The market woes have continued as we entered the 2nd quarter of 2022. However, the normal dynamic of bonds as a safe haven from stock market declines has not played out this year. While stocks are down 10%-15%, the broad bond market is down almost 10% off it’s highs. What does this mean for diversified portfolios? Is the 60/40 model of asset allocation dead? How should you allocate in the future? All of this, plus we answer listener questions from the mail bag. Tune in to hear it all!
Steve (00:03):
Welcome to plan for life now. Episode number 90, Dave. Welcome.
Dave (00:11):
Wow. Wow. Thanks Steve. Good to be here. <Laugh>
Steve (00:17):
Sounds like you’re a guest or something.
Dave (00:19):
Right. Welcome. I know. Cause we don’t do these. We don’t do these in person, I guess at some point, but, quite frankly, they work fine this way. What’s going on with everything
Steve (00:35):
I know
Dave (00:36):
Working fine. Why change things now?
Steve (00:39):
It’s a whole new world, a whole the impact of all of this. I mean, we’ve all heard it, but the, the work from home story, the remote working, the recording podcasts, not together, it it’s all changing,
Dave (00:55):
, and I, on purpose, I guess you said you had a lot to talk about, but I said just surprise me, but I don’t know if this is one of the things you had to talk about, but now we’ve gone through, it’s interesting. Probably a record number of podcasts where the stock market been down, where it’s basically been,?
Steve (01:18):
Yeah.
Dave (01:19):
That narrative, the narrative of all the other podcasts three, five have, has sort of gone away for all podcasts, 85 and later we’ve gone several now in a row where the market is just not so hot down, not even in the ballpark of its all time high, which is really the stock market story. So far anyway, of 2022.
Steve (01:47):
All right. So you, I mean, you’re diving right into the, the opening show notes that I made and I, I did actually make show notes here. So, let’s, let’s get right into it because you’re right. Frankly, the, the declines that we’ve seen since 2008 have been relatively brief. Obviously, we know that the coronavirus declines while it was horrible in that one month, it snapped back really quickly. And we haven’t had, big declines like that since 2008, but there have been you some 17, 18, 19% declines., I, I know it’s even hard to remember now, but back in 2018, we were worried that global growth was slowing in China was not going to grow as much and there was an 18% decline. But it basically only lasted, a couple months there. So you’re right, Dave, this, this is pushing on. If, if not longer than those other ones, it’s, it’s getting pretty close at this point.
Dave (02:54):
And it’s interesting because the reasoning for it is similar so far to that time, we decided to haul off the Baltimore to go to that conference with that retired fed vice chair guy who was basically gloom and doom saying it was like 10 years ago. One easy is ending interest rates are going to go up and you’re just going to see the market go down. Well, the guy’s prediction was only 10 years off.
Steve (03:21):
<Laugh> right. He wasn’t wrong. He was just early. Right. <laugh> exactly, exactly early. Yeah, but you’re right, because I mean you think back to that time period, we actually went back and looked when we saw that guy talk. We told this story before, but it was back in 2013 where he was talking about how the fed was going to raise interest rates and they were going to stop these asset purchases. And, that basically was going to lead to the market correcting by 25%, and everybody should just stick everything in treasuries or, or something safe and not invest in the market. Sort of a similar situation right now, the fed raising interest rates no longer doing that, quantitative easing, of course we’ve got the inflation question, whatever you want to call it, thrown in there, etc as well.
Steve (04:22):
So, the question is, was that guy right? Or is that the situation we’re in now? So here’s, here’s some notes that I made right now, right now being April 25th. I know it always takes a couple days before you guys hear this, but April 25th stock market is down over 11% off of its highs. If you are looking at small cap stocks or international stocks, or certainly if you’re looking at technology stocks you’re looking at even bigger declines, , at, at some point some of those even touched in that 20% range, which would officially be a bear market. Now that’s interesting. <Laugh> as a euphemism for, something that’s not great. That’s interesting, but I think, and what, what I’ve said is even more interesting is what the bond market has done this year. And Dave, the bond market, the broad bond market is down almost 10% year to date.
Steve (05:32):
Wow. And that’s absolutely incredible simply because in the past, when stocks have gone down, had these time periods where they’re, they’re down 10 or 20% bonds have been that natural asset class that rallies in a sort of a safe haven. And I think most investors have sort of gotten used to the idea that I have this balanced portfolio. If stocks are down, then my bonds will be up and I’ll just take withdrawals from my bonds for a while and then stocks will recover and then I, everything will go back to normal. So, this idea that, that bonds are town 10%, that’s, that’s troubling for a lot of investors.
