The Asset Class Everyone Abandoned Might Be the Smartest Thing in Your Retirement Right Now

Your checking account, your brokerage, and your 401k are three completely different jobs, and treating them the same way is one of the most expensive mistakes in retirement.

Ready to build a retirement plan around your life, not a product?  

Get the free book and tools 👉 RetireOnTime.com/Free 

This is for educational purposes only and is not financial advice.

What is How to Retire on Time?

Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.

Mike: 00:00

So the last couple of years, what happened? Well, we had inflation. What happens when inflation hits? You increase interest rates. What happens when you increase interest rates?

Mike: 00:10

The the those interest rates have an influence over treasury rates. They're not actually connected. People don't understand that, but they do influence each other. And when interest rates go up, bonds and bond funds lose value. So the bond doesn't actually lose unless you sell it early, but it's important to understand because a lot of people have bond funds in their portfolio.

Mike: 00:32

Well, now everyone's got this bad taste in their mouth about bond funds. Now look, I haven't used bond funds or even like thought about bond funds my entire career. Over a decade, it was never competitive. I'll explain how I got there in just a second.

David: 00:45

Okay.

Mike: 00:46

But now people are leaving bond funds saying, it's a crappy investment, it can lose money, it's it's it's supposed to not have risk, but it does have risk and there's not much growth potential anyway. So let's just get rid of the bond funds and go all That setup is significantly increasing the retirees risk, because today bond funds are finally a good deal.

David: 01:10

And do you have to have a broker to get into a bond fund, or can you No.

Mike: 01:12

Do do it on your app.

David: 01:14

You just do it on the app?

Mike: 01:15

Yeah. Ask your favorite AI. What's a good bond fund? It's probably gonna go like AGG or BND. Those are Vanguard total bond funds.

David: 01:22

Okay.

Mike: 01:22

Vanguard does not sponsor this at all. No. But they are a very credible, wonderful institution. They've done people a great service in how they've structured their business.

David: 01:32

And that's like is that like a mutual fund that holds a bunch of different bonds or an ETF or both?

Mike: 01:36

Today, most people are doing ETFs. Oh. Yeah. Okay. But it's basically a bunch of bonds, mid, short, some sometimes long term that are just being traded, trying to have that stability in the portfolio.

Mike: 01:48

Mhmm. Okay? Should we explain how that well, hold on. Yeah. Let me let me just kind of put a nice preface here.

Mike: 01:55

Alright. So if the ten year treasury just gonna ask you a question. If the ten year treasury is low, mortgage rates are low. Making it a good time to buy a house. Alright.

Mike: 02:08

Or to refinance your house.

David: 02:10

Love that.

Mike: 02:10

The ten year treasury is high. How does that change your real estate opinion?

David: 02:16

Oh, so then is the if it's high, does that mean I have a high interest rate? Now I don't wanna buy or I don't wanna refinance?

Mike: 02:23

Yeah. Yeah. I mean, you refinance 2% mortgage to a 7% mortgage? I will hang on

David: 02:30

to my 2.6, like, know, APR on my interest

Mike: 02:34

Okay.

David: 02:35

Home loan till I die.

Mike: 02:36

So if the ten year treasury is averaging less than 3% returns, why would you have bond funds in your portfolio? All you've got is either a low return with interest rate risk. Meaning if inflation gets out of hand, they increase interest rates and your bond fund loses money. And that's what happened to almost everyone that had bond funds from 2020, 2021, 2022, and they walk into that and they're losing money on what they thought was a less risky asset. It was never a good deal.

Mike: 03:07

And I can't believe how many people walked into the office saying, no one told me. And so now they're trying to get it out of their portfolio because they don't wanna be wrong. But it's like now, okay, bond funds, the ten year treasury, which is kind of the gold standard that that tracks a lot of the bond market. It's around $4.05 percent or so. It's above my rule of thumb of 3%.

Mike: 03:32

That's a reasonable return of the dividends being paid out and the bond fund will just kinda sit around, not do too much. That's a reasonable expectation though. And so when you have reasonable expectations, what happens? You might wanna add it back in. There's a a small probability that interest rates are going to go up significantly from this point.

Mike: 03:54

Inflation's sticky, but I don't think they need to really jack up interest rates anytime soon. Doesn't seem like there's a high probability of that situation, which means you either have a good rate of around four or 5% of the bond funds, and that's an oversimplification what they are, but that's pretty okay for stabilizing your portfolio. And then if markets go down, what do they typically do? They lower interest rates to make money cheap. If you lower interest rates, your bonds or bond funds become more valuable and that's why they increase.

Mike: 04:26

Here's where I'm going with it. Had you invested in the sixty forty stock bond fund mix from 2000 to 2010, instead of the S and P's average performance of basically zero, you would have had around a and this is the CAGR or a compounding rate, which is more honest. You would have had around a three to 4% growth on a flat market cycle. Because the bonds and bond funds saved you. When markets were going down and they lowered interest rates, bond funds increased in value.

