A diversified portfolio contains a mixture of cash, bonds, and stock investments. Not knowing how these assets work together leads to some of the most common and harmful investing traps. Today, Paul invites Arlene Brown onto the show to explain how cash holdings, bonds, and stocks can work together to limit your risk of short-term market fluctuations and long-term inflation. Listen along as these advisors go into detail about the strengths and pitfalls of having investments in each category.
Want to cut through the myths about retirement income and learn evidence-based strategies backed by over a century of data? Download our free Retirement Income Guide now at paulwinkler.com/relax and take the stress out of planning your retirement.
This material is for general educational purposes only and is not personalized investment, financial, tax, or legal advice. Past performance does not guarantee future results. Nothing here is an offer, solicitation, or recommendation for any security or strategy. All financial decisions involve risk, and you should consult qualified professionals before acting on this information.
Advisory services offered through Paul Winkler, Inc., an SEC-registered investment adviser.
Paul Winkler: Welcome. This is “The Investor Coaching Show,” and I am Paul Winkler.
At least I think I am. Last time I looked in the mirror, yep, that was me. Yep.
But after a weekend, Arlene Brown is here with me today. Arlene, welcome. Certified Chartered Financial Consultant, Chartered Divorce Financial Analyst, and a few other things, whatever you are. You’re lots of stuff too.
Now, I don’t know about all of you out there, but if you’ve had a week like me, a lot of you, I know, have had a week like my wife and I, and just dogs and cats and squirrels and whatever, without power for the entire week still. I’m shorting NES. I’m shorting it.
Arlene Brown: No, they’re working so hard.
PW: Doesn’t mean I’m not going to short it. I’m not blaming anybody out there. No, I’m just shorting it. It’s been a rough week for a lot of people.
AB: Yeah.
PW: Oh, my gosh. You talk about a wild one. So yeah, I would not want their job this week. That is a tough job, being out there in that cold.
And God bless them for getting out there and doing that. But yeah, it has been a difficult, difficult week. But anyway, I’m in front of my microphone now, and I’m in here in a warm office, actually, because the office did not lose power, which is a beautiful thing.
PW: But anyway, this week, we’re going to be talking about investing basics. We’re going to get into just the stuff that you probably wish we’d talk about other weeks, where you’re sitting there going, “I have no idea what they’re talking about.” We’re going to cover that stuff today because that’s what I’ve been telling the guys at the station.
I said, “Talk about it. That’s what we’re going to talk about this week.” So we’re going to get into, it’s been a really interesting week in markets in general, and we’ll pepper it a little bit with what’s been going on because I think it’s pertinent to understanding the investing process.
And some of the things that I often talk about on the show here, I’ll have a couple “See, I told you so” moments because, and not with glee or anything like that, but there have been things that I’ve been talking about happening that have taken place this week that are case in point. I know in the investing industry, when I was working for the big broker-dealer, big investment firm, worked for some insurance companies. We have people that work with us that came from the banking industry. Arlene, you came from Merrill.
AB: American Express and Merrill, yes.
PW: Okay. Yeah. So a lot of the traditional investing firms that you hear advertised out there were doing all the things that I said, “I just can’t do this anymore.” And we had to walk away from it.
And all of us did this. We all came from that background. And the reason was because of what we’re going to be teaching today.
I want to walk through some of these things. And some of this stuff was so intuitive when I started to learn it. I was frustrated that I was not taught these concepts working for the big investment firm. You would think that would be the first thing an investment advisor taught.
AB: No, because the first thing they were teaching us was sales, how to sell.
PW: That’s right.
AB: How to sell.
PW: And that is so true.
AB: And products, of course.
PW: Yeah. Oh, product sales. Yeah. Well, of course, that is the big deal is the product sales process and how do we get the product in the person’s hands and whatever it is that we’re trying to move, whether it be annuities or with mutual funds or whatever.
And not that any of those things are problematic. I mean, it’s kind of like, was it Bogle? Bogle said it this way. Basically, here’s what Bogle said.
