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Why should I buy conservative fixed income when rates are so low?

Rates are super low around the world, but buying high quality fixed income still makes sense, says Jonathan Scheid. The reasons? Stability, diversification and predictability.

Transcript

Tim Maurer:
Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Jonathan Scheid, Buckingham’s managing director of solutions. And Jonathan, again we’re talking fixed income. Why should I buy conservative fixed income when the rates are so stinking low right now?

Jonathan Scheid:
Yeah, it’s unfortunate that rates are at these levels, but this is where rates are in the US and around the world. And so in our mind even with rates at these levels, we still think it makes a ton of sense to buy conservative fixed income and we don’t feel it makes a ton of sense to reach for yield. We’ve seen the lower quality bonds sell off in this environment and that’s exactly why we have this preference for higher quality fixed income.

Tim Maurer:
Well, is it about helping define the purpose of fixed income in your portfolio, perhaps?

Jonathan Scheid:
There’s definitely benefits to having fixed income in your portfolio and having the right type of fixed income in your portfolio, I think matters most. From a return standpoint we don’t look for fixed income to be a big driver of returns. That’s where stocks come in. But from a broader diversification standpoint and an investment perspective, anybody that’s on a distribution plan or living off of their portfolio. Income, fixed income is vital. And the way that we think about it is, stocks are great because they generally tend to move up, but we know they’re subject to bouts of volatility like we’re seeing right now. And when they’re having those bouts of volatility, we don’t want to be forced to sell them, any portion of those stocks because we know that we’re selling at a bad time. So we would rather sell those stocks when they’re up to fund our distribution and then avoid having to sell them when they’re down.

Jonathan Scheid:
And that’s really where fixed income comes into play. And so when markets are down, what we’re able to do with high quality, shorter term, intermediate term fixed income is use that asset class to finance your distribution needs. And so that’s the really nice thing and the balance that you have by using this more conservative fixed income than stocks. Because if we didn’t use more conservative and fixed income, we used high yield or emerging market debt and we’re trying to reach for credit, those assets would be down at the same time. And then we’d be looking at everything in our portfolio and you’d say, well everything’s down. What am I going to try to sell to finance my distributions?

Tim Maurer:
Well, it makes sense. So if you want to make money, stick with equities, don’t settle for say, potentially corporate bonds or high yield bonds where you might suffer the same of fluctuations in price as we do in the equity markets, or similar fluctuations in price. But Jonathan, I’m hearing about the potential for the most conservative bonds to actually go negative. What does that mean? Is it possible that we could be writing a check to the US government in order to keep our money safe?

Jonathan Scheid:
Yeah, it’s actually possible and it actually occurred, believe it or not. On March 25th for a very brief period of time, a one month keynote and a three month treasury bill traded at negative interest rates. Now negative interest rates are pretty new for the US and as we record this, our rates are still positive and we would anticipate them to stay positive in the US but obviously we never know what happens, but outside of the US there are trillions of dollars that are earning negative interest rates. A huge portion of the government bond market in Europe is yielding negative interest rates. Japanese bonds are also yielding negative interest rates and they’ve been actually yielding this for some period of time.

Jonathan Scheid:
There’s a couple of reasons for this. The central banks in those countries have been more aggressive in trying to stimulate their economy. And so by setting their equivalent of what we call our federal funds rate. It’s that rate that we always see the federal reserve adjusting, moving it up and down and they moved it down very quickly as the coronavirus contractions started.

Jonathan Scheid:
But other economies like Euro Union, what they’ve had to do is reduce their rates to negative to discourage savings. Because they want people to go out and spend their money. The challenge is we just haven’t seen from a policy standpoint that actually turn into something positive. And so we’re hoping that the US federal reserve avoids that as a policy move. But extreme times call for extreme measures and we’ve seen a pretty impressive response from the federal reserve outside of just changing interest rates. So we’re hopeful that that might be all that’s needed in the US.

Tim Maurer:
Jonathan it’s amazing when we think about interest rates being [loaded 00:05:18] at, I feel like we’ve been talking about this for quite a long time. I can remember having this discussion all the way back in the year 2000 and it seems like every time we think rates can’t get any lower, they continue to nonetheless. And especially with that in mind, I wonder does it make sense to pay an advisor to manage bonds that are earning so little?

Jonathan Scheid:
Absolutely. I think it does. The way I think about it is we are fiduciary advisors that are providing a broad range of comprehensive advice. And that advice and some of the services behind that advice is portfolio management, but it also includes retirement planning, reviewing your tax documents and helping you identify and hopefully meet your financial goals. And so it’s really a comprehensive service that you’re paying for through your financial advice. And we’re not charging you in differently for the different investments that we’re using. You’re getting one flat fee for your entire portfolio

Tim Maurer:
For sure. So you’re not just paying for one investment, you’re paying for portfolio management. You’re not just paying for portfolio management, you’re paying for wealth management, a broader service. Thank you so much, Jonathan. And thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website askbuckingham.com or emailing your question to question@askbuckingham.com or if you see something in the corner of your screen right now, you can just click that and go directly to the website. Remember, there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions. It will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision making. So please follow us and by all means, ask Buckingham.

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