Long Term, Not Tactical

Christine Benz at Morningstar wrote an article advising investors to stop trying to be tactical with the fixed income portion of their portfolios, essentially that most people aren't good at being tactical, and the opportunity costs of being wrong are high. 

Examples of being tactical she cited were trying to assess yield curve dynamics. game the Fed or guess about inflation. There was an implication that these types of trades are done with a very short term focus. Yes, if someone is trying to execute some sort of bond strategy based on what the Fed will do over the next nine months, odds are high that they'll get some part of the trade incorrect. 

Someone going into that trade based on the Fed with a nine month timeframe who then figures they will readjust to the next trade after that, obviously has a very short term focus. That really is a tough way to make a living. 

Forget about tactical though. A 2% yield for a ten year treasury is far riskier than a 6% yield for a ten year treasury. That is not a tactical lens. 2% for ten years will be a very risky position regardless of how long it stays that low. That assessment is about risk. I personally was not willing to take the risk of 2% (and lower) for ten years. I wouldn't take the risk of 5% for ten years. 6%, maybe. At 7%, go on I'm listening. You get the idea. 

With that sort of approach, it is likely you are making longer term decisions. I suppose there could be a some sort of panicked spike in yields that might require a acting quickly to capture the yield. With 7% for ten years, if I can get 60-70% of the return of the stock market for 1/4-1/3 of the volatility (maybe less) in the fixed income sleeve, I am probably interested in that. Buying at 7% and that yield turning out to be a high price on the way to yielding 9% would be far less painful than buying at a 1% yield on the way to 4.5%. To be clear, I am talking about individual treasuries not treasury ETFs.

Where this is very often a longer term proposition, I've been avoiding duration since before the financial crisis, this chart can refute some of Benz' argument about active decisions going bad.

Portfolio 1 is comprised of four fixed income funds, not alternatives, that we use or talk about regularly for blogging purposes, equal weighted 25% each. These funds have been in the conversation here for many years. Unacceptably low yields elsewhere forced me to find other fixed income sectors with adequate yields for risk taken which I did and they work well most of the time. Long term, not tactical. 

Toward the end, Christine talked about whether to use individual bonds. I don't think she was saying not to use them but I would clarify the point. Yields for individual issues will probably be a little lower than in funds but I would definitely include individual issues for a large enough portfolio and someone inclined to spend a little time doing the work. I would not buy $1000 and $2000 bond pieces for corporates, munis might be ok because I often see very small positions offered all the time and buying $1000 into a treasury should be fine.

The bigger point is a diversified fixed income portfolio, if big enough, should include some funds and some individual issues. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.