Dave (06:26):
It is, I, I should interrupt right now for our clients who are thinking, oh my God, my bonds are down 10%.
Steve (06:34):
No,
Dave (06:35):
You have been kinda like that Fed guy, but with bonds, because we’ve been, we’ve been predicting interest rates to be rising forever now. And we’ve always, for the most part, tried to keep our clients in the short duration stuff. I guess anticipating, but anticipating pretty early, because we’ve been going through this speech with clients for a long time. What’s finally happening again now.
Steve (07:00):
Right. And yeah. And you’re right. I mean, I say the broad bond market is down almost 10%. most of the bond investments that we have are down three, four, 5%, which believe me, I’m not thrilled to be down that much. And I will talk about sort of broader how we, diversify. But you’re right. I mean we’ve held the belief for a long time that the place of bonds in the portfolio was not to try to take risk and, and squeeze out a few extra basis points there. The place of bonds in the portfolio was, was supposed to be that stability. So, first let me talk about why bonds are down so much and what that means going forward. And then let’s talk about portfolio positioning and how we diversified and have diversified beyond just stocks and bonds.
Steve (07:56):
So, some people, they want the real quick and dirty explanation of why would bonds be down so much? The easiest way to understand it is let’s look at a 10 year government bond from a year ago, a 10 year government bond a year ago was paying you interest of about 1.8%. So that meant if you went out, you bought a 10 year government bond, you would get 1.8% per year. And at the end of the 10 years, you’d get your money back. And that’s great. You could, if you could live with that, that’s fine. What’s happening now is a 10 year government bond is paying 2.8 or 2.9% somewhere in that range. So, what’s happened is if you’re one of those people owning the 1.8% bonds, nobody wants to buy that for full value. Why would they want to buy that for full value when you can get a brand new one for 2.8, right?
Steve (08:58):
So the value of your underlying investment has gone down. Now. That’s like I said, quick and dirty explanation of the bond market. Obviously if you own a bond fund, it’s much more complicated than that because you don’t own one bond. You own hundreds of bonds that are maturing at all different times. So of course, the reason why we’ve said stay on the shorter end of the yield curve, meaning have those bonds in your portfolio maturing in two or three years instead of 7, 8, 9, 10 years <affirmative> is because now when interest rates have gone up, yes, you have some short term pain, but the yield has actually gone up. Now, isn’t this what we’ve all been crying about that we can’t get any yield on our short-term investments or safe investments I should say.
Dave (09:54):
Yeah. And now it’s just to get the, there, I think <laugh> you like it to magically happen? I can just get more yield on my investments in safer scenarios, but it there’s, there’s a little pain, but at the end of the day, this is sort of what we’re looking for. And to add on top of that because I’m also a hawkish on what the Fed is doing. I’m sort of in favor of it, whatever, they’re the hawkish stuff that they’re doing. Yeah. I think it’s good to have some ammo there in the Fed’s pocket for the next great recession, huh? Whatever that is. And with interest rate to zero, there was no ammo there. The deal with whatever might happen five, 10 years now, where being able to lower interest rates to really help the economy. Well that was, that was huge in the great recession and almost impossible to do again, unless you have what’s going on now.
Steve (10:51):
Yeah, no, you’re absolutely right. They can’t sit there with interest rates at zero and have, no ammunition left. They like to say, when coronavirus hit and they cut rates to zero, oh yeah. We’ve still got plenty of other ammunition that we could utilize. But the fact of the matter is with rates that low there, they’re relatively limited as to what they can do. Now
Dave (11:18):
I’m bullish on this bearish stuff going on
Steve (11:21):
<Laugh>
Dave (11:21):
To use financial phraseology,
Steve (11:25):
Well that you’re bullish on the bearish stuff.
Dave (11:29):
I’m bullish on all this bearish stuff going on. We need to have the market actually decline for a while. Historically you’re never going to get to where want to go without it. We need interest rates to go up. At least a lot of our listeners want to be able to have money there in the future that, that they can get that they don’t have to take big risk and get some return. And what I said before about the fed, having some tools in the toolbox for the next crisis. So yeah. I’m going to stick with that. I’m bullish on the bearish events of today.
