Interest Rates – Parrott Wealth Management, LLC.

Bonds, Baby!

September 15, 2023Posted in UncategorizedTagged Bonds, Federal Reserve, Interest Rates, Investment ManagementLeave a comment

Is it time to buy bonds? The Federal Reserve interest rate hikes decimated bonds, wiping out years of gains, and if you own bonds, you feel the pain. Long-term government bonds lost money for five years, while stocks produced stellar profits. Over the past decade, the S&P 500 is up 221%, and bonds have risen a paltry 15%, with dividends. If we removed the income, bonds lost more than 11%. Long-term bonds crashed 26% last year, the worst performance in over one hundred years – hardly a ringing endorsement to buy bonds.

Why buy bonds if they performed poorly? Good question. The Wall Street consensus believes the Federal Reserve will stop raising interest rates soon, and Jeffrey Gundlach, CEO of Doubleline Capital, thinks they won’t raise rates again this year. If true, interest rates could stabilize or even fall, a bond benefit.

The Federal Reserve hiked rates by 100% from February 1994 to February 1995, and bond prices dropped by 7.8%. In July 1995, they lowered rates, and bonds soared 31.7%. The Fed raised rates again in 1999 and 2000, and bonds fell 9%, but they lowered them in 2001 and 2002, launching a massive bond rally that lasted several years. From 2000 to 2009, long-term bonds jumped 118%, while the S&P 500 fell 34%.[1]

Bond yields are substantially higher because prices have declined and are approaching a level not seen in over a decade. The current yield on Vanguard’s Long-Term Bond ETF (BLV) is 4.27%, an increase of 64% from last year’s low. US T-Bills did not produce any income during COVID-19 now yield more than 5.5%, and corporate bonds routinely pay more than 5% and 6%. The higher income gives the patient investor a reason to buy bonds; you’re getting paid to wait.

Has the Federal Reserve finished raising interest rates? I don’t know, but I doubt rates will climb more than 3,000% from current levels as they did during COVID-19. It’s possible rates can rise more, but I believe the risk-reward ratio now favors the bond buyer since prices are depressed and yields are higher, especially if the Fed has completed its mission. It could be a classic buy low, sell high strategy.

1994 was my first experience with rate hikes, and it was not fun as I watched bond portfolios fall, but it allowed me to buy them at substantial discounts. Investors who purchased bonds as they fell saw their portfolios increase when prices recovered. The combination of higher income and rising bond prices generated significant capital gains. I hope history repeats itself.

Bye-bye, and buy bonds!

Nobody likes high interest rates. ~ Chanda Kochhar

September 15, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. Prices and yields are for today only and are subject to change without notice. Past performance is not a guarantee of future performance.

[1] Dimensional Funds Returns Web Tool

What’s a Yield Curve?

March 30, 2023Posted in InvestmentsTagged Interest Rates, Recession, Yield Curve, YieldsLeave a comment

The hot topic is the yield curve or, more importantly, the inverted yield curve. A yield curve is a collection of interest rates, or yields, plotted on a chart, beginning with the One-Month US Treasury Bill and ending with the 30-Year US Treasury Bond, plotting all points in between to determine whether it is inverted.

Historically, the yield curve slopes upward and to the right because short-term rates have been lower than long-term rates. It makes sense. If you buy a 30-year bond, you want to earn more interest for your risk exposure.

The yield curve can be normal, flat, or inverted. A normal yield curve occurs when long-term rates yield more than short-term rates. If the yield curve is flat, it doesn’t matter which bond you buy because all rates are the same. When the yield curve inverts, you earn more interest from short-term bonds than from longer ones.

A normal yield curve signals a strong economy with no known issues on the horizon – ceiling and visibility unlimited. When the curve inverts, trouble awaits. What trouble? A recession. An inverted yield curve has previously been a reliable recession indicator, and it’s a sign the economy may be losing steam. The current yield curve is inverted. The US 2-Year Treasury Note yields 4.02% while the 10-Year yields 3.55%, and the spread between the two is the widest since 1980.