John Bogle: The reason we do all this, create all these funds, is because this is a marketing business, has become a marketing business. And what’s going on here is, for example, when we have the new economy mania of the late 1990s, people create internet funds, they create telecommunications funds, they create technology funds, a whole lot of funds focused on the fads.
PW: And recently too.
JB: And guess what? The reason they’re fads and fashions is those stocks have gone way up.
PW: That’s exactly right.
JB: Through all of human history. You don’t want to pay any attention to the fads of the day, except to ignore them or to avoid them.
PW: And that is exactly what happens. So we’re going to walk through the basics.
PW: Now, number one, let’s start at the foundation. When it comes to investing, people typically don’t want to know a whole lot.
They don’t feel like they can understand it. It’s intimidating. Things that I fear tend to be things I don’t understand.
And as a result, what we see is a lot of people getting to retirement and living on literally Social Security and little else. There are a lot of people that that is their main source of income.
Last I saw, I think Arlene, what are the stats? What do you think the stats are on the people that are only on social security? Like half the population?
AB: About 40, 42%. Something like that.
PW: I know it’s pretty high.
AB: But Social Security still comprises like 40% of the retirement income.
PW: In general, yeah. Even if you’re not just living off of it is only supposed to be about that much.
And the problem is that people typically have accumulations that are far lower than they should be, simply because they don’t understand how markets work.
They blindly trust. They blindly trust the investing industry, is what I’ve found.
In general, people tend to go to their workplace and they have a 401(k) and they think, Well, my employer must have vetted this investment. It must be really good or they wouldn’t have this in our 401(k). And I know that the provider has a fiduciary responsibility.
Which is the most overused, most meaningless term in all of investing these days. “We’re a fiduciary. You will do well when you do well.” I see that in advertising all the time.
And the reality of it is that a lot of what comes down to being prudent investing is being ignored. Matter of fact, there is a rule, and I’ll probably hit it at some point during the show today, called the prudent investor rule. What constitutes a prudent investment?
And I’m going to tell you, I can’t remember the last time I’ve seen it actually followed by the typical investment industry practitioner. So we’re going to get into that.
PW: Okay, so let’s walk through this.
And the idea is to get payment for the use of my money, and we call that cost of capital. Arlene, what are a couple of things that you find are often bought by investors that have no cost of capital involved with them?
AB: No cost of capital? Oh, gold.
PW: Gold.
AB: Silver.
PW: Yeah, gold. Silver. Keep going.
AB: Crypto.
PW: Yeah, crypto. Yeah, perfect. There you go. So by definition, those are not investments, and yet they’re often talked about as investments.
Now, I often hear people talk about their home as an investment. And the idea is if I move out of my home and I pitch a tent when I’m in retirement, then it was an investment.
But it is technically, that is something that, yes, has utility. I can live in it and it’s great and everything, but we don’t want to think about our home as our biggest investment. I hear people say that. No, I got to live someplace.
And I picked that up because John Savage, one of my mentors early on in my life, used to say that. He says, “It’s not an investment unless you’re going to pitch a tent and go sell it and you’re going to move out.” But you can downsize, so there might be something to that.
But real estate can be an investment. There’s a cost of using your money. So, real estate, what’s the payment to use your asset?
Well, we call that rent. If we’re dealing with stocks, we get earnings of the company. We get dividends. If we’re dealing with bonds, you get —
AB: Interest.
PW: Yeah, exactly. If I have a CD, what’s the payment to use my money? Interest, again, same thing.
PW: So when we’re looking at investing, we’ll have what are called asset classes. And I’m going to get to that in just a second, but let me stop back at the basic couple things that I just named.
Cash. Cash is typically something like a CD or a savings account or a money market account. We typically refer to that as cash investments, so to speak, because it can be turned into a liquid asset right away.
I can go and I can walk into my bank and say, “Hey, I put money in this bank, here, give it back. I got $10,000 in this bank. Write me a check for $10,000. I need my money back.”
It’s cash. It’s very liquid. As a result, it doesn’t fluctuate in value.
It doesn’t go up and doesn’t go down. It doesn’t fluctuate. It just stays the same.