Steve (12:08):
No. Yeah. I mean, I, I think if you step back, it’s always hard in the moment, but if you step back and you say, okay, is this the right thing? You can have discussions about, should the fed have done this sooner? Are they a little late, blah, blah, blah. But you step back, and you say, is this the right thing? We do need to go through this pain to get to the place we need to be. Yeah. I, I absolutely, I agree. It’s, it’s the right move there. Now I did want to take a step back from, specifically looking at these returns, just to talk about a discussion we’ve had with a lot of people around this idea of diversifying beyond bonds. And I mean, frankly, this has been a discussion we’ve had, for the last 10 or 12 years or so. Going all the way back to 2008 is talking about this idea of just a 60/40 portfolio and you should be fine to saying, well, maybe we should diversify beyond that. And specifically, we’ve utilized tools like annuities whether that’s fixed index annuities, variable annuities, any of those where we’ve said, okay, instead of having extra exposure to bonds, look what can happen in bonds? Is it, it’s not all guaranteed. I’m going to get these returns. They never go down. So utilizing an allocation, I’ve heard some people talk about instead of 60/40, we should be 60/20/20 or 60/25/15, whatever the, the final numbers wind up being, we’ve had this thought for quite a while that you, you can’t just have that money in bonds. And you’re much better off, like I said, specifically, the annuities that we’ve utilized, where you can get returns, that, that aren’t correlated to bonds, but we’ve also used real estate investments in there as well. And I think, some of those real estate, I always say sort of falls in between stocks and bonds in terms of, stocks, we’ve got those big upside potential, but we’ve got big loss potential as well. Bonds, this is the worst losses that we’ve seen in 40 years, but we don’t have the big swings like we do in stocks. And I put real estate sort of, somewhere in between that. So
Dave (14:46):
Yeah, well, you know what, I, I’m going to interrupt you for a second cause I lose the thoughts. As I get older, I need the thoughts need to come in, but right.
Dave (14:55):
There’s really two types of advisors doing the kind of planning we do. One school of thought is for long term growth stocks based funds, whatever. And that’s it. And for, for the short term stuff and for protection, I guess, and liquidity it’s bonds. And that’s one school of thought our school of thought is more, there is a there’s stocks, which is long term growth and obviously more volatility there’s bonds, which you most people need for, annual, you’ll get some return over times, certainly in the short duration, but liquidity is a big factor there. And then there’s this in between stuff in the toolbox like annuities, like you talked about like various real estate investments and things that are better for, you could start to prove out statistically make sense for long term money, but you don’t want to be, I don’t want the volatility of stocks. I just see two different schools of thought with different advisors. We’re certainly in the latter camp.
Steve (16:03):
No. And, and I mean, we’ve, we’ve used the analogy, we’ve probably beaten it to death of the tools and the toolbox that you’ve going to look at all the things that are, that are available and out there. I’ve even talked about, utilizing in the right situation, life insurance for clients, as that tax deferred, fixed income substitute sort of, alternative in there, the annuities, the real estate. I think you’ve going to think beyond that now. I would caution people against going too crazy and saying, oh, okay. So they, they think we should be in alternatives. Now we should put everything in Bitcoin and doze coin and, blah, blah, blah. Okay, those are alternatives. But what, what we’re trying to do in most cases is lower the risk profile or lower the correlate. And those things might be diversifier, but they’re also super risky. And not saying it’s not for, for anyone, there are some people out there who that would fit, but that that’s for a lot of clients who are in retirement, getting close to it, increasing the risk is not what they’re looking for.
Dave (17:16):
Right. And I always get like frustrated reading CNBC and other sites that we read. Frustrated as if I’m a consumer, because all you read is sort of black or white. And this is it’s like versus the gray area of what we end up doing based on a, a client situation where not waste, people’s time talking about this anymore. If you have time, if you take the time to plan out, there’s a lot of a lot of things, like we keep saying tools in the toolbox that we can do to actually to make your situation as good as possible for your risk tolerance. Yeah. Versus what I think you read on financial sites, which makes it seem like it’s, you’re black and white, I’m going to be all conservative or all aggressive.
Steve (18:06):
Yeah. No. And I mean, that’s, that’s also a good point is, if you took each one of our clients and lined up their portfolios next to each other, and I will, I’ll say even our own personal clients or my mom’s portfolio and all this, none of them are going to be exactly the same. I mean, there’s a, a defined set of investments, tools that we use. So, we’re invested in the same stuff that our clients are, but they’re not, they’re not going to be exactly the same because everybody’s situation is a little bit different. So, does Dave have a little bit more of this than that? And, it’s all going to be a little bit different there. And I, I definitely agree that, the financial media makes it sound like, and, for the sake of an article, they kind of have to, okay, here is the one solution and this is the best. That’s the worst, you must follow this. In reality, it’s, it’s not that black and white.
