Investing in Bonds

When I told my partner Marshall that I was planning on writing an article on the wisdom of continuing to hold bonds in our client’s portfolios he suggested an excellent approach.  Namely, should we plan for investing last year, or should we invest for this year, 2014, or should we plan to invest for the future.

If we plan to invest for 2013, last year based on what happened in 2013, which of course we cannot, last January we would have eliminated all holdings in fixed income or bonds, cash, real estate investment trusts and emerging markets.  This would have left us mainly in US Large Cap Stocks, growth and value, US Small Cap, growth and value and international.  But, and here is the big issue, if we had based this investing on what happened the year before, 2012, we would have invested a lot differently, we would have invested in real estate, emerging markets and BONDS!  Here is a hot flash, as I write this, January 22, 2014, Large US stocks are down, real estate and bonds are up!

Using this strategy for 2014, we should load up with the 2013 winners but we have just seen that had we done that in 2013 based upon 2012, we would not have had such a good year.  This concept known as tactical investment strategy of predicting the future based on the past or some other method and concentrating on the “sure winners” has cost many people a lot of money.  After the horrible stock launch of Facebook, who would have bet on its future and who would have predicted Twitter would do so well.

Clearly, this is not the way for sustained growth in your investments to meet your financial goals.

Now, let’s get to the question, why invest in bonds anyway?  We have a specific reason to invest in bonds as they provide the anchor for your portfolio and they serve to reduce portfolio volatility.  We are not looking for income as so many do.  Rather, we are looking to ground your portfolio in solid investments, typically high quality government or corporate bonds that usually maintain their value whatever befalls the equity markets.  This establishes the bedrock, the foundation of your portfolio so that we can then invest in other asset classes such as stocks to provide the growth needed for you to meet your financial goals in the risk framework and investment time horizon you desire.  It is just that simple.  We develop your holdings to maintain a solid base so we can then take advantage of other quality investable assets with higher growth and volatility to provide your portfolio the opportunity to grow capturing all dimensions of the financial market place. 

When we consider the liquidity needs of our clients, we consider cash flow rather than income.  Income coming from bonds, bank accounts and CDs are fully taxable at high ordinary income tax rates, so we look to distributing the proceeds of long-term capital gain items to provide low tax cost liquidity solutions.

-Norman Berk