MOOT MATURITY?

It’s said that the future of our profession will be right brained. Soft skills like communication, coaching, and empathy will, theoretically, become more valuable in the age to come, as our once revered analytical skills are replaced by a computer; something rather easy to accomplish due to the formulaic nature of math and analysis.

Perhaps a harbinger of left brained doom is the frequency with which even technical market discussions circle back to the arch importance of human behavior. It’s no secret that markets rise and fall with the collective force of human emotion, and that makes them tricky to navigate and impossible to predict.

To escape from or hedge against this uncertainty, investors often turn to bonds. While bonds occupy a legitimate and necessary place in most investor portfolios, they should be used in proportion to the risk tolerance of the individual investor. And it should be acknowledged that even bonds carry risk.

Perhaps one of the more applauded attributes of bonds is the comfort-inducing idea of holding an individual bond to its maturity date in order to retrieve all that delicious principal at the end. As discussed last week, this is a key argument for those who decry bond ETFs in support of individual bonds. The illustration below explains why we think it’s overemphasized.

Let’s establish first that investors invest for returns. If your only concern is principal preservation a coffee tin of cash and gold in a clever hiding place may be the best guarantee there is. We’ll need to create an apples-to-apples comparison, so we’ll assume our investors have selected the same bond strategy, let’s say intermediate muni bonds.

Buyer A spends $10,000 on a 5-year muni bond that pays 3%. Buyer B invests $10,000 in a bond ETF with the same strategy. Interest rates rise in the 4th year of Buyer A’s bond, so that when his or her first 5 years are up, they are eager to buy another $10,000 muni bond, this time paying 5%. At the end of the combined 10 years, Buyer A received a combined return of 4%.

Buyer B remains invested in the muni fund ETF for those same 10 years. When Buyer B sells out of the fund, their return will be 4% as well without the need to purchase again or risk being locked into a term when rates rise.

We’re not trying to win an argument per se; we’re demonstrating what it is at best, a moot point; no clear advantage for individual bonds over ETFs from a return perspective. Hence, last week’s comment that individual bond maturity may not be as advantageous as some think.

That said, if yields are the same, and our client is ok with additional trading costs, we’ll support them choosing an individual bond if it affords them a sense of peace. And that’s where we come back to human behavior.

Your advisor is an asset to you as far as they understand your values and vision for your life, and their own limitations. A sense of empathy, the ability to use one’s expertise to coach people financially through difficult markets and personal trials is what adds value; when to insist and when to give a little.

That’s why the industry is busy honing its soft skills; they (we) know that markets are unpredictable and historically, staying invested in the market has been more beneficial to investors than attempting to time it and jump in and out at certain points.

That means it’s our job to help keep you in your seat, especially when you’re afraid. If the difference between a client abandoning the market and staying put is the potentially benign comfort of an individual bond, we’ll buy the bond every time.