Steve (19:12):
All right. I want to shift gears here a little bit, Dave, because we had a, a client who sent us, this was a couple weeks ago almost a month ago now. Geez. He sent us these questions and he said, oh, maybe you could just answer these in the next podcast. And I, I told him, I said, Tim, you, these are phenomenal questions. I will address them in the next podcast. Cause I think everybody should hear ’em, but I actually went ahead and emailed him back the answers right away, because I thought he deserved the answers right now. So let me go through a couple questions that, that Tim put to us here. His first question was about tax loss, harvesting. We have talked about this in the past. I think we probably was it November or December.
Steve (20:02):
We did a, a podcast that talked all about this. Some of the tax planning that we do, But this has become something we’ve done, done a heck of a lot of this year, but <laugh> the strange thing about what we’ve done for tax loss harvesting this year is that it’s been in bonds more than it’s been in stocks. So first let me explain what it is. Tax loss harvesting basically says, let’s say you put a hundred thousand dollars into an investment at the beginning of the year. And for these purposes, let’s say it was into us, large cap, us stocks, and now your investments at $90,000. And that stinks because obviously you wanted your money to go up, but you’re a long term investor and you plan on staying invested. What you are allowed to do is you are allowed to sell that original investment and buy a different, can’t be the same one, but buy a different mutual fund, ETF, or even if you’re talking individual stocks, you could buy a different individual stock in the same sector. Now what that allows you to do is on paper, you just lost $10,000. And when you go to do your taxes next year, how Dave everybody this year was complaining about all the capital gains from last year. Yeah. Last year was a pretty good year in the market. If you owned any mutual funds, they probably had some capital gains distributions. Well, these losses help you offset any sort of capital gains or capital gains distributions. And you can even use it against ordinary income. So you can use 3000 against ordinary income offset, any other losses., if you don’t use it all up, you can carry it forward to the next year. So,
Dave (22:02):
And we should remind people, and I know this is a little remedial, but this is not for your investments that are in 401ks or a IRA.
Steve (22:10):
Oh, thank you.
Dave (22:11):
This is, this is all after tax stuff.
Steve (22:14):
That is a, a good point, right? Because if you say, oh, Steve, that sounds fantastic., I’ve got $2 million in my IRA. Can we do this? Now, this only applies to non-qualified accounts. So non IRA accounts. Now why I say we’ve been doing this a lot in bonds this year is normally we do this tax loss harvesting. And it’s when the stock market declines. In 2020 with the coronavirus declined, did, did plenty of it back then. Now we’re actually seeing these declines in bonds. And in particular, I didn’t even talk about specifically municipal bonds. But municipal bonds have really sold off pretty hard. So, if you’re a client of ours and you’ve seen some of this activity and you said, well, that’s really weird. They just moved from whatever, ABC municipal bond fund to XYZ municipal bond fund.
Steve (23:20):
It, it looks like I’m just moving from one municipal to another. Why would they do that? Well, it’s to harvest those losses there. And everybody on the end, if you manage that stuff on your own, you should be aggressive about that. Go ahead and do that and don’t, don’t leave that money on the table there. All right, the next the next question from Tim, he said tax drag, what is that? He said he understands aerodynamic drag because he is a technical guy who would understand that stuff very well. We, you and I, Dave, we’d be totally lost talking about aerodynamic drag,
Dave (24:01):
Not even in the ballpark.
Steve (24:04):
So tax drags pretty easy. It is basically if you’ve got an investment that returned, 8% per year, but every year they have taxable distributions of 2% of, of that 8%. Well, you didn’t really earn that full 8% because you had to pay taxes on of that growth. So that’s an important thing to look at. We strongly prefer and, anybody should, very tax efficient investments, ones that don’t have too many capital gains distributions. so there are mutual funds that focus on that or ETFs or index funds that, that tend to be much more tax efficient. Once again, like you said earlier, that does not matter when you’re talking about a retirement account. All right. Question number three. And I told him he is one of, probably five people who have ever asked me this question. But I think it’s fun to answer questions like this. Just, I don’t want to say flaunting knowledge, but it’s kind of cool when there’s a subject that a lot about and somebody asks you a detailed question. Dave, if, if somebody was asking you about like, early nineties Redkins wide receivers, I mean, you you’d probably crush it on that, right?
