Retirement Income Planning: The difference between bonds, bond funds, and leveraged bond funds. Why we don’t invest in leveraged bond funds for retirement? What are Investment Portfolio decisions when stocks and bond markets are down? In this edition of Retirement Income Show, Troy Sharpe discusses how to make the right decisions during a down market.
Bonds & Stocks:
Interviewer: Troy just said I’m 62. The sad thing is I liked your answer when you said, “Look, everybody thinks all annuities are the same. Everybody thinks bonds are all the same. Everybody thinks all cars are the same,” right? Everything’s got little subtleties and nuances. I liked that answer that “Well, no, there’s a whole bunch of different types of annuities, and they do different things. Some are good, some are bad, depending on your situation.”
The bond market is very confusing to me because my granddad, who would be 105 right now or 110, that generation was, “Yes, its bonds. Those are safe. You’re always going to be fine in that world.” Well, today, that’s not the case. Bonds are really down and getting hit hard with the rising interest rates that the Fed is doing to fight inflation, right? We all get that. You’ve been talking about it for a long time.
My question is, I always hear about bonds that if I hold a bond to maturity, I’m not going to lose anything. I might not have made a lot of money, but I’m not going to lose anything. Bond funds, that’s a totally different animal than holding a government bond, I would imagine.
Troy Sharpe: Yes. Think of a bond fund as a basket of individual bonds. A normal bond if you want to own individual bonds, that is issued by either a government or a corporate entity, and they have a maturity date. Theoretically, if you hold it until that maturity date, you will receive all of your principal back. In exchange for loaning them that money, you are to receive what we call coupon payments or interest payments throughout the course of that bond’s lifespan.
Now, two things to note there. Even with individual bonds, there are a couple of ways you can lose money, even throughout the period of holding it to maturity. Number one is the market value of those individual bonds absolutely goes up and down while you’re holding it. Let’s say you find a bond that’s paying 5%, and you say, “Great, I want that bond. It’s for 20 years. I don’t care. I want 5% for 20 years.”
Well, four years in, interest rates start to rise. The credit quality of that company that issued the bond deteriorates. The market value of that bond may lose 40%, 50%, 60%. Now, if you hold it for another 15, you’ll get your money back, but what happens if you need more than those 5% interest payments during that 15-year timeframe? Well, this is what happens to a lot of people, is you need the money.
You have to sell the bond at a point where you weren’t expecting, and you can have massive losses. Even with individual bonds, that’s one way that you can lose some money. Now the other way is it’s a corporate bond and that corporation goes under. If that corporation goes under, your bond payment basically is gone. Your principal is gone. The interest is no longer being paid because that corporation doesn’t exist.
Now with bond funds, it’s a collection of individual bonds. You can diversify some of that individual company risk, but there is no maturity date. Bond funds, again, the longer the duration or longer the maturity, the more sensitive the fund is to interest rate hikes. Now, additionally, there are a lot of bond funds out there that are what we call leveraged bond funds, where they use– I’ll try to keep this simple here.
Let’s say 1,000 people invest $1,000 into a bond fund. That’s $1 million. Now, the bond fund manager can use that $1 million from all 1,000 of you investors as collateral to borrow money and use that borrowed money to go buy more bonds. What does that do? Well, one, it increases the risk because now there’s leverage in play. It’s essentially margin. It can also increase the coupon payment.
Some very, very popular bonds, I’m talking hundreds of billions of dollars of AUM or assets under management that you may have in your portfolio right now. If you look closely and you do the research, you’ll see that it’s what we call a leveraged bond fund, where they’re borrowing $400,000, $500,000, $1 billion, $5 billion, these outrageous numbers to buy more bonds.
That increases the interest rate because there’s more bonds in there and also increases the risk. You have to be careful with that when it comes to bond funds. There’s no maturity date. You want to typically try to avoid the leveraged bond funds if you’re sensitive to market risk and fluctuations in value and understand some of those nuances. That’s where, from the retirement success planning process, that’s part of our job, right?