An inverted yield curve is a good recession indicator; however, the correlation between an inverted yield curve and a recession is not instantaneous. It may take one to two years before a recession occurs, if it happens at all, after the inversion because it takes time to slow down a $26 trillion economy.

The effective Fed Funds rate is 4.83%, the only rate the Federal Reserve controls. The remaining rates are left to market participants – buyers and sellers. Monitor the US 2-Year Treasury yield to determine where the Fed is heading. It currently yields 4.02%, down from 5.05% earlier this year.

In the movie Top Gun, Maverick and Goose inverted their F-14 Tomcat to take a picture of a Russian MIG pilot. After the encounter, they returned the plane to normal, flew back to Miramar, and buzzed the tower. Their inversion didn’t hinder their ability to fly their aircraft.

Slower growth doesn’t mean any growth. If our economy traveled 75 miles per hour a couple of years ago, it might be cruising at 55 MPH today.

Our economy is strong, corporate earnings are decent, interest rates are stabilizing, and taxes are favorable. These factors bode well for a higher stock market at some point. Follow your plan, diversify your assets, and think generationally; good things can happen.

Because I was inverted. ~ Maverick, Top Gun

March 30, 2023

What Is A Preferred Stock?

March 3, 2023Posted in InvestmentsTagged Fixed Income, Interest Rates, Preferred StocksLeave a comment

Preferred stocks can generate significant income and are hybrid investments, similar to stocks and bonds. The dividend income is usually higher than owning shares of common stock, and you may get some price appreciation. The preferred label comes from the pecking order on the balance sheet because shareholders receive their dividends before common-stock owners. In a corporate liquidation, bondholders receive their money first, followed by preferred holders, and common-stock shareholders receive whatever is leftover.

Preferred shares are typically issued at $25 per share and can’t be called or redeemed by the issuer before five years. If a preferred does get called, it’s at $25 per share.

The price of preferred stocks hovers around $25, and they may trade to $28 or $30 per share if rates are falling. When rates rise, the price may fall to $20 or $21 per share. They’re sensitive to interest rates, like bonds, and the prices adjust up or down based on the level of interest rates. Earning an income of six percent or more from preferred stocks is possible.

Preferred stocks are rated like bonds, so invest in ones with quality ratings. Standard & Poor’s and Moody’s apply ratings from AAA to D, depending on the quality of the issue. It’s rare to find AAA-rated preferred stocks; most ratings fall between BB and B . Ratings don’t tell the whole story, as we discovered in 2008, so pay attention to corporate balance sheets. During the Great Recession, several preferred stocks fell in price to single digits. Preferred stocks are sold with a prospectus, so you can read about all the features before purchasing your shares.

On the surface, a preferred stock sounds like a solid investment; however, the devil is in the details. As I mentioned, most preferred stocks get called after five years. If you purchased one intending to get your money back after five years, and it is not redeemed, you may hold your shares for thirty, forty, or fifty years or more!

Of course, you can sell your investment anytime, but you may get more or less than your purchase price. It is a risk for investors when interest rates rise because the value of your shares can fall. You can likely sell your holdings for a gain when interest rates drop.

Barron’s has a tremendous section of preferred stocks. In the stock tables, you can look for companies by name, price, yield, etc. Once you have identified a few, you can do further research online.

I recommend allocating approximately five percent of your fixed-income portfolio to preferred stocks if you want to give it a boost,

What do you prefer? ~ 1 Corinthians 4:21

March 3, 2023

What Is A Bond Ladder?

March 2, 2023Posted in InvestmentsTagged Bond Ladder, Bonds, Fixed Income, Interest RatesLeave a comment

An excellent strategy to protect your assets from rising or falling interest rates is to build a bond ladder—a portfolio of bonds with different maturities.

Bond maturities are similar to rungs on a ladder, and each one you climb gets you closer to your goal. Your ladder can consist of bonds maturing in thirty days or thirty years, and yours should fit your situation and time frame. You can also build multiple ladders designed to achieve several goals.