Dave (25:36):
Oh, I would be anything like that. Absolutely. Or things, little tidbits about the golf swing.
Steve (25:42):
Oh yeah. You’d be, you’d be all over that if they were, if they were asking you gosh, why am I blanking on your guru? For the golf swing,
Dave (25:52):
Ben Hogan,
Steve (25:53):
It’s Ben Hogan. Geez. I need more clocking.
Dave (25:55):
What’s your problem?
Steve (25:57):
Ah right, so <laugh> Tim email. He said, what about the Meyer Rickenstein tax torpedo. I’m sure that he, their names of economist, but he said, interestingly, these are also names of World War II U boat captains. And I’m sure Tim would, would be able to answer lots of questions about World War II U boat captains, which I actually am a big WWII buff. But man, I don’t know anything about you boat captains. <Laugh> So, what he is talking about here is the tax torpedo. <Laugh>, let’s take a step back and let’s talk about your social security benefits and the ..
Dave (26:42):
It was called wait, is this called the Meyer? What’s this called?
Steve (26:46):
Rickenstein tax torpedo. Most of the time, I just hear
Dave (26:50):
Rickenstein tax torpedo. Yeah. And you’re telling, and you’re telling me this is not mainstream and you have to be a financial geek to be interested. Is this what you’re saying?
Steve (26:58):
Oh, big time. I
Dave (26:59):
Thought, I thought everybody knew about the, whatever you just called it
Steve (27:03):
I would say the first part of that doesn’t get much run. It’s really just called the tax social security tax torpedo. But I, I was familiar with the white paper, whatever it is that that refers to those economists. So let’s take a step back and talk about how your social security benefits are taxed. Your social security benefits are taxed based on your overall income and it it’s kind of a moving target because you’ve got your non-social security income and then a portion of your social security income. But for simplicity purposes, let’s just say your social security benefit could be taxed. 85% of it could be taxable income, right? So there’s this threshold here where it can go from 50% of it could be taxable up to 85% could be taxable. And the, the whole idea is that if you are, let me give you an example here, you’re a single woman.
Steve (28:12):
And if your total income is $12,000 a year, well, your social security is only 50% taxable. That’s pretty easy. But if you’re a single woman and your income is $43,000, then your social security’s 85% taxable. But because, like I said, it’s this moving target there at that point, each additional dollar of income has a margin tax rate of 41%. Now this is very, this is hard to understand, even if you’re looking at the graph, but it’s hard to understand if you’re not looking at this graph. But the idea is that if you’re really close to that threshold and it’s a little bit different if you’re married. But if you’re really close to that at threshold, each additional dollar of income is taxed at a much higher rate than what the normal tax brackets would suggest. Now, if none of that made sense, but you’re sitting there and you’re saying, well, I’m husband and wife married, filing, jointly our income’s like a hundred thousand dollars. Forget about it. You don’t have to worry about it., it’s really, if you’re in that, that threshold right close to the limit of where social security is, is maximally taxed there.
Steve (29:43):
All right. That’s probably
Dave (29:44):
Not. Can you do anything about this?
Steve (29:48):
Well, I mean that, it just comes down to, if you are in that, that area there you would probably want to avoid any other sort of taxable income and just at income from your non-qualified your maybe even Roth IRAs, something like that. Because you would know that you’re, you’re being taxed at such a high rate there,
Dave (30:13):
Right? So this is a good cocktail party conversation for people in there. Certainly over 65 is a general rule. Let’s say, yeah, I know you’re getting your income and, and I’m sure you’re, you’ve been watching out for the Rickenstein tax torpedo. <Laugh> no go. What, what, what, what about the Rickenstein tax torpedo? What,
Steve (30:34):
Yeah, that, that one goes beyond even flaunting there. You you’d have to sit down with a cocktail napkin and start drawing some charts there. I would.
Dave (30:43):
No, you wouldn’t. That’s crazy. You would say whatever you want, that’s close to it. And people would just buy it.
Steve (30:48):
<Laugh> you’re right.
Dave (30:50):
They can’t even Google you on that one without wasting too much of their time.
Steve (30:55):
All right. I, I think we’ve covered enough for today. Anything else you wanted to hit?
Dave (30:59):
Nothing.
Steve (31:01):
Okay. All right. Well I hope everybody’s staying safe out there. Hope everybody’s healthy. And we’ll check in again with you real soon.