We don’t own bonds that use leverage for clients because we want to use bonds as income-producing tools and also as a lower-risk asset class that has some liquidity. We want to keep it short-term, high-quality, et cetera, but just understand what’s out there and what you own. I know most of you read that prospectus page by page. It comes to you in the mail every single year. I know you take time out of your day to go through and read that. Be careful of what you own and make sure that you do your research.
Interviewer: I’ve never read a prospectus, ever. That number if you’d like to chat with Troy or the team at Oak Harvest, it’s 800-822-6434. Again, no cost to chat with the team. They’re here to help you if they can. 800-822-6434. All right, we said we’re going to be talking about investment decisions and withdrawing income from a down market. What are some of the things?
We talked about the numbers, right, the third time in history that stocks and bonds downed in the same calendar year, bonds doing very poorly, obviously, with the rising interest rate environment. What kind of investment portfolio decision should we be making right now?
Troy: We did the live stream on YouTube. Those of you just joining the show, go to YouTube if you want. Check this out. It’s really, really worth your time. We have hundreds of videos out there. Just search Oak Harvest Financial Group. You’ll see the live stream. It should be one of the most recent videos that pops up. We had a lot of really good questions come in. We had some pre-submitted and also some that we answered live during the Q&A and one of the big ones was, “Troy, the market’s down. Should I be selling my stock? Should I be going to cash? Should I be buying bonds? Should I be doing this, buying a REIT, buying an annuity?”
When it comes to rebalancing your portfolio in a bear market, if you take risk assets like equities and you sell them near the bottom so you’re down 20%, 25%, it doesn’t make sense to sell those assets when they’re down 20% or make these emotional decisions and then move them into lower-risk assets like bonds or fixed annuities or cash because, at that point, you’re really getting rid of a lot of the rebound potential over time if you kept the equities in your portfolio.
If you do feel like doing that or maybe you’ve done that, you’re listening to the show and “You know what, Troy, I just did that. I actually just sold my stocks down 25%, and I moved to cash,” historically speaking, it’s one of the worst things that you can do. Now, the reason that people typically do this is because, one, they’re fearful, number one, but two, there was too much of the portfolio allocated to equities, to begin with.
When there’s too much allocated to equities, now with that said, it can be one of two things, one, what we call your risk willingness, or what’s more commonly known as risk tolerance. I like willingness as a better term, willingness because when we start to talk about risk, we want to quantify it in terms of dollars. Are you comfortable seeing the portfolio drop $100,000, $200,000, $400,000, $600,000 in the short term?
Okay, but there’s another concept called risk capacity. This is much less commonly known, but it has to do with taking income out of your portfolio and the amount of income your portfolio can support. If you have a very low-percentage income need, let’s say 1%, your portfolio then has a high capacity for risk because if you suffer a 20% drop, 30% drop, that’s not going to impact your lifestyle nearly as much as if you need 4%, 5%, 6% out of your portfolio.
If you need 6% out and you lose 20%, all of a sudden, your portfolio is down 26%. The higher the withdrawal rate or distribution rate from the portfolio, the lower that portfolio’s capacity for risk. There’s two components I want you to be aware of: the capacity component, which has to do with income, and then the willingness component, which is “How willing am I to stay invested during turbulent times?”
Bear markets are not new. Bear markets are not unhealthy. What we’re going through right now, no matter how bad it feels, it’s actually healthy, and it’s good for the markets. Now our position is the Federal Reserve is being overly aggressive to make up for being very lax in the– Let’s go back about a year and a half ago. We believe they should have started raising interest rates a bit more gradually, a bit sooner, instead of now inflation is prolonged at 7%, 8%, 9%, and they’re trying to play catch-up.
They’ve really mismanaged this just like they did in the fourth quarter of 2018, completely mismanaged there as well. We were hoping that they would have learned from that experience in the fourth quarter of 2018 when President Trump started to put the tariffs on China. The Federal Reserve also started on an aggressive interest rate hike path, and of course, the markets proceeded to lose 20% in that quarter.
I don’t want to call it a disaster, but it was very shortsighted, let’s say. When we tie this all back to you and your portfolio when you’re going through a bear market, how do you protect against it? What do you do during the bear market? This is why we have the retirement success plan. It’s because we want to build a portfolio for you that is expecting this type of bear market declines.