AB: Well, it goes down. Purchasing power.
PW: Yeah, purchasing power. Yeah, exactly, Arlene. Yeah, it goes down.
Purchasing power. So after inflation, if we look back through history, the rate of return of treasury bills after inflation, which is a cash type of investment, has been …
AB: One to two percent.
PW: Point four.
AB: Point four.
PW: Point four. Going back to 1926. It’s even worse. It’s even worse.
It is not meant to be something that protects you from inflation at all because it has no fluctuation.
You’re not putting up with anything, as I like to say, when I have a treasury bill or I have a savings account. I’m not putting up with any fluctuation in value, so nobody has to pay you much money to use your money when you’re not putting up with anything.
PW: Now, when we talk about bonds, now there are … Name a few different types of bonds that are out there, Arlene.
AB: Municipal bonds?
PW: Okay. So municipality borrows money.
AB: Corporate bonds.
PW: Corporate bond. A corporation borrows money from you.
AB: High-yield bonds.
PW:
It pays a higher yield because it is high risk. So that’s the type of bond.
AB: You can call it junk.
PW: And we call it junk. That would be the non-marketing term. If we’re going to use the marketing term, it’s high yield because that sounds better.
AB: For marketing.
PW: Junk sounds terrible.
AB: Yeah.
PW: But that’s what we call it in the industry. We call it junk bonds. You have extendable, retractable bonds.
AB: There are many flavors of bonds.
PW: There are lots of them. Now, the thing to keep in mind is this: Cash is there for absolute safety in the very, very, very short run, where it won’t fluctuate in value.
Bonds, you can have a little bit of risk, but you want to stay away from the high-risk bonds. And the reason is, what are bonds for in an investment portfolio?
AB: Stability.
PW: Stability. It’s like Mark Twain said, “I’m more concerned about the return of my money than the return on my money.” He was probably a big bond guy as a result of it.
But the reality of it is, when we’re looking at bonds, you’re barely going to be able to beat inflation with those types of bonds. You might have a 1% to 2% return after inflation.
Now, people get fooled. They look at a 5% interest rate and they go, “Oh, that’s great.” But recognize that inflation, if it’s 3 or 4%, your rate of return after inflation is nothing. And if I’m trying to draw an income in retirement and I’m trying to draw it from a bond investment and I’m getting 5%, recognize that back in the 1970s, you could be living off of $10,000 per year.
AB: No, that was 13%, 18%.
PW: But you could be living off of $10,000 income for the whole year and you’d be fine. You’d be right in the middle of middle America with that level of income. You could buy a car, a brand new car, for $3,000. Shoot, you could buy some cars for $2,000.
You could buy a house. I remember my parents buying a house in the 1960s for like $16,000.
So if I have this investment that’s paying me 5%, but inflation is at 3 or 4%, then really, if I want to keep pace, I may only be able to live off of 1% of my money. So if I get a million dollars, I can live off of about $10,000. Which you look at that and go, “That’s ridiculous. That’s terrible.” If I want to keep pace with inflation.
So, when I see people that have all their money in retirement in CDs thinking that they’re safe, I’m like, “You are anything but safe. You are not safe. You have huge risks.”
And the reason is that the dollar goes down in value. Why? Inflation.
PW: Inflation is not necessarily this terrible boogie man that prices go up. It has a use.
That drives people to buy things now. It drives corporations to get profits now, and it drives the government to get taxes now. So inflation is something that we have now.
Now, prior to the 1900s, there was no such thing as inflation. It didn’t exist.
AB: A little bit of inflation is nice.
PW: It is. A little bit is okay.
And the interesting thing is that in the 1800s, you didn’t have inflation because the dollar was tied to gold. Right. And hence we didn’t have inflation.
Now, the problem was when it was tied to gold, we had a huge problem on our hands. We would have these fluctuations in the economy that were just untenable. So hence, we went off that.
Now this, I don’t want to get into too much detail on, but the whole idea of “The Wizard of Oz,” as I’ve told people many times, is that was all about the gold standard. The whole play, movie, whatever you want to call it, was about the gold standard. And it was a big debate in the late 1800s.
