Why Investors Should Only Buy Individual Fixed Income Securities

post picture

LCM Capital Management has always been a big proponent of buying, whenever possible for our clients, individual fixed income securities such as municipal bonds, CD’s, Treasuries etc. Owning and managing an investment advisory firm, as my partner and I have for the last 23 years, we are constantly inundated by mutual fund companies or Exchanged Traded Fund (ETF) providers explaining the “benefits” to us, for our clients, in using their products. In their defense, it’s their job and if I was in their shoes, I would do the same thing since firms such as ours have already done the heavy lifting part which is finding and retaining clients. But I’m not one of them and I believe our clients are better off and happier because of that.

A few of the reasons we do not like these products are the fees associated with them and the fact that most of the products do not have a maturity, i.e. no set end date.  They can use leverage or margin which adds risks and costs to you and they can buy whatever the manager wants up to a certain percentage of their portfolio. Here is a question for you, have you ever read a prospectus? In reading one, you would be surprised by some of the latitude you typically have signed up to give to your fund manager.

Now mind you, you don’t often hear the portfolio manager, product sales rep, broker or your advisor of these funds talking about these fund characteristics. My guess is, they assume you already know this but you know what they say about the word “assume.” Additionally, in my opinion, unlike the portfolio manager, the advisor/broker or sales rep is likely to know very little, if anything, about these products, let alone care. That in and of itself is a reason not to own these products. The sales reps/broker talks about performance and diversification and my favorite, something called duration. Duration is a measurement of a bond's interest rate risk that considers a bond's maturity, yield, coupon and call features. These many factors are calculated into one number that measures how sensitive a bond's value may be to interest rate changes. The problem with this number is, it’s a guess by the fund manager because no one knows how people will react once their fund starts to lose money.  In these circumstances, if everyone decides to sell as they did in 2022, your duration number goes right out the window.

I was recently looking into BlackRock’s iShares 1-3 Year Treasury Bond ETF (SHY). I happened to be talking with a sales rep from another fund provider and I asked him and the portfolio manager of a fund who was on the call, why SHY, and for that matter most ETF’s with the same maturities at that time, were yielding approximately 2% when the 1-year Treasury was yielding 3.54%?  We were given some explanation as to why it was and that eventually the dividend/yield would catch-up and therefore I would not be any worse off.  Even with my 35 years of industry experience, I still did not understand what they were talking about, which is yet another reason not to buy these products.  

I decided to use SHY as a test case. I set out to prove my point of why investors should buy individual bonds versus a product. I bought one share in my Roth IRA of SHY on 9/12/22 at a price of $82.065. The 1-year Treasury that day was yielding 3.54%. One year later, my 12 monthly dividends on SHY have totaled $2.11 or 2.57% and the price of SHY was $80.89, so I’m down 1.43% in principal. Now let’s do the math: 2.57% dividends – 1.43% in principal loss = 1.14% gain. I just lost 2.40% (3.54% treasury yield versus 1.14% SHY gain). I would have been better off buying a 1-year Treasury bond.

Now think about this, that total does not even include the fee that I would be paying my broker/advisor (in this case it was me) so add that onto your “loss” and I think it’s clear, at least to LCM Capital Management, why investors should avoid bond mutual funds and bond ETF’s whenever possible. 

So where did all that money go? It’s a massive fund with over $25 billion in assets and my dividend yield alone is almost 1% less. 1% multiplied by $25 billion is a lot of money. If I called BlackRock and asked to speak to the portfolio manager, assuming of course he/she or CEO Larry Fink is reachable on their private plane, I bet I would not understand their answer to this question either. 

There is a better way to invest!

About John Nowicki

John Nowicki serves as co-founder, President and CCO with over 36 years of industry experience. He spends his days helping executives, physicians, and business owners prepare for a retirement that is comfortable by reducing costs, taxes and balancing risk.

John is passionate about providing transparent financial services. He is committed to empowering his clients with financial knowledge and understanding so they can make the right decisions for their life and family.

Connect with John on Linked-In here, or contact us here to arrange for an appointment.