How can you create a bond ladder? Let’s look at an example. Start with five bonds with maturities ranging from one to five years with corresponding rates of 1, 2, 3, 4, and 5 percent. The average yield for this hypothetical ladder is three percent, with an average maturity of three years. At the end of year one, your first bond matures, and you’ll receive a portion of your principal. With the proceeds, you purchase a five-year bond paying five percent. The remaining bonds have now moved up by one year, and your bond ladder currently consists of bonds with original maturities of two, three, four, five, and five years, paying 2, 3, 4, 5, and 5 percent. Your average yield is now 3.8 percent, and the average maturity stays the same because you still own a portfolio of bonds maturing each year for five years.

At the end of the second year, bond two matures. With the proceeds from bond two, you buy a five-year bond paying five percent. The remaining bonds are one year closer to maturing, and your ladder consists of bonds with original maturities of three, four, five, five, and five years and paying 3, 4, 5, 5, and 5 percent, with an average rate of 4.4 percent. You can repeat this process indefinitely.

A bond ladder always has bonds maturing to provide liquidity, while longer-term bonds generate above-average income. The income from the original ladder was 3 percent; by the last example, it jumped to 4.4 percent—an increase of 46 percent. At the same time, your average maturity remained constant at three years. If interest rates rise, your maturing bonds allow you to buy new ones at higher rates. If rates fall, you generate higher income with your longer-dated bonds. Also, if rates fall, the value of your bond portfolio can rise in value to produce capital gains.

The bond ladder is flexible, allowing you to use any fixed-income investment to construct your portfolio: CDs, tax-free municipal bonds, corporate bonds, or US Treasuries. You can mix and match the fixed-income choices. For example, you can structure a ladder with US Treasuries, corporate bonds, and tax-free municipal bonds. The treasuries can be short-term—from one to two years—corporate bonds from two to ten, and municipal bonds from ten to thirty years.

Investors often have a high percentage of cash in their accounts, waiting for interest rates to rise or the stock market to crash. If you hold a significant cash position, you can use short-term US Treasuries to create your money-market fund with better results. In addition to higher rates, your investments are guaranteed, regardless of how much money you invest.

Several years ago, I helped a client construct a short-term bond ladder with US T-Bills. He inherited several million dollars and wanted to buy CDs from local banks for safety and liquidity. I informed him he’d have to contact fifteen banks to qualify for the full FDIC insurance coverage, and as a result, we built a short-term US T-Bill ladder guaranteed by the US government. It was one-stop shopping for his inherited assets with superior income, liquidity, and guarantees.

In summary, a bond ladder built for you and your family can help you achieve your financial goals without worrying about the direction of interest rates.

The ladder of success is best climbed by stepping on the rungs of opportunity. ~ Ayn Rand

March 2, 2023

Bond Math

February 5, 2023Posted in UncategorizedTagged Bond funds, Bonds, Federal Reserve, Interest RatesLeave a comment

As rates rise, investors struggle to understand why bond prices are falling, especially after last year’s rout in the bond market. Bonds are supposed to be stable and boring, not a volatile asset class, yet, they are complicated instruments, providing something for all investors.

The Federal Reserve raised interest rates from 0% to 4.5% last year, a significant increase and the steepest rise in history. As a result, the rate increase destroyed bonds, causing damage to numerous portfolios.

Bonds are fixed-income investments, meaning the coupon does not move, but the other yields can gyrate significantly. A bond is a contract with terms outlined in the prospectus, a legal document. Let’s explore some bond pricing to help you make better investment decisions.

Terms and Data

Coupon: The coupon is the fixed rate on your bond.

Current Yield: The current yield is a function of your coupon rate and today’s price.

Yield To Maturity: The yield to maturity rate is what you’ll earn on your bond at maturity, based on the coupon rate and the price of your bond.

Stable Rates

If interest rates are stable, flat, or not moving, then the coupon, current yield, and yield-to-maturity are equal. For example, if a bond trades at $100 with a 4% coupon, the current yield and yield to maturity are also 4%. You will earn $4,000 annually if you own a $100,000 bond.

