Almost every portfolio contains an allocation to bonds. Bonds can take many forms: treasury bonds, corporate bonds, inflation protected bonds, emerging market bonds and so on. Investors can use bond mutual funds or exchange traded funds, or buy individual bonds. In the big picture, bonds can provide returns independent of the stock markets and provide a known stream of income.
However, the devil is in the details, and many investors wanting bonds to improve their portfolio end up putting themselves and their portfolios in a losing position when it comes to bonds or bond funds. We have a lot of history on bond funds today compared with the mid 1990s. One idea that needs to be changed is the idea that paying fees on the bond side of your portfolio could add value or helps investors. The investment grade bond market is very efficient. It is very hard for anyone to beat the unmanaged bond indexes.
According to www.smartmoney.com, 80% to 92% of bond funds fail to beat the underlying index. When bond funds do beat the index, the gain is almost always less than 50 basis points, or .5%. In most cases, it is less than 25 basis points, or .25%. In addition to this fact, bonds are usually long-term holdings, which are held for time periods measured in decades. Bonds, and especially bond mutual funds, do not require daily, monthly, quarterly decision-making or action. Actions on bond holdings are usually limited to rebalancing the entire portfolio once or maybe twice a year. Paying 20% over a twenty year period just to hold half of your portfolio in bonds does not make sense.
These two facts translate to one investment truth: “Paying advisory fees or ongoing fees for bonds or bond fund management is a losing proposition for investors.” Yet this is still how the traditional financial advice model is structured today. Consider the investor who pays a financial advisor or planner to manage an asset allocation portfolio of 50/50 stocks and bonds. A 1% fee for managing the bond side of the portfolio virtually guarantees the investors will return at least 1% less than the bond index on the bond part of the portfolio, and that is if your fund matched the index. If you are invested in one of the 80% to 92% of funds that do not beat the index, then adding a 1% fee just hurts even more. Adding a 1% fee to the almost any bond fund will effectively make you the proud owner of the most expensive bond fund in America – an investment no one would want to own.
Bond fund returns will almost certainly be lower in the foreseeable future. The average bond yield from 1969 to 2009 was 7.62%. The average bond yield today is in the 3% to 4% range. It is more important than ever to get the bond side of your portfolio into fighting shape.
Advisory or management fees on the bond side of an asset allocation or balanced portfolio represent a free fee ride for advisors and planners. In effect, this practice doubles fees for advisors and planners with almost no chance to add value for the investor. I do believe that advisors and planners can add value. I just don’t believe they can do it by adding fees to bonds.
Take a look at your statement and portfolios to check and see how much you are paying for bonds or bond mutual funds. Anything over 20 basis points, or .2%, is too much with today’s investment options. If the best your advisor or planner can do is asking you to own the most expensive bond fund in America, then I would seek more enlightened or modern investment advice.
Download Chapter 8 from Less Risk, More Return on the home page and read more about “The Role of a Fiduciary Advisor.”