Managing Bond Investments Amid Market Volatility and Rising Interest Rates

In recent years, we have seen a lot of volatility, not only in the stock market, but also in the bond market. And a lot of people think, well, my bonds are supposed to be the safe part of my money. So if the stock market goes down, that’s simple, I pull the bonds, allow the stocks to recover. And this is a great strategy in theory. However, there needs to be a lot more intention behind what type of liquidity we have for those down markets. So let me just give you an example. In 2022, what we saw is we saw a climb interest rates.

So just very simply, a lot of people that used to get 3% mortgage rates now have to pay not the same people, but someone getting an interest rate years ago would pay 3% locked in, versus someone obtaining a mortgage now may have to pay seven and a half, even 8% in some cases. So what happens when interest rates climb? And the reason they climbed is the Fed said inflation is out of control, we need to taper spending down, interest rates rose, inflation dropped, it worked out very well. However, this does have an effect on investments. And you actually saw, for this exact reason, Silicone Valley bank fail, and some other smaller banks failed as well. So traditionally, bonds are still very safe investments.

But when we decide what a safe investment is, there’s also a time frame that has to be attached to it. So in 2022, as a result of this, just to use really simple math, if person a put $100,000 in a bond, paying, let’s just say, 3% in 2020, and that was an agreement with for five years. So let’s say this person had 100 grand, they gave to big corporation ABC. 100,000 goes to ABC. The corporation now has to pay the investor back $3,000 a year over five years. Plus they have to return $100,000 at the end. Very safe if that corporation is in good standing, or even better yet, this could be the US government, which is even safer than banks through the use of treasuries, because a lot of times you’ll give your money to a bank, it’s insured by who? FDIC.

Who’s that? That’s the government. So you can actually skip the bank and go right to the government through the same concept of treasury bond. So if this investor a does have the five years, and we’re talking a treasury bond, there literally is no risk to this investment. Where the risk comes into play is if the investor needs their money back before the five years is up. So here’s what happens. So let’s say investor B in 2023 says, I’ve got $100,000. I’m going to go to the marketplace, I’m going to buy a bond. Well, now we can buy the same exact bond paying 5%. So let’s say investor a said, hey, investor b, I’m three years into this bond. Can you just buy my bond? I actually have an emergency. I need this money back. Well, investor B is going to have the option.

They could pay $100,000 for two years left at that 3% bond, or they could just go buy a brand new bond that’s getting 5% returns. What’s investor B going to do? Obviously, they’re going to charge, they’re going to choose getting the 5%. So if investor a truly has to sell, they’re going to have to sell that bond at a discount, which over the same time frame, allows investor B to still get the same price. So maybe investor a has to sell for 95 or $96,000 and take a haircut because they had a liquidity problem before the duration came due. So this is just high level. When you do bond investing, it’s supposed to be safe, it’s supposed to be stable. You really have to pay attention to the duration of your bonds.

Do you have something else if interest rates fluctuate like they did in 2022, that you can rely on? Because bonds are safe from a principal perspective, from a liquidity perspective, they’re not always so. Typically, we recommend if you have a giant pile of money and let’s say you retire, let’s just say you need $10,000 a month or $120,000 a year to live, and Social Security is giving you 40,000. So our portfolio up here, we need 80,000 a year, which will be the gap between what you need to spend and what Social Security is. So we recommend, at a minimum, separate from your portfolio. Let’s say that’s primarily invested in equities. We want seven years. So seven times 80 would be 560 worth of safe money. That safe money just can’t be any random bond.

It has to be a layered strategy where maybe you have some 100% liquid cash spic insured up to 500, 250 per account. From a bank perspective, then we need to start layering this. Maybe one to five year durations, five plus year durations, maybe even longer. But there’s going to be increments where every five to seven years, there’s going to be a year where we need to pull from our safe bucket and let this portfolio over here recover and when you do that, we have to pay close attention to can this strategy withstain big interest rate fluctuations. The way we do that is by diversifying the time frames of what safe money is actually available safely, no matter what’s happening to interest rates or other factors that are out there.