Objective information about financial planning, investments, and retirement plans

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

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One of the best tax deductions for a small business owner is funding a retirement plan.  Beyond any tax deduction you are saving for your own retirement.  As a fellow small business person, I know how hard you work.  You deserve a comfortable retirement.  If you don’t plan for your own retirement who will? Two popular small business retirement plans are the SEP-IRA and Solo 401(k).

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

SEP-IRA vs. Solo 401(k)

SEP-IRA Solo 401(k)
Who can contribute? Employer contributions only. Employer contributions and employee deferrals.
Employer contribution limits The maximum for 2017 is $54,000 and increases to $55,000 for 2018. Contributions are deductible as a business expense and are not required every year. For 2017, employer plus employee combined contribution limit is a maximum of 25% of compensation up to the maximums are $54,000 and $60,000, respectively. For 2018 these limits increase to $55,000 and $61,000. Employer contributions are deductible as a business expense and are not required every year.
Employee contribution limits A SEP-IRA only allows employer contributions. Employees can contribute to an IRA (Traditional, Roth, or Non-Deductible based upon their individual circumstances). $18,000 for 2017. An additional $6,000 for participants 50 and over. In no case can this exceed 100% of their compensation. The limits for 2018 increase to $18,500 and $24,500 respectively.
Eligibility Typically, employees must be allowed to participate if they are over age 21, earn at least $600 annually, and have worked for the same employer in at least three of the past five years. No age or income restrictions. Business owners, partners and spouses working in the business. Common-law employees are not eligible.

Note the Solo 401(k) is also referred to as an Individual 401(k).

  • While a SEP-IRA can be used with employees in reality this can become an expensive proposition as you will need to contribute the same percentage for your employees as you defer for yourself.  I generally consider this a plan for the self-employed.
  • Both plans allow for contributions up your tax filing date, including extensions for the prior tax year. Consult with your tax professional to determine when your employee contributions must be made. The Solo 401(k) plan must be established by the end of the calendar year.
  • The SEP-IRA contribution is calculated as a percentage of compensation.  If your compensation is variable the amount that you can contribute year-to year will vary as well. Even if you have the cash to do so, your contribution will be limited by your income for a given year.
  • By contrast you can defer the lesser of $18,000 ($24,000 if 50 or over) or 100% of your income for 2017 and $18,500/$24,500 for 2018 into a Solo 401(k) plus the profit sharing contribution. This might be the better alternative for those with plenty of cash and a variable income.
  • Loans are possible from Solo 401(k)s, but not with SEP-IRAs.
  • Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP-IRA.
  • Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the level of annual government paperwork increases a bit.
  • Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
  • Investment options for both plans generally run the full gamut of typical investment options available at your custodian such as mutual funds, individual stocks, ETFs, bonds, closed-end funds, etc. There are some statutory restrictions so check with your custodian.

Both plans can offer a great way for you to save for retirement and to realize some tax savings in the process.  Whether you go this route or with some other option I urge to start saving for your retirement today 

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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Stock Market Highs and Your Retirement

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The S&P 500 Index reached another record high today, closing at 2488. This is a long way from the market bottom of 677 for the index in March of 2009. Today’s rally was deemed a “relief rally” by some reporters on CNBC, perhaps due in part to hurricane Irma being a bit less severe than expected and that North Korea hasn’t tested any additional nuclear weapons lately.

So far 2017 has been a good year for the markets with the S&P 500 up over 11.5% year-to-date. The Dow and other benchmarks have hit several record highs during the year as well. This in spite of the hurricanes in Texas and Florida, questions and issues surrounding the Trump administration and the situation with North Korea.

Difference Between Stocks and Bonds

At some point we are bound to see a stock market correction of some magnitude, hopefully not on the order of the 2008-09 financial crisis. As someone saving for retirement what should you do now?