Falling Rates

If interest rates are falling, your bond’s price rises like a see-saw in the park. For example, if the coupon is 4% and the price of your bond increases to $110, then the current yield is 3.64%, and the yield to maturity is 2.84%. When rates fall, the coupon is higher than the current yield, which is higher than the maturity yield. You will earn $4,000 annually if you own a $100,000 bond, regardless of the current yield or price.

Rising Rates

If interest rates are rising, then the price of your bond is falling. For example, if your bond has a 4% coupon and the price drops to $90, the current yield is 4.44%, and the yield to maturity is 5.3%. When rates rise, the coupon is lower than the current yield, which is lower than the yield to maturity. You will earn $4,000 annually if you own a $100,000 bond, regardless of the current yield or price.

One Percent Decrease

If you own a ten-year bond, then a one percent decrease in interest rates will increase the price of your bond by 8.5 percent, rising from $100 to $108.50.

One Percent Increase

If you own a ten-year bond, then a one percent increase in interest rates will decrease the price of your bond by 7.7 percent, falling from $100 to $92.30.

Bond Funds

What about bond funds since they don’t have a fixed interest rate or maturity? Vanguard’s Intermediate-Term Bond fund owns 2,144 individual bonds with an average duration of 6.29 years. The yield to maturity is a function of the portfolio’s average coupon, duration, and the prices of their bonds.

Bonds can be simple and complicated. A US T-Bill is simple, but a junk bond issued by a cryptocurrency company is complex. Pay attention to the rating and yield to maturity if you buy individual bonds. If you don’t want to sift through thousands of bonds, purchase a bond fund.

Bye, bye, and buy bonds.

When I was a kid I got no respect. I had no friends. I remember the see-saw. I had to keep running from one end to the other. ~ Rodney Dangerfield.

100 Years of Data

October 7, 2022October 7, 2022Posted in InvestmentsTagged baseball, Inflation, Interest Rates, Investment Management, Stock Market CrashLeave a comment

When will the market recover? When will inflation fall? Will interest continue to rise? These are the three questions clients ask about the current state of the economy. These are reasonable questions, but I don’t have any idea. I do have, however, 100 years of data to support my thesis that stocks will eventually recover and inflation will subside.

Stocks

Since 1926, the S&P 500 has averaged 10.07% per year despite wars, recessions, corrections, and politicians. The market has risen approximately three-quarters of the time, or three out of every four years, which means one-quarter of the time it falls. The S&P 500 has a winning percentage of 750%. The New York Yankees are considered the best major league baseball team in history, winning 27 World Series titles, and their winning percentage is only 570%. If the market finishes in negative territory this year, it will be the thirteenth time in the last fifty years, in line with historical averages. Since 2015, the S&P 500 has lost money in four calendar years, including this year. In other words, it made money 73% of the time. I don’t know when the market will recover, but I like my odds.

Inflation

Inflation has averaged 3.26% dating back to 1914. In the past, an increase in inflation resulted from an event like WWI, WWII, or the Arab Oil Embargo. I believe the recent spike is due to COVID, supply chain issues, and our government’s response to the shutdown. After each spike in inflation, it started to decline almost as fast as it climbed. We are already seeing signs of inflation easing at the gas pump, shipping containers, and used-car prices.

Interest Rates

Interest rates continue to rise in response to rising inflation. The one-year US T-Bill yields 4.19%; last year, the yield was .09%, an increase of 4,555%. Since 1871, the average long-term interest rate has been 4.49%. And from 1871 to 1967, the rate mostly stayed below the average. It wasn’t until 1967 that rates climbed significantly, rising from 4.59% to a peak of 15.32% in 1981. After the peak, interest rates fell 93% from 1981 to 2020. In 1994, the Federal Reserve increased interest rates by 100% from 3% to 6% before lowering them in 1995, which started an epic run for stocks where they soared 226% from January 1995 to April 2000.

I believe in reversion to the mean, and I expect stocks to rise and inflation and interest rates to fall, but I don’t know when it will happen, but I have one hundred years of data on my side.

