Last month we talked about a market adage “Sell in May and Go Away.” Well, we made it through May and things look a lot like they did at the beginning of the month. In fact, if you look at the stock market averages, not much has happened since the beginning of the year. As of this writing, the Dow Jones Industrial Average and the S&P 500 are nearly exactly where they started the year. But strangely it feels like a lot has happened, doesn’t it? If you look at the broad markets, not much has changed, even though it may not feel that way.
One thing that has changed is interest rates and the way they affect bond prices and interest rate sensitive stocks like Utilities and Real Estate Investment Trusts. If you had bought TLT (iShares 20+ Treasury Bond ETF) at the beginning of the year you would be down about 7% and the yield you would have received would not have covered the loss of principal. Not even close. So why are the prices of ultra-safe government bonds going down? Because interest rates are going up. Bond prices and bond yields move in opposite directions. So, when yields are going up, the prices of the bonds you are holding goes down. If you had been holding TLT (20+ Year Treasuries) during the 2008 financial crisis, you would have been handsomely rewarded because when the stock market began to turn ugly, investors rushed to buy what they perceived to be a safe bet. This is sometimes called a flight to safety.
Many of our clients hold some bonds in their portfolio. They have endured not just a flat stock market, even though it doesn’t feel flat, but a loss in principal in the bonds they own. Consequently, some clients had a slightly negative first quarter. So why have bonds at all? Two reasons, they provide income to a portfolio and stability in a crisis. They also tend to act opposite to how the stock markets do and therefore provide diversification. This means that when one asset is moving down another is moving up giving you a more consistent return over time. Why is it important to have a more consistent return? Because it prevents us from acting too hastily when the stock market is going down by selling stocks at the worst possible time.
If you are receiving income from a bond you may not be that concerned about the ups and downs. Here is a way to think about bonds and their income. They are a bit like owning an apartment building. You purchase the building and collect rents. The rents are a percentage of the purchase price of the building. If you are fortunate enough to keep the rents consistent and they are a fair return for the money you have invested, you are happy. The daily fluctuation of the apartment building market doesn’t really matter to you. You are in it for the income or the rents you receive. If your neighbor sells his apartment building identical to yours for a bit less than you paid do you care? Not if the rents are in line with your goals and the money you have invested. You happily collect your rents and go on your way. The only time you care is when you have to sell your apartment building. If prices have drifted down, the rents you have collected may not compensate you for the loss of capital.
Bonds and even dividend-producing stocks are a lot like the apartment building scenario. If you don’t need your principal back and you are receiving a fair dividend for the money you have invested why worry about today’s price. When markets are in turmoil it may be helpful to think about the apartment building scenario and ask yourself if you are happy with the rents or the income you are receiving. If that explanation doesn’t help your peace of mind and your account fluctuations are keeping you up at night, give us a call so we can make adjustments.
The information provided is for guidance and informational purposes only. The articles are not the opinions of ProCore Advisors, LLC.