So in essence, inflation is something that you have to protect yourself against. Now, if we look back and we say, “Okay, so now we have fixed income, like cash type investments, no inflation protection. What can we do?”
Well, you can look at bonds. Now bonds, you’re not going to have much inflation protection, but bonds are still something you want in an investment portfolio, typically because of the fact that it has the benefit of a little tiny bit of protection against inflation, but mainly the thing that bonds do that stocks don’t do is when markets go down in a big way, bonds tend to do what?
AB: Well, flight to quality.
PW: Exactly. So what Arlene’s saying is typically when people get scared, they flee. They go and buy whatever they see as stable. And if you have stable bonds in your investment portfolio, that is considered to be something that is attractive when stock markets go down.
What happens when people buy and they throw a bunch of money at something, what happens is the price tends to go up. Now, when that price goes up, that’s when interest rates go down and when interest rates go down, what do people do when interest rates go down?
What do they do? They buy stuff. You go buy new cars, you go buy furniture, you buy things when interest rates are lower because it’s cheaper. You buy houses.
AB: Buy bigger, bigger houses.
PW: Yeah, you buy bigger houses. And what does that do? It drives the economy back up.
So when the stock market goes down, people buy bonds, that pushes bonds up typically during market downturns. Not always, but a lot of times it does.
PW: Then what happens is that now I have something in my portfolio going up in value when the stock market goes down. I have a port in the storm, as I like to call it. I have a port in the storm.
And that is the purpose behind bonds. It helps protect when stock markets, not if stock markets, but when they go down. Now, there’s a port in the storm, and the reason that we buy bonds, more safe bonds, is we want something that’s more stable.
Now, what types of bonds might be more stable? Well, government bonds. Arlene talked about them before.
High-grade corporate bonds. Yeah. High-grade corporate bonds would be something.
Now, if we look at risks of bonds, you’ve got to watch out for certain types of risks. And this is one of the things that you’ll deal with with a lot of corporates. You might have call risk, where the corporation refinances their debt when interest rates go down.
That’s what you have with high yields.
AB: Well, municipal bonds.
PW: Municipals. And you think, Wait a minute, it’s the government issuing this bond, Paul and Arlene.
AB: Well, I said municipal bonds because municipalities and state, they can’t really tax to death all their people.
PW: They can’t because if they try to raise taxes too much, people do what?
AB: And they cannot print money.
PW: They leave. And they can’t print money.
I see the commercials, “Get your bonds tax-free, municipal bonds.” And the problem is you take years like 2008, and you had municipal bond funds going down 20, 30% right down with the stock market. Big, big problem.
So one of the issues that we deal with is people getting into the wrong types of bonds. What are the better types of bonds that I want to hold in an investment portfolio? I will typically keep the maturities where they’ll mature. In other words, when I buy a bond, I pay $1,000 for it.
A typical bond will pay, they’ll cost $1,000, and it will mature, let’s say, in five years. When it matures, I get my $1,000 back. Between the date that I buy it, I pay the $1,000 for it, and when it matures, I’ll get the interest. So if the interest rate is 5%, I buy it for $1,000, it’ll pay $50 a year, 5% of $1,000 for five years, and at the end of five years, I’ll get my $1,000 back.
PW: Now, the reason bonds go up when interest rates go down is because when the interest rates go down, that bond that you owned that was paying 5% before, now it’s only paying 4%, is more valuable because when I buy that bond from you, I’m going to get a 5% interest payment. I’m going to get $50 per year, whereas the new bonds are only paying $40.
We want to have something that when the stock market goes down precipitously and you have a big decline and interest rates go down, I want something that spikes in value, and that’s exactly what the right types of bonds do.
So those are bonds. I’ve covered two things so far. We covered cash, never any fluctuation, even short run, with cash investments. You look back through history and treasury bills, they’ve never had a negative year, never had a negative year.
Money market funds are never supposed to break the buck. I said, “Never supposed to.” When they have, companies have come in and shored up their money market accounts.