History never repeats itself, but it does often rhyme. ~ Mark Twain

October 7, 2022

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. Though the Yankees are the winningest team in MLB history, I expect the Dodgers to win this year’s world series.

It’s An Emergency!

June 15, 2022Posted in InvestmentsTagged Emergency Fund, Federal Reserve, Interest Rates, Investment ManagementLeave a comment

Dave Ramsey takes a lot of heat from financial professionals, but his seven steps have helped millions of people pursue a better life. I don’t agree with his entire philosophy, but establishing an emergency fund, paying off debt, and saving for retirement are tenants that make sound financial sense.

During challenging times, an emergency fund is paramount. I recently bought a new refrigerator, and my Jeep needs an engine repair. Thankfully, I have an emergency fund to cover the costs. If I didn’t have the fund, I would have charged the expenses to my credit card, and a credit card is not an emergency fund!

Stocks and bonds are down sharply. The S&P 500 has dropped 21%, while long-term bonds have fallen 26%. It’s difficult for investors as all major asset classes are in negative territory, and cash is the best-performing asset. If cash is your best investment, you know it’s a tough year! However, a significant cash balance allows your stocks and bonds to recover, and that’s why an emergency fund is necessary if you want to be a successful investor.

What is an emergency fund? Well, it’s a fund you can tap in an emergency, so you’re not forced to sell stocks or bonds when they’re down. The fund is a liquid resource you can tap at any time without losing money. Your emergency fund should own cash, money market funds, CDs, or T-Bills. A silver lining to rising interest rates is you can buy short-term investments with competitive yields. The 1-Year Treasury rate currently yields 3.15%; two years ago, it was 0.14%, an increase of 2,150%!

Here are a few suggestions for establishing your emergency fund.

Invest in short-term instruments like cash, money market funds, CDs, and US T-Bills.
Your emergency fund should cover nine to twelve months of expenses in the current environment. For example, if you spend $10,000 monthly, your fund value range would be $90,000 to $120,000.
Ladder your emergency fund with CDs or T-Bills maturing monthly: one month, two months, three months, etc. The short-term maturities provide liquidity when you need it most.
Automate your savings so you don’t have to think about investing monthly.
Don’t use Bitcoin, stable coins, credit cards, or a line of credit as a substitute because they can lose value or get terminated by your bank. During previous recessions, banks curtailed credit, and it wasn’t easy to get a loan.

Markets always recover as they did in 2020, 2018, 2016, 2008, 2000, etc., and an emergency fund allows your stocks and bonds to rebound. Cash is valuable, especially when the economy and markets are imploding.

An emergency fund turns a crisis into an inconvenience. ~ Dave Ramsey

June 15, 2022

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management, located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Offense and Defense

February 20, 2022Posted in InvestmentsTagged Financial Planning, Inflation, Interest Rates, Russia, Stock MarketLeave a comment

The New England Patriots trailed the Atlanta Falcons 28-3 in the third quarter of Super Bowl LI. At that point, the odds of winning the game were about 1% to 3%. Their situation was dark and bleak. Did the Patriots panic or quit? No. They kept their composure and followed their game plan despite digging a big hole, and slowly but surely, they engineered the most incredible comeback in Super Bowl history, winning the game 34-28.

The current investment environment is depressing as stocks and bonds continue to fall over worries Russia will start another meaningless war. Russia’s eagerness to invade Ukraine overshadows other headwinds like inflation and rising interest rates.

Russia has a long history of war, dating back to 879. In 1979 they invaded Afghanistan and remained there for ten years.[1] During their occupation, the S&P 500 climbed 267%. Inflation peaked in 1979 at 13.3% and dropped to 5.8% by 1989. In 2014, they annexed Crimea, and since then, the S&P 500 jumped 135%.[2]

Inflation averaged 3.8% during World War I, and stocks averaged 10.1% from 1939 to 1945. The year after Pearl Harbor, the S&P 500 rose 20.3%, and by the end of the war, it soared 102%.[3]

I’m not comparing football to war, but we can learn much from the Patriot’s Super Bowl victory.

