Positive Vibes

The probability of a rate hike at the December 16th FOMC meeting, as calculated by the market, now stands at 80%. Whether it actually takes place in a week, or whether the move takes place at one of the next two meetings, the consensus is that short-term rates will move higher soon. We have written over the past months, and even years, not only our view of when the Fed will raise rates, but also what the impact will be on the most rate-sensitive area of most portfolios: bonds.

Just yesterday I received an email that was likely similar to emails you have been receiving lately, from one of the many financial services firms who have taken it upon themselves to save our fixed income portfolios. The subject header read, “Is your fixed income portfolio prepared for rising rates?” The first line, in bold, warned me, “It’s the interest rate risk inherent in fixed income: when interest rates rise, bond values fall.” Based on the severity of warnings such as these, that we have all been subject to through news media outlets and the marketing divisions of asset gathering financial companies, I decided to do some digging to see just how “at risk” we truly are with regard to bonds.

In actuality, my “digging” involved updating a chart to which I like to refer that I think should relieve those concerned about rising interest rates. The chart below, using data compiled by Morningstar’s Ibbotson SBBI 2015 Classic Yearbook, shows that even during long periods of rising interest rates, US intermediate-term government bonds rarely exhibit negative returns: (Click on the chart for a larger version)

Negative Returns Uncommon

While the long explanation for these welcome results is related to duration and convexity (i.e. more is gained from a fall in yield than is lost when interest rates rise), the shorter answer is that total returns from bonds comes from a capital appreciation component and an income component. In a bond portfolio that is properly laddered and/or managed, maturing bonds are reinvested at higher rates, so that over time, higher rates mostly offset capital losses, even during rising rate periods.

An even more positive chart (pun intended) explores what happens to bond returns with longer holding periods. This data, also provided by the Ibbotson SBBI 2015 Classic Yearbook, demonstrates how holding assets for long periods of time has the effect of lowering the risk of experiencing a loss of capital: (Click on the chart for a larger version)

Long-term positive returns

Throughout these 5-year rolling-periods there were times where interest rates undoubtedly rose for an extended length of time. In spite of rising rates, bonds have demonstrated a remarkable ability to preserve capital when held judiciously and through full market cycles.

It should be noted that here at Northwest Investment Counselors we invest primarily in corporate and US Government Agency debt securities. Agency bonds tend to move almost in lockstep with US Treasuries due to their implicit government guarantee, the major difference generally being the structure of agency bonds, many of which are callable, compared with plain vanilla, non-callable Treasuries. The above trends, while similar for all high-quality, investment grade bonds, are likely somewhat different for corporate bonds, with the notable difference being the higher return volatility of corporate bonds. Since they are inherently riskier, the returns in good years will be higher, and the negative return years will see more capital depreciation. Nonetheless, well-researched corporate bonds will offer many of the same portfolio stabilizing characteristics of US intermediate-term government bonds when held for long periods, while in most cases providing a higher level of income.

Please contact us directly to learn more about the contents of your bond portfolio specifically or to hear about our various fixed income solutions that provide income while also matching cash flow with liabilities.

Major Changes to Social Security Claiming Strategies

A backroom budget negotiation at the eleventh hour in order to save the country’s borrowing authority has left a Social Security claiming strategy that was starting to gain popularity due to the potential increase in benefits on the “cutting floor”. The two strategies that potentially increased a couple’s total social security benefits, “File and Suspend” and “Restricted Spousal Benefits” now only benefit those that were born within the right time period.

• If you are already 66 or will turn 66 within six months of the new law being enacted (expected May 1, 2016) you can still File and Suspend or:
• If you turn 62 by December 31, 2015 you will still be able to claim just a spousal benefit when you turn 66 as long as your spouse is either claiming Social Security at that time or had File and Suspended by May 1, 2016 and then switch to your higher benefit when you reach 70.

For all others, you are no longer going to be able to claim only a spousal benefit while letting your own benefit accrue delayed retirement benefits. Nor will you be able to File and Suspend in order to release benefits for family members while letting yours increase.

The good news is for those who have already deployed one of these strategies those are grandfathered in as viable strategies and benefits will continue to be paid as such. It is a complicated twist to an already complicated benefit so please call or email us with your specific situation and we will be happy to offer some clarity.

Are You Financially Retirement Ready?

We are frequently asked, “How much do I need to retire?” It is difficult to answer without a lot of buts and ifs and detailed spreadsheets.  So while nothing can substitute for a financial assessment by one of our Wealth Managers, you can use our Retirement Cash Flow Estimator (RCF) to help you gauge your retirement readiness (see graph).  The RCF Estimator uses the life expectancy data for females.[1]  It is an estimate of the present value of a $1 financial annuity ending at age 95 and beginning at the age you select in the graph.  We adjust the $1 annual annuity to account for inflation, mortality, and the time value of money using a recent yield curve for investment grade bonds.[2] Thus, you should think of the RCF value as what the average retiree can expect.

RCF EstimatorThere are two ways to use the RCF value.  One, divide your portfolio value (excluding your primary home equity[3]) by the RCF value nearest your age to estimate the real cash flow (it will increase by the expected inflation rate over your retirement period) the average person can expect in retirement.  For example, say you are 65 and your current portfolio value is $1,000,000.  You would divide the portfolio value by 20.01 from the graph and get $49,975.  This is an estimate of the real pre-tax cash flow a $1,000,000 portfolio would produce through age 95 for the average investor.  At age 95, the portfolio of the average retiree would be drawn down to zero.  If your retirement budget is equal to or greater than the $49,975, you probably need to save more (i.e., work longer) or find ways to cut your retirement budget.

