Updated Friday, December 19, 2014 as of 4:22 AM ET

Best Income Strategy: Bonds or Annuities?

MAY 29, 2014
9:20am ET
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If historically low interest rates remain historically low, should advisors reconsider their clientsí allocations to bonds? What factors are most important when a planner is debating whether a client would benefit from an annuity? And which type of annuity might be best? Financial Planning put these questions and many more to leading experts in a panel discussion called Bonds vs. Annuities that was nearly always illuminating and occasionally provocative.

The panel was composed of four CFPs: Kimberly Foss of Empyrion Wealth Management in Roseville, Calif.; Allan S. Roth of Wealth Logic in Colorado Springs, Colo.; Tom Orecchio of Modera Wealth Management in Westwood, N.J.; and David Blanchett, the retirement research chief at Morningstar Investment Management. We challenged the panelists to offer specific strategies advisors and clients can use in constructing portfolios.

Watch the videos:

Hereís an edited transcript:

Fed Chairwoman Janet Yellen essentially says the central bank will do whatever is needed to aid the economy. Nonetheless, interest rates will logically ascend over time ó of course, no one knows for sure how quickly or when. If clients ask, 'Why not minimize the bond position in my portfolio?í how do you counter that? Can bonds still perform when rates are rising?

Foss: I do believe that. I think there are four essential elements to having bonds in the portfolio. First, and noteworthy: No one can forecast interest rates. We just donít know when interest rates are going to rise. We thought this back in 2009 and weíre still in this environment. No. 2 is that itís not to say that we canít go back to normal any time soon. Japanís been at its normal for 15 years. No. 3 is that bonds perform differently in portfolios than stocks, so I think that itís really important, as a diversifier, that we keep bonds in the portfolio, even though theyíre at the lows right now.

Fourth is thereís no guarantee that, even if interest rates rise, long-term bonds would underperform short-term bonds. Dimensional Fund Advisors did a study from 1976 into 2007, and there were periods in which they saw interest rates rise, and the end result was that, in all of those four periods, the Barclays indexes all rose except from 1976 to 1980. I think itís really essential that we do have bonds in the portfolio.

Roth: Top economists have a track record of predicting the direction of rates less than a coin flip, and the purpose of the bond portfolio is that of the shock absorber. Amid all this talk about a bond bubble, people have to remember that stocks are riskier in a day than bonds are in a year ó high-quality bonds, anyway.

Orecchio: I would add that clients are worried about volatility and we use bonds as a volatility dampener. Keeping them in there on a day where the market moves 200 points in either direction, the bonds really dampen that volatility. Thatís more important to us than the income that they generate.

Roth: Being the argumentative person that I am, I completely disagree that bond rates are near an all-time low, because if you go back to 1981, you could get 12% on a CD, which meant after taxes you had 8%, inflation was at 15%, so you had 7% less spending power. Rates are much better today.
And all that really matters are after-tax returns, right?

Roth: After-tax, real inflation-adjusted returns.

Blanchett: After fees.

Orecchio: One more thought on the inflation issue: Yellen was talking about the concerns of deflation, and in a deflationary environment, bonds with low yields perform very well.

The bond market, of course, is really multiple markets: Treasuries and munis and corporate debt, developed market debt and emerging market debt, all sold as individual bonds and bond funds. Should a balanced portfolio hold all of these?

Orecchio: We believe in broad diversification, so we think they should ó all of those and more. By including different dimensions of risk, you dampen the volatility of the portfolio.

Comments (2)
Great article, thanks for the dialogue!
Posted by William R | Thursday, May 29 2014 at 2:00PM ET
indeed a nice article and the video links you mentioned are really very helping to understand.really an informative content.thanks for the upload.
Posted by fifo c | Friday, June 13 2014 at 12:03AM ET
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