Don’t panic. If you panic and sell during down days, you’ll never experience victory. Markets rise and fall daily, like the tide. Since 1926, the S&P 500 had stretches where the returns were less than 2%. From 1929 to 1944, stocks averaged 1.7%, from 1969 to 1975, they returned 1.6%, and from 2000 to 2011, they earned 1.7%. For thirty years, stocks averaged about 1.7%, but since 1926 they averaged 10.1% per year if you held stocks in good times and bad.
Follow your plan. The Patriots followed their game plan, and I’m sure they made adjustments. When financial chaos arrives, we often check our client’s financial plans to ensure they are on the right path and the recent volatility is not impacting our client’s goals. A financial plan allows us to navigate difficult circumstances with confidence, and it can help you as well.
Play offense. It pays to play offense when stocks fluctuate because they eventually recover. If you don’t have equity exposure when they take off, you can miss significant opportunities. The biggest up days typically follow the biggest down days. If you wait for the all-clear signal, it’s too late. After stocks bottomed in March 2020, they soared 45% over the next six months despite the uncertainty surrounding COVID.
Play defense. During financial uncertainty, it pays to play defense because stocks could remain depressed for a long time. If stocks drop, allocating money to cash and bonds can help preserve your assets.
Be patient. If your time horizon is three to five years or more, continue buying and holding stocks. If you need the money in one to three years, consider money market funds, CDs, T-Bills, etc.

The market hates uncertainty, which is why stocks are down, and volatility is up. If there is good news, stocks rise, and they fall if there is bad news. Unfortunately, it will remain this way until there is clarification surrounding Russia, inflation, and interest rates.

The Patriots won Super Bowl LI because they followed their plan, played both offense and defense, did not panic, and were patient. Let’s follow the Patriots game plan, even if you’re a Giants fan.

I know worrying works, because none of the stuff I worried about ever happened. ~ Will Rogers

February 20, 2022

[1] https://en.wikipedia.org/wiki/List_of_wars_involving_Russia

[2] YCHARTS

[3] Dimensional Funds 2021 Matrix Book

Buy Bonds?

February 11, 2022February 12, 2022Posted in InvestmentsTagged Bonds, Federal Reserve, Fixed Income, Inflation, Interest Rates, Wealth ManagementLeave a comment

Buying bonds is the ultimate contrarian play because everyone knows interest rates are rising, and when rates rise, bond prices fall. The yield on the 1-Year US Treasury increased 1,528% over the past year, while the yield on the 10-Year US Treasury “only” jumped 64%. All rates along the yield curve have increased substantially, and they will probably continue to rise.

In 1990, long-term interest rates reached 9%, and I could not give bonds away since investors were convinced rates were going higher because, in the 1980s, they touched 15%. However, rates declined from 1990 to 2020, falling to a low of .62% – a drop of 93%. The ultimate bull market in bonds occurred from 1982 to 2020.

A 30-year bond will fall 19% if interest rates rise from 2% to 3% – not a compelling argument to buy bonds. And the higher rates go, the lower prices will fall. We sold most of our long-term bond holdings in March 2020 as yields pushed below 1%, and we shortened our maturities to about two to three years and realized gains while transitioning to a defensive position. As interest rates rise, we will extend the maturities of our bond holdings to capture higher yields.

If rates rise, is there a bond strategy that makes sense? I believe there is, and it’s called a bond ladder. A bond ladder works in a rising or falling interest rate environment, and as rates rise, a bond ladder allows you to generate more income.

Here is how it works. You purchase a three-year bond ladder with bonds maturing in one, two, and three years and they pay 1%, 2%, and 3%, respectively.

Bond 2023 pays 1%
Bond 2024 pays 2%
Bond 2025 pays 3%
Average yield = 2%

When the 2023 bond matures, the remaining bonds are now one-year closer to maturity. You now purchase a new three-year bond maturing in 2026, paying 3% with the proceeds from the 2023 bond. Your new ladder now looks like this:

Bond 2024 pays 2%
Bond 2025 pays 3%
Bond 2026 pays 3%
Average yield = 2.6%

Your income increased from 2% to 2.6% or 30%.

