treasury bonds

Letters to Our Children #7: Know Your Assets

canstockphoto168801.jpg

Our previous letters have talked about the three buckets you have for your money: short term, long term, and in-between. Each one serves different purposes. Today we will dive into the details of the different assets you can put into those buckets.

The simplest and most familiar asset class is cash. It has a fixed value and is completely liquid, available to spend any time you want. While the change jar on your counter is not exactly an investment, you can put it in a savings account and generate a little bit of interest. Short term certificates of deposit and Treasury bonds can also be considered cash equivalents as long as the maturity is within a few months. They can not be spent without notice, but could be turned into cash quickly for major expenses.

Longer duration CDs and bonds fall into another asset class: fixed income. You can expect higher interest by accepting longer maturities and shakier credit ratings, so fixed income will generate more income than cash. There is a reason for this: your risk exposure also increases. Buying bonds with poorer credit quality increases the risk that the borrower will go broke and default. And if you lock in your money long term at a fixed interest rate, you will be in for pain if inflation and interest rates rise. This can make fixed income investing difficult in a low interest rate environment.

The third main asset class are equities, or stocks. These are what you are thinking of when you talk about the stock market. Stocks represent partial ownership in a given company. Exchange-listed stocks are liquid, and owning a share of a rapidly growing company offers the potential for higher returns. But again, these returns come at a trade-off of volatility and risk. There is no fixed face value or interest rate on equities, and the market price can change rapidly.

There are also alternative investments outside of these three main asset classes. Most alternative investments are tangible assets such as real estate or physical commodities. These assets are largely speculative: they do not grow on their own and do not pay out interest. As such, we do not generally recommend them.

Different assets are useful for each bucket. Your short-term bucket needs both liquidity and stability, so it should be mostly or entirely in cash. Your long-term bucket can tolerate more volatility and will probably want to seek higher returns, so equity investments may be more appropriate. The intermediate-term bucket can hold a range of investments, although you will probably want a healthy proportion of cash and short-term investments.

Your financial situation is unique, and there is no one-size-fits all approach. Clients, if you want to discuss what is in your buckets, please call or email us.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

CDs are FDIC Insured to specific limits and offer a fixed rate of return if held to maturity.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Stock investing involves risk including loss of principal.

Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Change is Still Constant

pyramid

We wrestled for a long time with the issue of how to build portfolios in a zero-interest environment. The crushing of interest rates distorted values in the investment markets. The old ways of thinking carried too much risk, in our opinion. (When interest rates rise, bond prices tend to fall.)

So about a year ago, we settled on the concept of ballast. This enables us to tailor portfolios to address individual preferences. Different clients can have differing portfolios, while retaining common elements that enable efficient management.

Ballast refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast may reduce the volatility of the overall portfolio, thereby making it easier to live with. And it may serve as a source of funds for buying bargains when the market seems to be low. We’ve been able to put this thinking into effect.

A little over a year ago, monetary policy in the U.S. shifted from zero interest to a plan to raise interest rates over time. As we foresaw, this has not been great for bond prices. But now U.S. Treasury securities actually have a little bit of a yield these days, with short term maturities recently reaching over 1% for the first time in years.1

The return of interest rates on lower volatility, short term, liquid balances makes it easier to hold cash and cash substitutes as part of a portfolio structure. As interest rates continue to normalize, returns on cash could increase.

We like the portfolio framework, shown above, that we developed a year ago. We will continue to assess clients that may be suitable for this strategy. As the economic environment changes, we will review the need to adjust the tactics used in each layer of the portfolio. Change is still constant.

We will update you soon on the trends we are seeing in our long term core investments. Clients, if you would like to talk about this or anything else, please email us or call.

1Effective Federal Funds Rate. Federal Reserve Economic Data, Federal Reserve Bank of St. Louis. Accessed March 2018.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Tactical allocation may involve more frequent buying and selling of assets and will tend to generate higher transaction cost. Investors should consider the tax consequences of moving positions more frequently.