This month I got a notice that a municipal bond in a client’s portfolio was maturing. I looked at the details of the bond to realize that it was purchased twenty-five years ago which was the year I entered the financial services business and the same year I met this client. The bond paid 6.125% for this twenty-five year period and the income was free from state and federal tax. Not bad by any measure!
Things seemed so much simpler back when rates were higher, such as when seniors could invest most if not all their money in highly rated bonds and generate income of 5, 6 or even 7 percent and not worry about the markets. My client with the municipal bond was 70 years old when we met and is now 95. Over the summer, we celebrated her milestone birthday over lunch with one of her sons and such a gratifying experience it was!
Volatility is Normal and Manageable
During the past twenty-five years, we have experienced great bull markets and great bear markets. The ups and downs of the markets have been extreme at times. Most attention is placed on the volatility of the stock markets but the bond market has seen high levels of volatility as well. In 1994 after the Federal Reserve raised rates six times, the value of many long-term bonds, like that owned by my client, were temporarily down 20 to 30 percent. Few of today’s investors in bonds were in the market during that time. To put things in perspective, the Fed Funds rate was 3 percent in 1993 compared to 2.25 percent as of September of this year and rates are expected to be raised further this year and next. In these twenty-five years, the rate has been as high as 6.5% and as low as 0.25%.
In the past when bonds would mature, I would reinvest the proceeds into a new bond so that my client could continue to collect income to fund her retirement. However, over the past ten years, rates dropped so much that bonds were no longer attractive as a long-term investment for someone seeking income. The choice many made was to invest in stocks which often were paying higher income from dividends than safe high-quality bonds or to remain in cash earning little if any income and wait, hoping for rates to rise before reinvesting. Those who reallocated to stocks have been rewarded over the past decade while those remaining in cash are only recently starting to earn a higher level of income after nearly a decade of rates near zero percent. My client allocated some but not all of her maturing bonds into stocks for income.
Successful investors learn to adapt to the changing economic climate and don’t fixate on a single type of investment. Trends can be very long and bonds served their owners well for many decades but have been losing value in the past few years. Stocks have rewarded investors over the long-term but there have been periods of high volatility and occasional large drawdowns that can lead to emotional reactions.
Diversify and Adjust
Some would say that investing in a twenty-five-year bond for a 70-year-old is too long or that investing in stocks for someone in their 70s or older is too risky. At today’s low rates bonds probably aren’t a good long-term investment. And, some high growth stocks are trading at multiples that are hard to justify and would be too risky. However, if properly diversified, and especially if focusing on companies with dividends and that have a history of growing those dividends, stocks can be a core component of a portfolio at any age. Bonds, too, if invested at the right time in a market cycle can be a core component of a portfolio at any age.
Age and Investment Strategy
A big question that comes to mind is what does a 95-year-old investor do with funds from a maturing bond today? We will likely keep the funds in a money fund or short-term CD since rates remain low and rates on municipal bonds are nowhere near where they were twenty-five years ago. But, what should an 85-year-old investor do? Or a 75-year-old investor or even a 65-year-old investor?
People are living longer than prior generations and statistics show that higher net worth individuals have longer life expectancies than the general population. Should an 85-year-old remain in cash considering they may live another 10 years and could earn more income and grow their assets over that period of time? There are lots of active seniors that are enjoying travel and entertainment well into their later years, and I’m fortunate to be working with many of them. They need a growing source of income to maintain their active lifestyles.
I advise many clients and their families. My experience shows that the investments made for one generation often pass to the next generation in kind, meaning that their bonds, stocks, or real estate get passed along and continue to be held by the next generation. One of the greatest tax benefits that still exists is the step up in basis on appreciated assets. If you buy a stock and hold it long-term and then pass it to your family, they don’t have to pay any capital gains tax if there was any appreciation in the holding.
Doing What’s Best for Kids and Grandkids
Some of the greatest investments of the past century have been stocks in companies like McDonalds, Coca Cola, Procter & Gamble and Microsoft. These companies’ shares have all hit record high prices recently, but more importantly, they have all been paying regular quarterly dividends for many years and have been raising those dividends consistently every year.
At any age, investments that pay regular income that grows annually is beneficial. And, these same investments can be passed on to the next generation, avoiding the capital gains tax, while passing on an investment that could potentially provide income for one’s children or grandchildren.
Children of today’s seniors may be best served by inheriting a well-diversified portfolio rather than cash in the bank. For those people fortunate to have parents who followed long-term investment principles during their lives, an already diversified investment portfolio will be the passing gift more likely to provide growth and income into future generations along with a lesson on successful investing.
Learn from what Works
So much can be learned from our parents and grandparents, especially the ones who understood the principle of diversifying to guard against an unpredictable future. Experienced and well-trained financial advisors have always known that keeping the majority of one’s savings in one place, no matter what it may be returning now, has never been as effective as diversifying investments into stocks, bonds and, yes, even some cash, at the appropriates times during market cycles.
Balancing your portfolio for your individual or family situation is a critical exercise that you and your financial advisor should engage in on a regular basis. This could be done annually or at recommended intervals you’re most comfortable with. The important thing is to remain proactive in your financial planning and stick with the principles that history has shown us to be reliable for investors – those common sense principles that have worked for every past generation and continue to work today.