When the 2024 bond matures, the remaining bonds are now one-year closer to maturity. With the proceeds from the 2024 bond, you buy a 2027 bond, paying 3%. Your new ladder now looks like this:

Bond 2025 = 3%
Bond 2026 = 3%
Bond 2027 = 3%
Average yield = 3%

Your income increased by 15%.

Your bond ladder can consist of any maturity from one to thirty years, depending on your appetite for risk. Eventually, your ladder will contain higher-yielding long-term bonds with monthly, quarterly, or annual liquidity.

A physical ladder will take you higher with each rung you climb, and a bond ladder can produce higher income as you purchase new bonds. In addition to higher yields, buying bonds can protect your principal if stocks fall, especially if you own short-term bonds. For example, the NASDAQ is down 9.3% this year, while short-term Treasuries are only down 1.57%.

If interest rates continue to rise, you will have the opportunity to buy bonds at a discount, increasing your total return. For example, if you buy a 10-year bond with a 2% coupon at $100, your current income and yield-to-maturity will be 2%. If rates rise by 2%, the price could fall to $84. If you purchase the bond at $84, your current yield jumps to 2.4%, and the yield-to-maturity increases to 3.9%. It pays to buy bonds at a discount. One person’s trash is another person’s treasure.

What is the top for inflation and interest rates? I don’t have a clue, nor does the Federal Reserve. No one can predict where inflation or interest rates are going. If interest rates continue to rise, consider adding bonds to your portfolio so you can generate more income.

As I mentioned, buying bonds is the ultimate contrarian play because everyone knows interest rates are going higher, but what if everyone is wrong? What if rates don’t rise? What if inflation falls? If you buy when others are selling, you could make money with your shrewd investing skills. Who knows?

Bye, bye and buy bonds.

Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance. ~ Benjamin Graham

February 11, 2022

Should You Pay off Your Mortgage?

January 10, 2022Posted in UncategorizedTagged Financial Planning, Inflation, Interest Rates, Mortgage, Stock Market, Wealth ManagementLeave a comment

Interest rates are near historical lows, so does it make sense to pay off your mortgage? Eliminating debt is satisfying, but should you sell stocks or bonds to make it happen? Let’s explore a few options.

Pay off your mortgage

If your cash balance at your bank is high, it’s wise to pay off your mortgage because cash earns nothing. Current mortgage rates are 3.11%, significantly higher than the 0% you’re making from your bank.
Do you plan to retire in the next few years? If so, eliminate your mortgage. Housing is a considerable expense for retirees, even if you’re debt-free. Property taxes, upkeep, and maintenance are not cheap, so removing one more payment is prudent.
Can you commit to investing monthly for twenty or thirty years? If so, pay off your mortgage. The monthly payment for a $500,000 home is approximately $1,700. Investing $1,700 per month for thirty years could grow to more than $3.8 million.
If it brings you peace and reduces your stress, pay it off regardless of the math.

Do not pay off your mortgage.

Do not pay off your mortgage If you expect inflation to rise. In fact, I would recommend borrowing more money because rates are low, but they will increase as inflation climbs.
If your investments earn more than 5% per year, paying off your mortgage does not make sense. Your gross return could drop by 1% to 2% per year, depending on your tax bracket. For example, if you’re in the 32% tax bracket and earn 5%, your after-tax return could fall to 3.4%. When calculating your return, include all your taxable assets, including stocks, bonds, and cash. Do not cherry-pick your best investments.
If you expect to move in the next few years, do not pay off your mortgage. Instead, keep your investments as a safety net or apply them to your new home.

The stock market has soared the past ten years, so letting your investments grow is smart. However, there have been several periods where stocks have not performed well, like 2000 to 2013, where the S&P 500 fell about 3%. We are not promised tomorrow, and returns are fleeting, but expenses are forever.

“Creditors have better memories than debtors.” ~ Benjamin Franklin

January 10, 2022

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Tag: Interest Rates

Bonds, Baby!

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Bond Math

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100 Years of Data

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It’s An Emergency!

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Offense and Defense

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