Bond mutual funds have lost money in 2013. Even worse, bond funds this year are down in price more than their current yield can recover.
In the last five years from December 1, 2008 to December 1, 2013, the Vanguard Total Bond Market ETF (BND) is up about 6.78%. Over that same time period, the S&P 500 index is up over 120%.
There has been a terrible investment performance cost to individual Minnesota bond mutual fund investors. The sales practices of the financial advice industry are to blame. Those sales practices include the concepts of Modern Portfolio Theory, strategic asset allocation, diversification and rebalancing.
The concept behind Modern Portfolio Theory is to own an asset allocation of stocks, bonds, and cash. The investment objective is to control the volatility of investing. At the core are the concepts of diversification and rebalancing.
The rules state that to rebalance an investment portfolio on predetermined dates. That process consists of selling a portion of the assets in the investment portfolio that have gone up in value. In the last few years, those assets have been stocks.
The proceeds from the sale are then reinvested in assets in the portfolio that have done nothing or gone down in value. In the last few years, those assets would be bonds.
You sell your investments that have performed the best. And you buy more investments that have performed the worst. You rebalance with the hope that investment performance will change in the future.
No wonder they call it a theory! Where else on earth does that strategy work?
Would the Twins trade Joe Mauer for a player that they think may become a better hitter? Would the Vikings trade Adrian Peterson in order to draft a college player who may become a better running back?
Strategic asset allocation and rebalancing are intended to take the emotion out of the investment management process. Those same concepts also take the common sense out of the investment management process.
Interest rates have only risen a little bit from their all-time low levels. What will happen to bond mutual fund prices when interest rates rise even higher?
I have an ethical problem advising my investment management clients to follow rules based on theories that clearly have not worked in the last few years. These investment management theories don’t adapt to what is really going on in the stock and bond markets.
A theory is one thing. What really works when the stock and bond market environments change, is another thing. My clients pay my advisory fees for what works.
The right thing to do over the last several years has been to own more stocks than bonds. When that fact changes, I advise my clients to change. Forget the theory.
Ric Lager
Lager & Company, Inc.