Mike: 05:05

Now it's not a guarantee. But it does happen when interest rates are higher and they can do that, that's often what happens.

David: 05:13

Okay.

Mike: 05:15

Now if you follow the rule of 100, which suggests that your age is basically the percentage of your assets that should be in bond funds, one of those arbitrary rules, your average annual return would have been around four to 5% in a flat market cycle. Because bond funds back then were a good deal, and they saved you in the flat market cycle. Now am I saying you should get in bond funds? No. And this is a show.

Mike: 05:43

This is not financial advice. This is information, and that's it. But am I making an argument that bond funds may be a good part of part of your portfolio? Bond funds could be a good deal right now.

David: 05:54

Because?

Mike: 05:55

Because it's it's, you know, the ten year treasury is at a reasonable rate.

David: 05:58

Oh, okay.

Mike: 05:59

It's above my rule of thumb of of 3%. And I should also mention that you wanna make sure that interest rate is trending either to be flat, or if it's if the interest rate's going down and your bond funds are making money. You don't want the the rate to keep going up, because if it keeps going up, that's a problem. So all I'm getting at is the thing that everyone hates the most is the thing that might save them or help save them in their in their portfolio if the markets go flat. Because a flat market is a flat stock market, not flat all markets.

David: 06:31

Oh, right.

Mike: 06:32

And we forget that. Yeah. Now in my opinion, I think there are other tools in the toolbox that can be more helpful. So using, for example, buffered ETFs as a way to slow the decay when the markets go down, and then buying the dip when the markets are far enough down. That's a more sophisticated strategy.

Mike: 06:51

You can use indexed annuities as a basically a buffered ETF from an insurance company with less liquidity but more growth potential. That's another thing you can add in there. And there are many other tools in the toolbox. You could do structured notes. You could use alternative asset classes like real estate and so on.

Mike: 07:09

All of that matters. But the point being, is the stock market, the thing that everyone's loved, may not be the thing you love moving forward.

David: 07:21

Mhmm.

Mike: 07:21

Had someone walked up to you in 2020 and said, hey, look, they're printing a lot of money, inflation's gonna get out of hand. If inflation gets out of hand, there's a good chance that your bond funds are gonna lose money. You might wanna get rid of these. Would you have liked someone to have said that to you? Probably.

Mike: 07:34

Yeah. Yeah. That's what I'm suggesting today.

David: 07:38

Okay.

Mike: 07:40

And may the record show this is not financial advice, this is education on basic economics. Matters. Yeah. That matters. And here's just these are just back tested.

Mike: 07:55

I mean, just real simple. Okay? You did that. I think in the rule of 100, most of your assets were in bond funds. At the time, they were a good deal.

David: 08:02

So if this is between 02/2010 and you're Yeah. 55 years old or 60 and you have 60% in bonds?

Mike: 08:08

Yeah. So I mean, when the S and P was down eight to 9%, that rule of 100 would have kept you at about a positive 4% for the year. Uh-huh. That feel pretty good. Yeah.

Mike: 08:19

Feel great. And then in 2001, you might be up about 11% or so. It's, you know, nothing to write home about, but the market's down 12%. So I guess it's something to write home about. Yeah.

Mike: 08:31

The difference matters. Yeah. It's not about shooting for the moon and trying to outgrow performance. It's not trying to say, I'm gonna make so much money that I can just take one on the chin. Mhmm.

Mike: 08:43

The math doesn't work that way when you're close to retirement, and that's about five years or so away.

David: 08:48

Alright. So how does one know if I could sneak in a question? Let's say you wanna make the transition in 2010 away from the rule of 100 and into, like, growth mode? Like, how do

Mike: 08:58

you know when to do that? So I hate the rule of 100, actually. So yeah. So here's why I hate the rule of 100. It's an arbitrary way to sell a product of stocks and bonds in a portfolio that charges you one to 2% a year in advisory fees.

Mike: 09:13

Yeah. I mean, could I could I be more clear? And the reason is, I think in retirement, there are two portfolios. The overall. First off, you have your lifestyle portfolio.

Mike: 09:28

That's the money that you're going to live off of. And if you want max income, then it might just be one portfolio. But let's say you don't have max income. A lot of people have legacy intentions. It's very common to say, I want x amount of my Roth to never be touched.

Mike: 09:42

I want it to be aggressively grown just for the sake of legacy purposes. I want it only for the kids. Mhmm. Yeah. Now you've got two portfolios, and your strategies should be treated differently because they have two different goals.

Mike: 09:55

That's it. I mean, if you think about what's the goal of your checking account versus the goal of your four zero one k versus the goal of your brokerage account. Well, if you think about it, your checking account is for near term spending. Your brokerage account is for long term growth, but you have access to it in case of emergency. And your four zero one k your entire life with illiquidity issues was there for retirement years later.

Mike: 10:21

Yeah. They each should have been invested differently for different purposes.

David: 10:25

Right.