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Got Bonds?

Do you own fixed income mutual funds and exchange traded funds (ETFs) instead of individual bonds? If so, you have already had your moment of reckoning. …Wait, that’s not exactly right— you’re experiencing an ongoing moment of reckoning.

Fixed income ETFs (and funds) are down massive amounts this year, and by the way, anyone who thought last Friday was the end to the pain is nuts. It was not.

US payrolls were slightly weaker than expected across the board. 150,000 jobs were added vs. the 180,000 forecasted, with downward revisions to previous months yet again—that’s been “a thing” over the last couple of years. The household survey dropped, unemployment rose a tick to 3.9%, and average earnings undershot 0.2% month over month.

These data still show a tight labor market, and they’re still way out of line with the strong Job Openings and Labor Turnover Survey (JOLTS) number, low weekly jobless claims, the huge pay deals struck by the UAW union, and Institute of Supply Management (ISM) services prices paid. Nevertheless, global bond yields plummeted like one would only expect if we had seen a negative payrolls print. The US 10-year fell to around 4.50%, the dollar dipped, commodities were up, and the S&P continued its rise for +3.9% in the last three days of the week.


So, for many readers, this week’s Insights may be an eye opener; I know that because I’ve recently reviewed so many portfolios of investors who are getting hosed.

Here’s a little Bonds 101:

Fixed income ETF’s and funds won’t meet your financial planning or portfolio performance needs, and here’s why. If you buy a 10-year bond at 4.8% yield to maturity, you know that you will make 4.8% every year until the bond matures and then get back all of your principle. But with a fund or ETF, the shares don’t have a maturity date; there’s no date at which point you can be assured of getting back all of your principle. Quite the contrary, in a rising interest rate environment (as many readers have experienced), the net asset value of the ETF shares will continue to decline as long as rates continue to climb.

Here's a chart of the iShares 20+ Treasury ETF (TLT) over the last two years— it’s off 42%:

(By the way, losses like that mean that your investment has to make about 78% now just to get back to even.)

Here’s a chart of the iShares 7-10 Year Treasury (IEF) over the same time period— down 22%:

Last but not least, here’s the chart of the iShares 3-7 Year Treasury ETF (IEI)— down 13%:

Just to add insult to injury, the yield on IEI is 2.26% while the yield on the five-year Treasury itself is 4.6%. The yield on IEF is 2.9%, but the yield on a ten-year Treasury bond this week is 4.6%. The yield on TLT is 3.7%, but the yield on a 20-year Treasury bond is 4.9%. …Oh, and a 13-week T-bill is paying 5.3%.

In other words, not only are ETF holders getting saddled with massive capital losses, they’re getting less current yield.


These bond ETFs’ performance illustrates the importance of having a maturity date for your fixed income instruments. And those bonds should be held in a traditional brokerage account instead of a fee-based advisory account, or at the very least, in an account with an extremely low fee.

It's just plain unreasonable to own a 10-year Treasury bond that yields 4.6% in a fee-based account, especially when you consider that the commission to buy a ten-year bond is less than half a point these days. If the annual fee is extremely low, it might make sense, but if it’s only moderately low, say 50 basis points (0.5%) a year, it’s a pretty weak idea.

Let’s say an advisor is charging that 50 basis points (0.5%) a year; the advisor is making five points (0.5% a year) over the lifetime of a ten year bond instead of just a half point one time.

To be clear, I have seen lots of portfolios structured this way, but it’s pretty obvious that the performance and planning components of a financial advisor’s fiduciary duty are not well served by owning fixed income ETF’s instead of the bonds themselves, and even if one owns the bonds themselves, the fee is almost always impossible to justify.

In summary, by owning the ETF, you get less yield, get charged a fee to own it, and have no maturity date when you know you’ll get your return of principle.


Over the last century, there have only been four 10-year rolling periods when the stock market had negative returns, and stocks still returned better than any other asset class all four of those times-- stocks did poorly, but bonds and real estate got utterly destroyed.

That kind of empirical evidence suggests that any money an investor needs in ten years or more should all be invested in stocks. And money that you need in three years should be in a bond that matures in three years, money that you need in five years should be in a bond that matures in five years, and so on and so on. Invest your long-term money long-term, and invest your short-term money short-term.

Click here to invest with Chad.

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