Transcript:
Easan Arulanantham:
You know, why should I keep a portion of bonds in my portfolio when these returns are pretty abysmal? And sometimes even negative?
Tom Vaughan:
Yeah. Okay, so this is a philosophical differential that I run into constantly with the way that I handle portfolios versus the way that other people tend to think about him. I don’t look at bonds as an investment, per se, I look at stocks as an investment. wealth is created from real estate and stocks for most of us, you know, unless you’re a superstar like LeBron James, who creates wealth by playing basketball or whatever, for the majority of us, you know, we create wealth from stocks and real estate. So I want to have each client have as much stock as they can possibly handle right? In terms of their own tolerance for risk, that might be 10% of the portfolio stock, it might be 100%, whatever that might be. And so then what the bonds make up in that portfolio is the parachute for when the stock market falls apart. Because literally, you know, you’re right, the bond market for the last year is actually down some. But I’d rather be you know, if the stock market drops, 35%, and your bonds are down, you know, point one, bonds look awesome in that environment. And so what it does is it just allows you to have kind of a parachute. And it’s a great, it’s a great analogy altogether, you got to have the right size parachute, right. So if you’re going to jump out of a plane, and your parachute is this little teeny thing, you’re gonna fall hard, right.
And so you have to understand what that is, bonds can sometimes go up, when stock market goes down. That’s what we saw on this last downturn. Not always, but generally, they do fall last, when they do fall like 2008, you know, the S&P 500 was down 57%, something in that range, I’d say the average bond thing that we were looking at was down maybe eight or 10, still pretty dramatic. But that’s a heck of a lot less bonds look fantastic in that environment. And so you have, it’s the parachute bonds or a parachute. Now, you can do some things to try to moderate. You know, I think right now, our average return on bonds is positive, just barely, even though the stock market is negative. And so we’ve done some things with treasury inflation protection securities, we’ve done some things by having some short term bonds instead of so many long term bonds. But you have to be really careful there, if you do everything kind of really short term bonds, you just made a teeny little parachute, because they don’t go up much when the market goes down. And so you know, again, all of a sudden, you’re falling out of that plane with that used to have these little GI Joe guys that had a had a parachute, you know, that’s my visual. So you don’t want to have the GI Joe parachute. Because of what you’re a lot heavier than that plastic GI Joe.
So basically, you want to make sure that that parachute is adequate for the risks you’re willing to take. That’s what bonds are. And even if they underperform stock markets up 25% This year, I don’t care if those bond markets down 1% It doesn’t matter to me whatsoever. Thus, I we make our money on the stock side, what I’m worried about is the negative 25% of stock market that could happen. I want to make sure that you know those bonds are there to mitigate some of that risk. And that’s what bonds are for. And that’s that’s a different outlook. People look at bonds is rate of return vehicles, they’re looking at yield all the time they’re chasing yield. So right now, if you’re chasing yield, you’re probably got a lot of high yield bonds, those dropped two, I think the stock market was down 35% and 2020, high yield bonds that I was looking at dropped about 23%. That’s not a parachute at all. It has a high yield. And we have some high yields in there because it’s part of the mixture. But most of our bond mixture is around the parachute, trying to have you know, some a good amount of treasuries, even though treasuries aren’t that great and probably won’t be that great going forward. But you never know when we’re going to face the next 35% stock market drop. And so that’s what they are. It’s again, not everybody agrees with that, believe me, I’ve run into different scenarios, but that’s what we what I’ve been doing for 35 years and I stand by that wholeheartedly, because we do the bond portion, right. It allows people to stay in the stock market allows people to have a higher percentage of stocks in their portfolio, and that’s where the money is made stocks and real estate. Those are the two things that we all get wealthy off of. Not bonds. I’ve never met anybody that wealthy off of bonds outside of the bond brokers like Michael Milken and what have you.