This year begins as the worst start to a bond year in nearly a decade. According to Adam Harter, CFA and Chief Investment Officer at the Financial Enhancement Group, “2013 was a doozy for bond owners, and this year is so far on pace to well outdo the Taper Tantrum’s damage to bond indices that year.”
Harter continues, “With a world so well populated with stock opinions, I think I can fill in some gaps to help people understand bonds. We were early adopters of fixed income Exchange-Traded Funds, and our decades of experience provide a backdrop of explanation for a complicated topic. Also, I can rest reasonably assured that a Reddit mania will not come along and render these thoughts null and void.”
Bonds are primarily mathematical beasts. Much of that has to do with the nature of merely being legal contracts with an expiration date. Bonds mostly move based on a series of math equations. The overwhelming majority of investors inside retirement plans own bonds through a fund that tracks the most extensive bond index – the Barclays Aggregate Bond Index. It is of the utmost importance to understand that your risks are higher than they were a few short years ago.
The critical term for the risk roller coaster this year is duration, which measures how sensitive bonds are to changes in interest rates. All the duration equation tells us is that if interest rates are up by a certain percentage, then our bonds would be down a certain percentage. As interest rates fell and duration increased, a peculiar situation has occurred. The market is signaling a toxic relationship of lower rates but with higher risks!
One group in the crosshairs of this dynamic are lifecycle and target-dated funds. Many fiduciary advisors abhor target-dated funds. The funds are typically indexed to the Barclays Aggregate index. As baby boomers age, uninformed investors are plowing money into funds aimed for near-term retirement. The lifecycle fund industry reduces equities and increases bonds as folks age. This increase in bonds and a decrease in stocks occurs regardless of current economic and market realities.
Thus far, the battle of the bonds in 2021 has been due to the underlying levels of interest rates. With the promise of massive fiscal stimulus, a recovering economy lit the fuse to raise market interest rates and harm existing bond portfolios. However, an important note is that bonds still play an essential role in your retirement portfolio – even if your access is limited to the primary aggregate bond index. Even though our firm has had fewer bonds over the past several months for some of the reasons mentioned above, this is not a blanket statement that fewer bonds are in order. But it will still be time to pay very close attention as to how that exposure is garnered. Always know what you own, why you own it right now, and what you expect it to do for your portfolio.
Joseph A. Clark is a Certified Financial Planner and Managing Partner of The Financial Enhancement Group, and an SEC Registered Investment Advisor. This article was co-authored with Adam Harter, CFA. Contact Joe at yourlifeafterwork.com or 800-928-4001. Securities offered through World Equity Group, Inc. Member FINRA/SIPC. Advisory services can be provided by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.