Fixing Fixed Income
by Richard
Two recent back-to-back articles in the WSJ highlight both the peril and the promise of fixed income investments.
April 11 (c1) brought us the alarming article “Schwab Fund Pitched Safety, Courted Danger“. It recorded the sickening slide in what had been one of Schwab’s most successful offerings.
The culprit was, of course, mortgage backed securities. At a time when the average ultra-short (maturity) bond fund was down 1.9%, the Schwab fund had lost 24%.
I’ve touted the Schwab OneSource no load fund market many times, and continue to use that platform for most of my fund investing, so fairness requires that we highlight their missteps as well.
False Sense of Security
Investors were essentially lulled into a false sense of security, thinking that there would be little difference between a money market fund, with an average maturity of 30-40 days, and the ultra-short duration (approximately one year) of this category.
The brokers, of course, did little to nothing to alert investors of the potential perils. And that was before we knew how improperly rated and overpriced and illiquid the mortgage bond market had become.
It also highlighted the driving force that motivated the fixed income market, which was product packaging and innovation, that incrementally encouraged creeping out on the high-risk spectrum just to squeeze out a percentage point or more of yield.
Risk and Reward had become deliriously unhinged, but the collective and draconian shrinkage of values these past few months has helped bring the market closer to equilibrium.
Head for the Treasury
Contrast this sorry spectacle with the April 12 (B2) article “Piece of the Treasury for $10o”, which announced the introduction of marketable treasury securities in increments starting now at $100, vs. the prior $1,000 minimum.
At last somebody in the government has done something sensible and appropriate to the cross-currents in the fixed income market.
Anyone can log on to treasurydirect.com, and once you prove your identity and taxpayer ID, and linkage to a commercial bank, you can build out your very own fixed income ladder, without having to be pigeonholed into whatever CDs are offered to retail savers.
And you can be sure that banks are not anxious to compete at this micro-level, often setting minimum CD balances at $1,000, $5,0000 or even $10,000.
I still like savings I-Bonds, referenced in an earlier post, but that is long term money, not meant to be tapped prior to five years, to avoid prepayment penalty. It is also a hedge against dollar devaluation and incipient inflation.
These new mini-treasuries can be used to harvest portfolio gains in your longer term investments, and park them in an ultra-safe vehicle that will pay nominal interest until redeemed.
The best practices of retirement income planning match two essential but divergent goals- Long term equity investing as a longevity and inflation hedge, coupled with absolutely predictable draw downs from a risk free pool of capital to smooth out consumption.
And as opposed to running all over town as you ride herd on your former CD portfolio, it can all be managed from your home computer, with direct deposit from the Treasury to your core banking account.
Protecting Fixed Income Investments
I plan on revisiting this issue many times. The investing public has been lulled into a false sense of security with regards to their fixed income investments. The recent market turmoil has given us a window into how corrupted these securities have become as a result of exotic financial engineering.
You will always want a core component of your portfolio invested in fixed income, to dampen portfolio volatility.
And as an added bonus, you will want the funds to maintain their face value, plus interest, absolutely, positively, guaranteed to pay you back.
There was a time when a bread and butter corporate and mortgage bond portfolio would offer just such a predictable return, but we’ve fallen away from our common sense and discipline, and I’m not encouraged that we will ever find our way back.
It’s not easy putting the toothpaste back in the tube.