The other way to use the RCF Estimator is to multiply the RCF value by your estimated retirement budget to determine the size of the portfolio the average retiree needs to cover retirement expenses. If your current portfolio value is well above the amount calculated above, you may be financially ready for retirement.  Now you can take the next step and meet with one of our Wealth Managers to perform a detailed financial assessment.

This should be used as a rough guide or starting point to your estimated cash flow in retirement.  It is not a guarantee of any kind nor does it reflect fees and taxes.  As it represents what the average retiree can expect, your results are likely to be different.


[1] U.S. Department of Health and Human Services, National Vital Statistics Reports, 2010. Using mortality data for females results in more conservative estimate of potential cash flow from your portfolio.
[2] Thank you to BlackRock, Inc. for inspiration and similar calculations.  We encourage you to also use BlackRock’s CORI™ estimator at https://www.blackrock.com/investing/insights/retirement/cori-analysis.
[3] We recommend leaving out your home equity and consider that a margin of safety in retirement.

Retire.Ready: Spotlight on the Bond Ladder

Clients near or in their retirement years consistently express three primary financial concerns:

  1. Do I have enough money?
  2. Is my cash flow predictable?
  3. What if I have an emergency?

Our Retire.Ready solution addresses these concerns. We believe those nearing retirement should transition from a pure total-return approach to a hybrid total-return and liability matching strategy to reduce risk while managing retirement cash flow. The Retire.Ready solution consists of three important components:

  1. In-depth financial assessment that creates a retirement budget
  2. Social Security optimization
  3. Portfolio divided into three financial buckets including unique 10-year bond ladder to match future cash flow needs (see diagram)

Just like our long-standing, traditionalbuckets portfolios Retire.Ready utilizes high-quality bonds. Uncovering attractive yields is always an important goal, but safety and predictability are the cornerstones of the Retire.Ready bond ladder. It takes a prudent investor to know when to pass up the siren call of even slightly more yield in favor of capital preservation. This is a tradeoff we take to the next level.

Our traditional total return portfolios that incorporate our intermediate fixed income securities are designed to be extremely safe, but also maintain a manageable amount of risk, to increase income responsibly. In our intermediate fixed income composite, we have the flexibility to target an array of credit ratings across either a range of maturities or a more consolidated timeline, as long as we feel comfortable with the overall diversification, yield, and safety. Our in-house research points us towards companies with wide economic moats and strong balance sheets, but also towards companies whose competitive advantage is based more on economies of scale in competitive, low barrier industries. We prefer companies with strong management teams and high cash flow generation, but our research allows us the flexibility to favor unusual credit metrics over others, such as a company’s ability to tap the credit markets, cut large historic dividend payments, or divest less profitable business lines. Our internal, rigorous, and evolving due diligence is our advantage in finding individual bonds that we feel confident will mature at par, all while providing higher than general market yields to maturity.

Retire.Ready takes a slightly different approach. The typical bond portfolio risks, be it interest rate risk, reinvestment risk, or headline risk have been reduced by a bond ladder designed to match our clients’ upcoming liabilities. The bonds in the ladder won’t always be the highest yielding bonds in a particular credit sector, due to our prioritizing of safety, and will in most cases be held to maturity. Though we plan to hold bonds to maturity, this is not a “set it and forget it” portfolio or high priced annuity. We continue to monitor the portfolio, be it corporate or municipal bonds, to ensure the persistent high standard of credit quality we recognized when the bonds were purchased. Retire.Ready bonds will benefit from institutional pricing and also the nimble nature of our bond desk to find mispriced “odd-lot” bonds when appropriate. The Retire.Ready portfolio will make use of corporate, agency, and municipal bonds to find the right mix of credit quality, tax-efficiency, and income. Please contact us to learn more about what goes into the Retire.Ready portfolio and how it may help you to be and feel more secure financially.


If you missed the live showing of our Private Wealth Management series on managing retirement cash flows and optimizing your Social Security strategy, here is a link to the replay on YouTube.  If you want a copy of the slides, please contact us.

The securities mentioned are not the only securities we have purchased in the last year for our clients.  If you would like a list of all securities purchased in the last year, please contact us.  Additionally, it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned.

Retire.Ready Private Wealth Management Series

Here is a picture from our Retire.Ready presentation this morning.  We will have a video summary up soon for those who missed the presentation.  Thank you to all who attended and thank you Christel Turkiewicz, CRPC and Matt Roehr, CFA for presenting our retirement solution.20150519_162008819_iOS Please follow us at @NWInvestment or @NWRetireReady to stay informed.

Retire.Ready Private Wealth Management Series

Please join us on May 19 for our latest Private Wealth Management Series on our Retire.Ready service.  Are you prepared for retirement?  Have you prepared a budget plan?  Have you considered strategies to maximize your Social Security?  How should your portfolio be structured to meet your retirement cash flow needs and still be sustainable, predictable, and flexible?  Matt Roehr, CFA and Christel Turkiewicz, CRPC will lead the discussion on this important topic.  Space is limited and filling fast so RSVP today to Theresa O’Donnell at 503-906-9624 or todonnell@nwic.net.