Thursday, March 15, 2012 - 9:06 PM
I have noted before that "savers" are those who spend less than they earn, irrespective of the investment vehicle chosen for the monies thus saved. Folks who plunk 100% of the amount in excess of the amount spent in equities might be unwise, but they are no less "savers". Folks who plunk 100% of the amount in excess of the amount spent in cash, bonds, or other fixed-income products (such as CDs) might be unwise, but they are no less "savers".
An approach i have found useful over the years is "age-in-bonds" aka "fixed-income". It is similar to "glide-path" mutual funds which reduce one's equity exposure over time, such that a major decline in equities does not torpedo retirement.
My approach, however, has a major difference. Unlike "glide-path" or "target-retirement" funds, I suggest folks look seriously at CDs as a major chunk of the "bonds/fixed-income" component of the "age-in-bonds" asset allocation. To my knowledge, no major investment company (Vanguard, Fidelity, you-name-it) does this. The weakness of these "target" or "glide-path" funds is that the fixed-income (read: bonds) component is just that, bonds. You might get a smidge of "stable value" in the mix, but it's still mostly bonds. In a rising-rate environment (yes, Virginia, whether you believe it or not, we have turned the corner), bond funds get hurt. You have to have a lot of patience, and a firm belief in the concept of "duration", to keep the faith while that NAV keeps dropping more than the dividend keeps pumping.
The solution is to build a CD ladder, which is, in effect, a personalized bond ladder, with one big difference. Unlike a bond fund (whose NAV is adversely affected by rising rates), your CD ladder will (by definition) never suffer a reduction in par value. Your interest rate may seem paltry, but, trust me, a 2.5% yield with no par value risk is infinitely better than a 2% SEC yield in a bond fund with rates going up. Compare your PenFed 7-year CD to your gerden-variety intermediate-term bond fund over the past month, and you'll see what I'm talking about.
Purists hate this argument, since they state (with some credibility) that "nobody can predict interest rates" (Bill Gross being the perfect example).
At the risk of being hooted down, I would say Bill Gross was right, he was just off by a year. Treasuries are turning (finally) and, frankly, bond funds are not where I'd put new money these days. A month ago, I was probably indifferent. Now, not so.
A balanced approach, the one I take (and have for some time) is to have one's age in fixed-income. The balance in equities. That's not exactly rocket-science, nor is it new. But the "mix" of fixed-income, there I am somewhat of an outlier, as I would advocate a goodly amount of that FI in CDs. Personally, in FI, I am around 75% CDs, 25% bond funds.
Just my $.02 and good luck to all.
PS: As an aside, I should note that I have been hedging and re-balancing into the market froth over the past month. As a firm subscriber to the "greater-fool" theory, I whack off profits in equities in silly periods (such as now) and plunk said profits in good, old-fashioned, cash. Inflation risk aside, cash has a certain appeal. I doubt anyone seriously thinks Mr. Market will continue this parabolic uptrend for long. Even though I've been harvesting and hedging diligently, my equity positions are up YTD 12%, and that's just unsustainable. I suspect I'll sell a bit more into this rally tomorrow. It tends to be a tad easier to sell into a rising market. For those doubters among you, my sell order is in for about 80% of my trading account. Stated another way, to the extent possible, my money and my mouth are intact.