New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 16,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Diversification Isn’t (Necessarily) Necessary for Fixed Income

A reader writes in, asking:

“What are your thoughts on bond diversification? Is it ok to just do something simple like a treasury bond ladder or is it necessary to diversify bonds like you do with stocks?”

No, I really don’t think that diversification is necessary for the bond portion of an investment portfolio.

Several years ago, prior to switching to a LifeStrategy fund, the bond portion of my portfolio included nothing but Treasury bonds (via a single bond fund). And that didn’t bother me at all.

The goal for the bond part of my portfolio was (and still is, for the most part) simply to act as something that is unlikely to go down (by much) during a stock market downturn. CDs or Treasury bonds (regardless of whether or not they’re held in a mutual fund, and provided they aren’t long-term bonds) achieve that goal very well without any need for additional fixed income holdings.

When Diversification *Is* Necessary for Fixed Income

Just to be clear on this point, when it comes to fixed-income investments other than FDIC-insured CDs and Treasury bonds, diversification is important. That is, if you’re putting a significant part of your portfolio into muni bonds, corporate bonds, or international bonds, yes, you definitely want to diversify those holdings.

Diversification Isn’t a Bad Idea

For many investors though, the goal of their bond holdings isn’t only to act as “something safe.” They also hope to achieve some degree of “free lunch” via diversification. The general thought process is that if something has a low enough correlation to the rest of your portfolio while providing an acceptable return, adding it to the portfolio can result in reduced risk without a correspondingly large reduction in return.

This is the argument, for instance, that Vanguard makes in favor of international bonds in their funds-of-funds.

That’s a thoroughly reasonable line of thinking. And if things go according to plan (i.e., correlations and returns behave the way you hope they will) it will improve your results.

However, it isn’t necessary. And it’s not entirely obvious that it’s a clear improvement over an all-CD or all-Treasuries fixed income portfolio, because:

  • CDs offer their own sort of free lunch sometimes, if you can find longer-term CDs (that have relatively high yields due to the long term) with low penalties for early redemption, and
  • Corporate bonds (i.e., the most likely candidate for adding to an otherwise-Treasury bond portfolio as a diversifier) often have higher correlation to stocks than Treasury bonds do, so it’s not a sure bet that they will have the desired result.

Investing Blog Roundup: T-Shares for Mutual Funds

In recent decades, investors have been putting considerable pressure on mutual fund companies to lower their costs. Morningstar’s John Rekenthaler argues that the same thing is beginning to happen with the cost of advisory services. The new “T” share class for advisor-sold mutual funds is one example of such pressures.

Investing Articles

Other Money-Related Articles

Thanks for reading!

The (un)Importance of Social Security Full Retirement Age

A reader writes in, asking:

“I read over and over that it’s ideal to wait until 70 to file for social security but that it’s important to wait until at least full retirement age. But what is special about full retirement age exactly? Am I wrong in thinking that it is not much better or worse than a year earlier or later?”

No, you are not wrong.

In terms of general Social Security rules, full retirement age is important because:

  • It’s the reference point around which your benefit is calculated (with a reduction for filing early and a bonus for filing later),
  • It’s the earliest date at which you can suspend benefits (though that’s much less frequently relevant these days after the changes made in 2015), and
  • It’s the point at which the earnings test is no longer applicable.

And full retirement age is often the best age at which to file for spousal or survivor benefits because:

  • It’s the point at which survivor benefits and spousal benefits stop growing (i.e., there’s no increase for waiting until 70), and
  • It’s the earliest date at which you can file a restricted application for spousal benefits (i.e., an application for just spousal benefits) for those who are still eligible to do so (i.e., anybody who was at least 62 years old as of 1/1/2016).

But, from the perspective of when to start receiving your own retirement benefits, full retirement age is nothing special. It’s just one of 96 possible months at which you can start taking benefits.