Review and rebalance 

During the last market decline there were many stories about how our 401(k) accounts had become “201(k)s.” The PBS Frontline special The Retirement Gamble put much of the blame on Wall Street and they are right to an extent, especially as it pertains to the overall market drop.

However, some of the folks who experienced losses well in excess of the market averages were victims of their own over-allocation to stocks. This might have been their own doing or the result of poor financial advice.

This is the time to review your portfolio allocation and rebalance if needed.  For example your plan might call for a 60% allocation to stocks but with the gains that stocks have experienced you might now be at 70% or more.  This is great as long as the market continues to rise, but you are at increased risk should the market head down.  It may be time to consider paring equities back and to implement a strategy for doing this.

Financial Planning is vital

If you don’t have a financial plan in place, or if the last one you’ve done is old and outdated, this is a great time to have one done. Do it yourself if you’re comfortable or hire a fee-only financial advisor to help you.

If you have a financial plan this is an ideal time to review it and see where you are relative to your goals. Has the market rally accelerated the amount you’ve accumulated for retirement relative to where you had thought you’d be at this point? If so this is a good time to revisit your asset allocation and perhaps reduce your overall risk.

Learn from the past 

It is said that fear and greed are the two main drivers of the stock market. Some of the experts on shows like CNBC seem to feel that the market still has some upside. Maybe they’re right. However don’t get carried away and let greed guide your investing decisions.

Manage your portfolio with an eye towards downside risk. This doesn’t mean the markets won’t keep going up or that you should sell everything and go to cash. What it does mean is that you need to use your good common sense and keep your portfolio allocated in a fashion that is consistent with your retirement goals, your time horizon and your risk tolerance.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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401(k) Options When Leaving Your Job

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Retirement Funds over Time

Perhaps you are retiring or perhaps you are moving on to another opportunity. Perhaps you were downsized. Whatever the reason, there are many things to do when leaving a job. Don’t neglect your 401(k) plan during this process.

With a defined contribution plan such as a 401(k) you typically have several options to consider upon separation.  Here is a discussion of several and the pros and cons of each. Note this is a different issue from the decision that you may be faced with if you have a defined benefit pension plan.

Leaving your money in the old plan 

I’m generally not a fan of this approach. All too often these accounts are neglected and add to what I call “financial clutter,” a collection of investments that have no rhyme or reason to them.

In some larger plans, participants might have access to a solid menu of low cost institutional funds. In addition, many of these plans tend to be among the cheapest in terms of administrative costs. If this is the case with your old employer’s plan, it might make sense to leave your account there. However, it is vital that you manage your account in terms of staying on top of changes in the investment options offered and that you reallocate and rebalance your account when applicable.

Unfortunately far too many lousy 401(k) plans are filled with high cost, underperforming investment choices and leaving your retirement dollars there may not be your best option.

Rolling your account over to an IRA 

This route not only allows for the consolidation of accounts which makes monitoring your portfolio easier, but investors often have access to a wider range of low cost investment options than might be available to them via their old employer’s plan.

Even for do it yourselfer investors, rolling over to an IRA is often a good idea for similar reasons. You will want to take stock of your overall portfolio goals in light of your financial plan to determine if the custodian you are using or considering to offers a range of appropriate choices for your needs.

Rolling your account into your new employer’s plan 

If allowed by your new employer’s plan, this can be a viable option for you if you are moving to a new job. You will want to ensure that you consult with the administrator of your new employer’s plan and follow all of their rules for moving these dollars over.

This might be a good option for you if your 401(k) balance is small and/or you don’t have significant outside investments. It might also be a good option if your new employer has an outstanding plan on the order of what was mentioned above.

Before going this route, you will want to check out your new employer’s plan.  Is the investment menu filled with solid, low cost investment options? You want to avoid moving these dollars from a solid plan at your old employer to a sub-par plan at your new company. Likewise you don’t want to move dollars from one lousy plan to another.

Other considerations

A fourth option is to take a distribution of some or all of the dollars in your old plan.  Given the potential tax consequences I generally don’t recommend this route.

A few additional considerations are listed below (I mention these here to build your awareness but I am not covering them in detail here.  If any of these or other situations apply to you I suggest that you consult with your financial or tax advisor for guidance.):

  • The money coming out of the plan is always taxable, except for any portion in a Roth 401(k) assuming that you have satisfied all requirements to avoid taxes on the Roth portion.
  • You will likely be subject to a penalty if you withdraw funds prior to age 59 ½ with some exceptions such as death and disability.
  • There is also a pretty complex method for those under age 59 ½ to withdraw funds and avoid the penalty called 72(t). Additionally there are complex rules for those who are 55 and older who wish to take a distribution from their 401(k) upon separating from their employer. In either case consult with a financial advisor who understands these complex rules before proceeding.
  • If your old plan offers a match there is likely a vesting schedule for their matching contributions.  Your salary deferrals are always 100% vested (meaning you have full rights to them).  Matching contributions typically become vested on a schedule such as 20% per year over five years. You will want to know where you stand with regard to vesting anyway, but if you are close to earning another year of vesting you might consider this in the timing of your departure if this is an option and it makes sense in the context of your overall situation.
  • If your company makes annual profit sharing contributions, they might only be payable to employees who are employed as of a certain date. As with the previous bullet point, it might behoove you to plan your departure date around this if the amount looks to be significant and it works in the context of your overall situation.
  • Another factor that might favor rolling your old 401(k) to your new employer’s plan would be your desire to convert Traditional IRA dollars to a Roth IRA now or in the future. There could be a tax advantage to be had by doing this, however please consult with your financial advisor here for guidance tailored to your unique situation.
  • If you are 70 ½ or older and still working, you are not required to take annual required minimum distributions from your 401(k) as long as you are not a 5% or greater owner of the company. This might also be a reason to consider rolling your old 401(k) to your new employer’s plan, again consult with your financial advisor.

There are a number of options for an old 401(k) or similar retirement account when leaving your employer.  The right course of action will vary based upon your individual circumstances.  The wrong answer is to ignore this decision.

Approaching retirement and want another opinion on where you stand? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services. 

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Are Best Mutual Fund Lists a Good Investing Tool?

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We all like to read article with lists that rank things. Top colleges, top new cars, best and worst dressed and the like are just a few lists we see periodically. Mutual rankings have been around for a while.  Many top personal finance publications such as Money Magazine, Kiplinger’s, and U.S. News publish such lists that rank mutual funds based upon performance. Are these Best Mutual Fund lists useful to you as an investor?

Money (magazine)

Best compared to what?

In order for any mutual fund ranking tool to be useful the comparison needs to be apples-to-apples. Comparing a large cap domestic stock fund to a fund that invests in gold mining companies is a pretty useless exercise. Make sure that you understand what is being compared and the basis for the rankings.

Past performance is not an indication of future performance 

This is a pretty common disclaimer in the investment industry and it is one that should be heeded. Last year’s top mutual fund might finish on top again this year or it might end up at the bottom of the pack. This is especially true for actively managed mutual funds where results can often depend upon the manager’s investment style and whether or not their style is still in favor. Mutual funds that have a big year often find themselves inundated with new money from investors who chase performance, this influx of new money can make it harder for the manager to replicate their past success.

Who’s in charge? 

It is not uncommon for a top mutual fund manager to be wooed by a rival fund company or for them to go off and start their own mutual fund. This is not such a big deal with index funds, but when looking at any actively managed fund be sure to understand whether or not the manager(s) who compiled the enviable track record are still in place.

What period of time is being used? 

Make sure that you understand the time period used in the rankings. Returns over a single year can vary much more than returns compiled over a three, five, or ten year time period. Understand that one or two outstanding years can skew longer-term rankings. Longer periods of time tend to smooth out these blips in performance.

Why didn’t you tell me about this fund a year ago? 

