Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

For regular SAA and TAA portfolios, the next re-balance will be on Monday, August 5, 2019. You can also find the re-balance calendar for 2019 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Income Portfolios In A Lower Yield Environment

With the Federal Reserve being expected to lower interest rate on this Friday for the first time since 2008, investors are grappling with an even lower yield situation amid an already lower interest rate environment. In this newsletter, we discuss fixed income portfolios’ yields. 

Low interest environment

Let’s first take a look at this historical 10 year Treasury bond’s yield chart:

The 10 year Treasury bond (or note)’s yield rose since late 2016 but it has started to drop back 2% since late last year. 

Now let’s look at the annual yields of one of our representative fixed income bond portfolios,  Schwab Total Return Bond, (you can find others on What We Do->Brokerage Investors page):

Please note that the yields can be somewhat perturbed as some mutual funds can make some large or small capital gains/interest payments occasionally (especially at year ends). 

From the above chart, one can see that in general the fixed income portfolio’s annual yields have declined since 2009. Yields in the recent years have been around or lower than 4%. 

Retirement income

For a retiree who relies on investment income (along with other retirement pensions and social security income), a rule of thumb is that he/she shouldn’t spend more than 4% of the investment portfolio annually (adjusted with inflation) to preserve the investment portfolio’s value for a long (or even perpetual) period. We have written various newsletters on this subject (see, for example, July 8, 2013: When To Retire And Bear Market Impact On Retirement Income And Spending). 

As we have experienced one of the longest bond bull market that started in 1980s. a retiree who relied on a total return fixed income portfolio such as ours has been very lucky: mostly, the portfolio has been able to satisfy the requirement (of providing about 4% annual withdrawal rate while keeping up inflation for the value of the remaining portfolio ). The following portfolio P Floor and Ceiling 4 Percent On Schwab Total Return Bond Portfolio withdraws 4% annually within some ranges (see the above newsletter for more details on the withdrawing strategy). The portfolio has the following IRR returns: 

Name YTD*
Return
1Yr
AR**
3Yr
AR**
5Yr
AR**
10Yr
AR**
15Yr
AR**
Since 2001
P Floor and Ceiling 4 Percent On Schwab Total Return Bond Portfolio 6.0% 3.0% 3.2% 2.8% 7.5% 4.0% 8.9%

The portfolio’s value at the end of 20018 was  207,461 with its starting value 100,000 on 1/2/2001. Investors would have withdrawn 117,074 in total from the portfolio since 2001. 

More importantly, the 207,461 value at the end of 2018 is  more than the inflation adjusted amount 145,650 (the original 100,000, adjusted Consumer Price Index (CPI) annually, CPI index has had 2.1% annual rise since 2001). Thus we can conclude that the portfolio has preserved its original purchasing power and added more. 

This means this fixed income portfolio has done well for a retiree who retired in 2001. 

However, the portfolio’s value at the end of 2018 is lower than that in 2017 (207k vs. 235k), in fact, this amount is actually lower than that at the end of 2012 (223k). This is not surprising as the portfolio, before withdrawing, has had a some low annual returns (before any withdrawal) for the past 3 and 5 years: 

Name YTD*
Return
1Yr
AR**
3Yr
AR**
5Yr
AR**
10Yr
AR**
15Yr
AR**
Schwab Total Return Bond 6.0% 6.5% 4.3% 3.5% 7.4% 7.9%

Outlook

The good news for a retiree who solely relies on a fixed income portfolio such as the above one is that as interest rates start to decline, existing bond prices will rise. This means the portfolio probably has some more room to increase its value. The bad news is that the current annual yield of this portfolio has been lower than 4% and it probably will be even lower in the near future. Thus, just relying on interest/yields from the portfolio will not be likely enough to meet the 4% withdrawing expectation. Investors will need to tap the principal (in this case, probably will need to sell off some mutual fund holdings) to get the enough withdrawal. 

The most concerning issue is that once interest rates stop dropping (after all, rates will not go much lower than 0), fixed income investing will become awfully difficult: one would not be able to get income from yields while in the meantime the prices of bonds will have no where to go but down. 

What the above discussion tells us is that in the current environment, it’s not a good idea to just buy and hold some bonds. One has to be tactical to be prepared for the eventual bond bear market (that has been predicted for so long and hasn’t materialized, but it will come for sure). On the other hand, even with a tactical portfolio like our total return bond portfolio (which we consider to be one of the best fixed income portfolios), one might still not be able to preserve purchase power for some period of time. 

Market overview

Now that 44% of the companies in the S&P 500 have reported earnings for Q2 by last week, the blended year over year earnings growth was -2.6%, slightly better that the previously expected -2.7% on 3/31/2019. It’s even more troublesome that analysts are now projecting -1.9% earnings decline in the next quarter which was revised down from previously expected positive earnings growth. One probably can say that investors’ main hope now is the Federal Reserve rate cut on 7/31. At any rate, stocks and bonds are currently in up trend. Given the extended market rise, elevated valuation and deteriorating earnings, we call for carefully managing risk while staying the course. 

For more detailed asset trend scores, please refer to 360° Market Overview

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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