And in fact, of those 96 months, the first one and the last one (62 and 70) come up much more frequently than other months as the optimal time to start benefits.

If you could claim at any age (i.e., with delayed retirement credits earned for delaying beyond age 70 and with early claiming available prior to 62 — with an accompanying penalty), people in particularly good health would often want to wait well past age 70. And people in very poor health would often want to claim very early — perhaps in their 50s even.

But those aren’t options. So everybody who would be best served by claiming prior to 62 (if such were an option) will find “claim at 62” to be the best strategy. And everybody who would be best served by claiming later than 70 (if such were an option) will find “claim at 70” to be the best strategy.

In other words, yes, it is very uncommon that full retirement age happens to be the best answer for when to start receiving retirement benefits. (And for both spouses to start receiving retirement benefits at full retirement age is almost surely a mistake. In most cases, that would be a dominated strategy.)

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Opening, Middle Game and Endgame of Retirement Planning

Retirement can last quite a long time. And, as Dirk Cotton points out this week, the risks facing you and strategies available to you are different from one stage of retirement to another. And it would be wise to explicitly account for such changes when crafting a retirement plan.

Investing Articles

Other Money-Related Articles

Thanks for reading!

Why Forex (Foreign Currency Trading) Is Useless and Dangerous for Most Investors

A reader writes in, asking:

“I recently saw an article that said that forex trading was invented to be a risk reduction tool. The nature of the rest of the article gave me the impression that it was just fear-mongering. Make me scared about the fate of U.S. Dollars so I turn my money over to them. But if you could discuss the matter in an article on your blog I’d be interested to read it.”

In some cases — which are rare for individual investors — currency-related investment products can be helpful as a way to reduce risk.

Example: Theresa is a self-employed engineer. She lives in the US (and therefore spends pretty much exclusively in dollars), but the majority of her revenue this year will come from completing a project for a client in the UK — a project for which she’ll be paid £70,000. She anticipates completing the project in October. If she wants to, she could use currency futures to “lock in” the current exchange rate so that she knows how much the £70,000 will actually be worth to her (i.e., in dollars), thereby allowing her to budget her finances accordingly.

Most people, however, are paid in the same currency in which they spend. So there’s no need to offset any such risk.

In fact, for most individual investors, foreign currency trading is not only pointless but also harmful.

Firstly, investing in currency is a zero-sum game, before costs. That is, with forex, the investment you’re holding is a currency (or a derivative product whose performance is based on the price of a currency), and currencies do not actually earn any money. (This is quite different from stocks and bonds, which do on average earn money.) With a forex trade, if one party earns money, it is solely because the party on the other side of the trade lost money. And, after accounting for transaction costs, the total amount earned by the two parties is not zero, but negative.

Second, forex allows for degrees of leverage (i.e., investing with borrowed money) that are truly insane for an individual investor. Forex brokers typically allow for 50:1 leverage, meaning that for each $1,000 you invest, you can buy $50,000 of something by borrowing the other $49,000. Investing this much borrowed money wildly magnifies your results, whether good or bad. Of course, the fact that you can borrow huge amounts of money doesn’t mean you have to. But forex does give you the tools to absolutely destroy your finances in a hurry.

Finally, most individual investors don’t engage in currency trading. As a result, you’re engaging in a zero-sum game (negative, after costs) with people who are, in most cases, professionals. They likely have more experience, better skills, and more information than you have.

Investing Blog Roundup: Americans Contributing More to 401(k) Plans

There’s a general consensus that, when it comes to funding retirement, we have a problem — some say an impending crisis, even. In short, most people aren’t saving enough money.

There is, however, some good news. Specifically, people are saving more than they used to. And there’s good reason to think that the trend will continue, because it’s largely the result of new policies in 401(k) plans (most importantly automatic enrollment, but also reasonable default investment options and lower costs), which aren’t likely to go away any time soon.

Investing Articles

Other Money-Related Articles

Thanks for reading!

Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2017 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy