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Is it wise to allocate 100% of your portfolio to fixed income? In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer shares why this strategy has gained popularity recently and the surprising reasons why we don’t recommend this approach for most investors.
Jared Kizer: All right. So today I’m going to tackle a question that I recently got from a client that I think is a good topic to tackle, which is the question of are there any scenarios where I should allocate all of my wealth to fixed income without any allocation to say stocks or alternatives of any kind? Are there scenarios where that makes sense? Want to talk about that today and basically think there are a couple of cases, but by and large we’re going to talk about why we think that doesn’t make sense. Interesting question nevertheless to tackle because of course, we have seen interest rates go up a lot over the last couple of years. So this was certainly a question that we wouldn’t have gotten probably two or three years ago because rates were so low by and large. This was not probably a great or even feasible approach for basically any situation, but certainly a reasonable question today to ask now that we have seen interest rates go up. So let’s start with the situations, just a couple where I think this type of approach could make sense.
There is a Fixed Dollar Goal
Jared Kizer: The first would be where you have literally a fixed dollar goal, an exact amount of money that you know today that is due at some point in the future. And you say, I want to set aside that amount or something slightly short of that amount entirely in fixed income to cover that goal in the future. Because I know exactly with no doubts whatsoever what the dollar amount of that goal is going to be. So that would be situation number one, where that could make sense, not necessarily a common situation, but you do see this every now and again.
Your Investable Wealth Far Exceeds Your Spending
Jared Kizer: Situation number two, also not terribly common, but a great situation for those folks that find themselves in this situation would be where you’ve got so much investable wealth relative to the amount that you’re trying to spend over time that virtually any allocation could achieve the goal that you’re trying to achieve. Again, not a situation unfortunately that a lot of folks are in, but for those that are, certainly a great situation in that case, certainly an allocation entirely in fixed income or something closely approaching, that could make sense. Now let’s talk about the balance of the cases, which are cases where I don’t think this is typically the best long-term approach to take.
Fixed Income Allocations Do Not Have the Lowest Volatility Over Time
Jared Kizer: And the reason is going to be maybe somewhat surprising is that you actually do not see historically that allocations that are entirely fixed income have the lowest volatility over time. May be a little bit surprising because you think of well wouldn’t allocating all of my portfolio to, say, U.S. Treasuries be the lowest risk approach over time or the lowest volatility approach and you actually don’t find that. What you find historically is that an allocation of, say, 5% to 10% to stocks historically has actually produced a lower volatility total portfolio than being entirely allocated to fixed income. Why is that the case? Surprising because stocks are, of course, very, very volatile. But what you see there is a basic diversification effect. You see that there are periods like 2022 and other examples that would be even better periods that are very, very difficult for fixed income, that might not be quite as difficult for stocks. And therefore you’re offsetting some of the risks of fixed income with that ever so slight allocation to stocks.
Consider Treasury Inflation-Protected Securities (TIPS)
Jared Kizer: Last thing I would say just in general, for folks contemplating very, very high percentage allocations to fixed income, you might want to consider a sizable allocation portion of that allocation going to inflation-protected securities. So hopefully that’s some helpful perspective on thinking about 100% allocations to fixed income when they might make sense, generally when they don’t tend to make sense. If you have other questions you like for us to tackle, feel free to share those with your advisor or click the link below and submit questions in that way. Thanks.
If you have any questions please feel free to drop us a note.
In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer provides an overview, update and outlook on interest rates and inflation as we head into August.
Jared Kizer: I wanted to jump on and provide an update of what we’ve seen in terms of interest rates and broader inflation readings within the economy as we head here into August. And we’ve certainly seen the last couple of months interesting developments on both the interest rate front and the inflation front.
How Will the Federal Reserve Handle Interest Rates?
Jared Kizer: So let’s start with interest rates. So we’ve seen how the Federal Reserve, which through monetary policy, basically determines what short-term interest rates are in the broader U.S. economy and of course has an impact at the global economic level as well.
The Federal Funds Target Rate Has Increased
Jared Kizer: We’ve seen it now increase its federal funds target rate from 5.25% up to 5.50%. You can think of the federal funds rate as essentially the benchmark in the marketplace that sets essentially all other short-term interest rates. So if the Federal Reserve is trying to hit a target of 5.5% interest rate on that particular rate, you’re now going to see, as we do that basically all other short-term interest rates are going to be north of 5% at this point and likely in the neighborhood of 5.5% or higher. So we’re now in certainly a rate regime well above what we’ve seen over the last couple of years.
Will the Federal Reserve Continue to Increase the Federal Funds Rate?
Jared Kizer: We think about going forward. I think the go forward picture is very interesting in the sense of will we see the Federal Reserve keep increasing short term interest rates. That’s one of the biggest economic questions currently out there and very muddled at this point. Whereas over past months it’s basically been with each month with each meeting, there is a general expectation that rates were going to be increasing. I think harder to say at this point, given what we’ve seen and broader economic and inflation readings, whether we’ll see additional increases in that short-term rate. So speaking of inflation, let’s talk about what we’ve seen there over the last couple of months and generally good developments in seeing inflation moderate significantly out there in the U.S. economy. So if you look over the last two months of the months of May and June, the month-over-month inflation rates have been just a .1% in May and .2% in June. Those are very, very low month-over-month inflation readings and certainly seems to indicate that we’re seeing inflation moderate. If you look back a little bit longer and say what have inflation rates been over the trailing 12 months, not just month-over-month, the last three readings have been an annual inflation rate of 5% down to 4% and then right around 3% in June with a trailing 12 months ending June 2023.
Inflation is Moderating
Jared Kizer: So certainly they’re also indicating that we’re seeing inflation moderate and hopefully that will continue. If we look forward and say, well, given that, what does the market expect inflation to be on a go forward basis? Relatively good news there as well.
Where Does the Market Expect Inflation to Land?
Jared Kizer: So if you look into the fixed income marketplace and asked that question, generally fixed income markets are expecting year-over-year inflation even over the longer term to be in that 2% to 2.5% range. So certainly the market is saying in addition to seeing inflation moderating in past data, it expects it to be relatively low going forward from here. So hopefully that’s a good overview in terms of where we sit here in August in terms of short-term interest rates and inflation and expected inflation. If you have additional questions you’d like for us to tackle, feel free to reach out to your advisor and suggest questions in that way or click the link below and submit questions there as well. Thanks.
If you have any questions please feel free to drop us a note.
Sources: Inflation measures are the U.S. CPI Headline Inflation Rate reported by the U.S. Bureau of Labor Statistics (BLS). Federal fund rates are sourced from the Federal Reserve.