off your lives but are undefeated over the long term.
Bonds are like Brussel Sprouts!
Growing up I loathed Brussel Sprouts – ours were steamed and served with no seasonings and worst of all - no butter! So as an young adult, my traumatized taste buds taught me to avoid Brussel Sprouts at all costs! Enter my Italian chef wife Mary…. who would serve a wonderful presentation of Roasted Brussels with red onion, pancetta finished with a splash of balsamic vinegar. For years I eschewed them based on experience…. when I finally tried them – wow – Brussel fan for life! Doug – seriously - Where the heck are you going with this analogy?
For the past three / four years – Bonds have left a bad taste in investors’ palates as investors experienced the worst possible combination while owning bonds / bond funds - Low-income generation coupled with eroding principal value as interest rates rapidly climbed. This hangover has resulted in a bit of a “lack of enthusiasm” for bonds. However, with rates now higher and appearing to be “higher for longer” bond investors are now poised to enjoy both high annual income and potential capital appreciation when the Fed cuts interest rates in the future (yes they will eventually cut rates!).
With interest rates at levels, we have not seen in years – and seemingly at the peak – Bonds are once again an attractive asset class. They pay significantly higher yields than money markets or CD’s and will benefit (capital appreciation) when interest rates begin to fall.
Certificates of Deposit & Money Markets
At its simplest level – a bank’s business model is to attract large levels of deposits and then loan that money out at a higher interest rate than they are paying depositors. Of course, the global business of banking is more complicated than this but in essence this is what they do. By issuing CD’s – banks tie up depositors’ money for x months or years against which they are able to base the duration of their loans. So what’s happening now - after years of interest rate pain – depositors are flocking to CD’s and money markets – feeling extremely please with rates above 5%. However (there’s always a however!) money market rates will begin to drop as banks hit their desired deposit threshold and or the rate environment begins to ease. This will cause depositors to ask – What the heck happened here?
When is risk free Money Market or CD’s a prudent investment choice?
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Money set aside to address life’s unexpected…its what I call “sleep at night’ money!
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Money set aside for a specific upcoming major expense in the coming year or two - house purchase, college tuition, wedding, major trip, etc.
To tie this up succinctly – having Money Market balances and CDs in a portfolio feel good, like a well-worn leather slipper on a winter morning…. But over several years – due to steady inflation and lack of any principal growth potential - only the slippers will provide you with the long-term experience you are seeking. Bonds are back and should be the destination for a conservative portion of a long-term portfolio.
Everyone's financial needs are different so please take the time to understand the different risks of investing in stocks, bonds and cash. Have questions - please reach out to the team at PWA!
If you would like Mary Birnies Roasted Brussel recipe - shoot me a note!
Cheers to all!
Doug
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