If you’re prior to the income distribution phase or after the distribution phase, the construction of that retirement portfolio from an investment decision standpoint, the asset allocation, how many stocks, how many bonds, real estate, et cetera, that’s a different strategy because if you’re in that income distribution phase or we’re preparing you for that income distribution phase, we want to allocate your assets when we get to the risk management and investment step, which is step one, in a way that is positioning you to have multiple streams of income in retirement that irrespective of market performance, that income is going to still come in, and your lifestyle is going to continue unchanged.
If you have too much risk and you’re in the income distribution phase and your income distribution needs are high, that means your portfolio has a low capacity for risk, and you better have a very, very high willingness to stay invested in the market. Otherwise, it will be a complete disaster if you have a low capacity and you sell out and you go to cash because chances are you’re going to miss that rebound.
I know that’s a lot of different pieces, but retirement planning is very complex. In the accumulation phase, when you’re 20, 30, 40, money’s simple. You earn as much as you can, you save as much as you can, and hopefully, you’ve tilted the portfolio more towards equities when you’re younger. When you get to retirement, it’s a completely different ballgame, okay?
The rules almost change. Now, every decision you make impacts every other aspect of your retirement. The allocation equities impacts what we call guardrails. What is the upside expectation, but what is also the downside possibility? That impacts how much income you can take out of the portfolio. How much income you take out impacts how much tax you pay. Where you take that income from impacts how much tax you pay.
When do you take social security? How does that impact everything I’ve previously said? These are the dominoes of retirement decision-making. This is why, when it comes to finding a partner to help guide you through this phase of your life, it’s an extremely critical decision. Whether it’s us or someone else, you want to find someone that, first and foremost, is a fiduciary, first and foremost, has their educational credentials.
Thirdly, they’ve done it for thousands of people before. It’s not something you just want to jump into and say, “Hey, I’m going to start retirement planning, all of a sudden.” Many people do that on their own, and they just don’t know what they don’t know. 1-800-822-6434. You can visit the website. It’s oakharvestfinancialgroup.com. I’ve been doing the show here on KTRH for 12-plus years now, and we’ve sat down with thousands of families and helped them walk through these retirement decisions.
If you’re soon to retire, if you have just retired, maybe you’ve been retired for a very long time, we want to have a conversation with you, see if you’re a good fit for what we do, you’re going to see if we’re a good fit for you and if so, we can go through this retirement success process where the end result is the retirement success plan that helps to answer those big questions.
Do you have enough? How long will your money last? If something happens to you, will your family be okay? How do you pay less tax? These are the big questions that you have. The retirement success planning process answers those questions, but you have to pick up the phone and give us a call. Visit the website oakharvestfinancialgroup.com. The phone number is 1-800-822-6434.
Leave a message on the weekends. We’re going to call you back. I don’t have my employees working on the weekends. I want our people with their family. Leave a message. We’ll call you back on Monday. 1-800-822-6434, oakharvestfinancialgroup.com.
Interviewer: We’re back with our final segment of the Retirement Income Show at Troy Sharpe of Oak Harvest Financial Group right after this.
Troy: Some people believe that retirement success is being able to spend the money you want with the people you love without the fear of running out. This is Troy Sharpe, CEO of Oak Harvest Financial Group. Let’s build a plan that focuses on generating more income for you while paying less tax in retirement. Don’t forget to check out the YouTube channel and visit oakharvestfinancialgroup.com.
Interviewer: Investment advisory service is offered through Oak Harvest Financial Group, LLC. Oak Harvest Financial Group is an independent financial services firm that helps people create retirement strategies using a variety of insurance and investment products. Investing involves risk, including the loss of principle. Any references to protection benefits or lifetime income generally refer to fixed insurance products, never securities or investment products.
Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Oak Harvest Financial Group, LLC is not permitted to offer and no statement made during this show shall constitute tax or legal advice. You should speak to a qualified professional before making any decisions about your personal situation. We are not affiliated with the US government or any governmental agency. This radio show is a paid placement.