That has happened. That happened in 2008. Yes, that’s exactly right, Arlene. That happened.
Now, bonds, keep it safe, keep it shorter term, keep it high quality. That’s what we want in our bond portfolio.
AB: Triple A.
PW: Triple A. Yeah. That’s right. Triple A, double A, single A.
AB: That’s it.
PW: You can go triple B.
AB: A little bit of B, but …
PW: You can go into the B arena, but only triple B. That’s about as far down as I’ll ever go. Yeah, good.
That’s what’s called the credit rating, is what Arlene’s referring to. That’s exactly right.
So we want a very, very high quality, and it’s short duration is what the term is called. Duration is what we’re talking about. And this might be something that you go back and you listen to the podcast to get this stuff down.
This isn’t, you don’t have to know everything we know, but it’s important to know these basics. It’s important to understand the basics of investing. And this is the first one. We’re going to go to the next one after this.
I’m Paul Winkler, Arlene Brown with me. We’re going to get back to more of the basics and into the stock market right after this. Stay tuned.
PW: Okay, so Arlene, we covered, we talked about cash in the investment portfolio. We talked about cash, what it is. No fluctuation of value, no protection against inflation. It’s there, it’s liquid.
AB: It’s boring.
PW: It’s boring. Use it for emergency funds.
AB: True.
PW: Use it for an emergency fund. Typically, people say, “What do I put my emergency fund in?” It might be a savings type of a vehicle, a money market account, might be high-yield savings, could be something that you use.
CDs aren’t typically something I’d recommend simply because you have a backend surrender. You have an interest penalty if you pull it out on most CDs.
AB: The word boring actually is about the expectations.
So, expectations.
PW: Yeah, no pain, no gain. It’s totally no pain, no gain.
AB: So that’s why I said boring.
PW: Right. And that’s exactly it. And it is not meant to be something that’s for a very long term. It’s not a long-term investment. Historically, 0.4% after inflation.
Now, how important is this stuff? In 2008, when markets declined, you had the intermediate treasuries go up about 11%. They went up like 16% in the 2002 downturn.
But if you look at like Vanguard high yield, “Ooh, high-yield corporate bond fund. High yield. I’m going to get lots of high interest rates, right?”
What did it do? Down about 21%.
AB: Yeah.
PW: Yeah, that’s exactly right, 21%. Municipal, muni bond fund, T. Rowe Price, they had a muni bond fund. What did it do? Same thing, 21%.
Oppenheimer had a Champ Income. I like to jokingly call it the Chump Income Fund. It was a bond fund, down 78% in 2008.
AB: At least not 80%.
PW: Oh, yeah. At least not 80%.
PW: So the next thing that we get into is in the stock market.
We’re loaning it to them. We get paid interest. If a company wants to raise money, but they don’t want to give away, they don’t know that they’re going to be able to pay interest payments on a regular basis, they’re a little bit worried, they’re not sure what’s going to happen, well, that’s when they issue —
AB: Shares of stocks.
PW: Yeah. They split the company up.
So if I have a company, it’s a million-dollar company, and I want to split it into a million pieces so that everybody can own a little bit of my company, each share will go for $1. So we split it up, and we issue shares.
And you see these stock certificates. I remember when we were in the Goodlettsville office and Facebook became a public company. And it was so funny because Jonathan couldn’t wait to get his hands on a share of a certificate for Facebook so that he could put it on his office wall.
So he did that. One of my favorite ones, one of my favorite companies was, people would buy …
AB: Apple?
PW: … the comics.
AB: Oh. Oh, Marvel.
PW: Marvel. They would buy Marvel stock so that they could get the shareholder reports, which were all comics.
AB: Oh.
PW: Really, really fun. So sometimes when you’re just trying to teach your kids how the stock market works, buying a single share of a company, I don’t think that’s a problem.
And they can watch that company, and they learn a little bit about the stock market. It’s fun. But if you’re going to do that, Marvel’s a fun one to get because they have comics all the way through their shareholder reports.
Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
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