At Henssler Financial, we’ve always advocated the Ten Year Rule investment strategy where any money needed within the next 10 years is placed in fixed-income investments to protect principal. Remaining money that will not be needed within the next 10 years should be invested in growth investments.
The problem we run into with most clients is that the concept of the Ten Year Rule is so simple that they don’t understand it. There are plenty of market pundits in the media keeping you continuously updated on what the market is doing right this minute or what interest rates may do in the next minute that it becomes difficult to invest through the noise and follow a simple strategy. The reality is no one can predict the future of what the markets may do; therefore, it is important to follow an allocation strategy that is based in academic studies. Since 1926, there have been only two rolling 10-year periods where Large Cap stocks did not outperform other asset classes. Whatever your long-term growth investment is, whether it is company stock, an S&P 500 Index fund or real estate, you have to be able to wait out a downturn.
When it comes to how much you need in fixed-income securities, it comes down to knowing how much you spend annually. It is not about your budget and what your fixed expenses are or where you spend the money, it is about your cash flow and what you actually spend a year. If you can determine what you’ve been spending, then you can then determine how much you need to allocate to fixed-income investments. If your spending is less than your income, then you should not need fixed-income investments.
That income could be from employment, Social Security, dividends, real estate, or something else. If you are in your 40s and working, money you’re saving for retirement generally cannot be touched until you are at least 59 ½. With such a long time horizon, there should be no need to hold bonds in your portfolio. If your Social Security benefits pay for your living expenses, then your assets can afford to be in growth investments. If Social Security benefits only pay for a portion of your after-tax spending, then your fixed-investment portfolio should make up the difference.
If you are in a situation where you do not need fixed-income investments, you may consider recharacterizing your portfolio for the next generation by taking on more risk with International, Small- and Mid-Cap stocks, or by adding exposure to Emerging Markets. Essentially, you’ve extended your time horizon 20 to 30 years, meaning you have the ability to wait out a downturn in riskier investments.
Now, it is extremely hard to convince a 70-year-old investor in this situation to be 100% invested in stocks. What most investors do not realize is that you can lose money in fixed investments if you do not hold your bonds until maturity. If you buy a $1,000 10-year Treasury bond today yielding 2%, you will be paid $20 a year for 10 years. At the end, you will receive your $1,000 investment back. If interest rates increase, the price you can sell your bond for will go down, because investors can buy a bond with a higher rate than yours. When rates increase, you need to ride it out, holding your bond to maturity. If you can stomach that volatility, knowing your bond is worth less, you should not be bothered by the daily fluctuations of your stocks.
You can also lose money in bond funds depending on when you have to sell. A bond fund is comprised of numerous bond holdings with various maturity dates. As interest rates go up, the value of the fund’s holdings fall. Unlike holding individual bonds, a bond fund does not have a set maturity date, so you’re never sure exactly how much you will get for your investment when it comes time for you to sell.
If your expenses are covered by your income, Social Security benefits or even by the dividends from your investment portfolio, then you should not need fixed-income investments in your portfolio. If you have questions regarding how your cash flow can affect your overall asset allocation, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
