How Much Does the Ride Impact your Enjoyment at the Destination?

West Financial Services. Long road to sun rise.

The start of spring is one of my favorite times of the year. It's not just the warmer weather itself, but also the excitement about anticipated trips to the beach and other vacation spots in the coming months. Wherever your favorite vacation spots are located, we've all been in get-a-way traffic, desperately searching Waze for the less traveled roads. It's a dilemma, as sometimes that back road doesn't save much time, versus the more crowded route, and one never really knows which would have been the better choice to take until you arrive. More so than saving time, we often choose the less crowded route by driving through small towns with few traffic lights, which is usually more enjoyable than the more direct but crowded road. Most importantly, you'll arrive at your destination less stressed and ready for your vacation.

I started thinking about this while reading an article in AdvisorPerspectives, "The Dilemma That Isn't: Bonds versus Bond Funds"1 written by Laurence Siegel. The conclusion of the article is that a bond fund is an equivalent access vehicle to individual bonds. The author makes some valid points in favor of bond funds, namely that a fund owning a portfolio of bonds should be similar to an investor owning a portfolio of bonds. In addition, we would agree with the author that it's a bit difficult for individual investors to buy individual bonds, other than treasuries.

My main critique of the article, however, is that it was written very much from the vantage point of the destination, and not the ride. After managing portfolios during a difficult 2022, I felt that our bond ladders helped provide a similar experience for our clients as those back roads do for vacation goers.

We typically ladder our bond portfolios out 6 to 8 years. We have a modest bias towards near-term maturities, but there is typically 10-15% of the portfolio maturing every year. With a bond fund, the entire portfolio is comingled with a single price.

Why does this matter?

In a year like 2022, a $1,000,000 bond portfolio would likely have had $100-150,000 maturing at par. For clients taking distributions, this allowed us to be able to use maturing bonds in 2022 to fund a significant portion of their distribution needs and not be a forced seller of bonds (or equities) at low prices. The remaining bonds in the portfolio will eventually recover to par at the maturity dates for each bond.

Bond mutual funds that track the Bloomberg Barclays U.S. Aggregate index2 were down -13% in 2022. The proceeds from bond fund sales made in 2022 would have locked in those losses. Bond funds have no maturity dates, so when the eventual recovery in price for the fund happens is unknowable. The recovery will also be on a smaller asset base due to the fund sale.

Another advantage of individual bonds is how the price has a "gravitational pull" towards par once the bond is within a few months of its maturity date, no matter the direction of interest rates. This allows us to sell soon-to-be-maturing bonds at pretty close to par if additional cash flow needs are required. Thus, I strongly disagree with Mr. Siegel's assertion that individual bonds and bond funds are neutral in planning for future liabilities; individual bonds have a clear advantage in liability management in my opinion.

Mr. Siegel is correct that, when looking backwards, a bond portfolio and a similarly invested bond fund will likely have similar risk and return profiles. A question for investors, however, is whether they want a less stressful ride.

Meet Matt Cohen, CFP®, CIMA® »

Read the May 2023 Financial Planning Focus:


1The Dilemma That Isn't: Bonds Versus Bond Funds
2Bloomberg Index


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