I changed my investment strategy this year and prepared for how it would turn out
In recent weeks, I’ve gone from passive investor to something of a living-room corporate treasurer, looking for ways to increase my portfolio returns by a few basis points.
I had to wrestle with the big questions, ponder the bond market, and guess where inflation was headed, all to keep my retirement egg from slipping through an uncertain economic environment.
I’d like to tell you I do this because I’m a great proactive guy who jumps into trouble early. I’m afraid not. I’m doing this because my business did really bad this year.
While this is mostly due to an awful market, I think it’s partly my fault for being so detached.
A year and a half ago, I decided to put most of my retirement portfolio into a single Vanguard fund simulating a 60% equity/40% global bond portfolio,
LifeStrategy Moderate Growth Fund
(Stock ticker: VSMGX). I’m 65 and it was my reasoning that the fund would protect me from myself by automatically dealing with the parts of investing that I often hesitate – like buying stocks when the market is down. I knew the markets were full of foam, but I thought this was the strategy that would serve me best for the next 20-30 years.
My reasoning was probably defensible, but the timing was terrible. The fund has managed to capture almost every segment of the market that has been killed off this year. The fund is down 16% year-to-date, as of Thursday’s close, and its losses were worse than a few weeks ago. As it stands now, this year is the worst for the fund since 2008 during the financial crisis.
With 40% of its equity investments located abroad, the fund’s shares have been hit hard, due to the rising dollar. I was more or less up for it and I don’t have much regret there.
I was not prepared for my bond losses. Instead of holding me back from those stock losses, my bond added to it.
The Fed has raised short-term interest rates by about 4 percentage points this year, causing huge losses. The fund’s bonds lasted more than 6 years and were hit hard by rising interest rates. The largest fixed-rate holding, Vanguard’s Total Bond Market II, is down more than 12%, which is a big chunk for the safe part of my portfolio.
I don’t blame the fund. I did exactly what her investment strategy called for and knew what I was buying. I blame myself.
When the interest rate curve inverted earlier this year, I should have exited my Vanguard and gone into short-term bonds or cash to protect myself.
If I had switched to shorter term bonds, I would have avoided a significant amount of my losses this year. The move to cash was avoiding losses altogether.
This is why some experts advise relying on cash more than bonds. William Bernstein, author of Four pillars of investment, a handbook for do-it-yourself investors, has been saying for years that the entire fixed-income portion of your portfolio should be cash. He notes that this is what Warren Buffett does
Which has $104 billion in cash or its equivalent.
And because my eggs were invested in one fund with an investment strategy based on medium-term bonds, I couldn’t move to short-term instruments without selling that fund and investing the proceeds in separate stock and bond funds.
Instead of doing anything, I hesitated and kept hoping that interest rates would come down. They kept climbing, and my losses kept increasing. I was doubling down on my worth, to borrow the term gambling.
I finally said enough and sold the fund, adopting a more defensive strategy that includes my stocks in three separate funds: a total US market fund, a foreign total market fund, and an American value fund. I overweight value stocks because I think they may outperform for a while in the current environment and because growth stocks have enjoyed such a massive rally for many years.
My primary bond fund is now
Fidelity short-term Treasury index fund
(Fombex). The average bond duration is 2.54 years. Because of its shorter duration, it will earn less if prices fall. But it will also lose less if it rises again. It currently yields a whopping 4.4%, which is much higher than medium-term bonds.
I didn’t stop there. I sold half of my bonds to buy 3 and 4 year certificates of deposit yielding 4.9% and 4.95% respectively. It yielded more than comparable Treasury bonds, but it’s federally guaranteed and completely safe.
If prices go up, the market value of these CDs will go down, but since I’m holding them to maturity, I’ll still charge about 5% interest, which isn’t bad. And if prices fall, 5% interest will look increasingly attractive in a low-rate world.
I am taking other actions to increase the yield. Outside of my retirement account, I keep a decent amount of cash in a Vanguard Money-Market Fund. I took out some cash and bought a 4 month treasury which yielded over 4% to squeeze my returns a bit.
All this search for yield is much more work than the one fund strategy. And I still risk not progressing in the end.
But if interest rates go up any more, I won’t be hurt as hard as last time. And if they fall, I will do everything right for several years.
I call this a win.
Write to Neal Templin at firstname.lastname@example.org
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