I recall looking at many of these lists over the years and wondering why the publication didn’t write about how wonderful the fund was a year ago before it chalked up this large gain. Well the answer is that this isn’t the job of the publication and they and most of us can’t really predict this.

Is looking at performance worthless? 

No it isn’t but you need to look at performance in context. Look at performance over varying time periods and always in relation to the fund’s peers. Among the things to look at:

  • Risk adjusted performance
  • Performance in up and down markets
  • Performance over rolling periods of time
  • Adherence to the fund’s stated style
  • Costs and expenses
  • Consistency of relative performance
  • Changes in the level of assets in the fund

In short selecting and monitoring mutual funds is about more than looking for the top performers of the past. Like any other investment vehicle, mutual funds need to be viewed in terms of potential future performance and in terms of how they fit into your overall investment strategy and your financial plan.

Approaching retirement and want another opinion on where you stand? Do you want an independent review of your mutual fund holdings and your overall investment strategy? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.

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Reverse Churning Are You a Victim?

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One of the best things about being a freelance financial writer and blogger is that I often learn new things in the course of my writing. A reader left a comment on a post here on the blog and mentioned reverse churning. Until that time, I had never heard this term, but after a bit of research I found that its’s one more thing that clients of stock brokers and registered reps need to be aware of.

The issue of reverse churning is one that will come to the forefront as the initial implementation of the DOL fiduciary rules commences next week. Here’s what you need to know about reverse churning to protect yourself and to make a good decision if your broker proposes a fee-based account.

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What is churning?

Investopedia defines churning as “Excessive trading by a broker in a client’s account largely to generate commissions. Churning is an illegal and unethical practice that violates SEC rules and securities laws.”

Churning conjures images such as the boiler room in the movie Glengarry Glen Ross (actually they sold real estate) or the iconic 2002 ad by Charles Schwab (SCHW) in which a brokerage house manager is depicted as telling the brokers, “Let’s put some lipstick on this pig” in reference to a sub-par stock he wants them to pitch to clients.

What is reverse churning?

A 2014 piece by Daisy Maxey in The Wall Street Journal describes reverse churning as follows:

“The Securities and Exchange Commission says the practice of so-called “reverse churning”–putting investors in accounts that pay a fixed fee but generate little or no activity to justify that fee–is on its radar. Regulators will be watching for signs of double-dipping by advisers who generate significant commissions within a client’s brokerage account, then move that client into an advisory account and collect additional fees.”

This occurs in brokerage accounts that at one point generated significant commissions for the broker from the purchase and sale of individual stocks or other commission generating transactions. If the activity in the account tails off the broker makes little or nothing from this client.

As a way to generate ongoing fees from this type of client, the broker may suggest moving to a fee-based advisory account, often called a wrap account.

Under this arrangement there is an ongoing fee based upon the assets in the account plus often trailing commissions in the form of 12b-1 fees from the mutual funds usually offered in this type of account. These generally include proprietary mutual funds offered by the brokerage firm, or at the very least costly actively managed funds from other fund families in share classes geared to offering broker compensation.

Fee-based is not fee-only

Fee-based is often confused with fee-only. I suspect the brokerage industry likes it this way.

Fee-only compensation means that the financial advisor earns no compensation from the sale of financial products including trailing fees and commissions. Their fees come from their clients. These can be hourly, a flat-fee or as a percentage of the assets under management.

Fee-based compensation, also called fee and commission, is a mix of the two forms of advisor compensation. A common form of the fee-based model entails the client paying the advisor to do a financial plan and then if the client chooses to have the financial advisor implement their recommendations this will often be via the sale of commission-based products.

The version with fee-based advisory accounts associated with reverse churning by brokers and registered reps arose out of a 2007 rule that prohibits the charging of fees in brokerage accounts. Many broker-dealers have a registered investment advisor (RIA) arm which runs these accounts.

The fiduciary rule

The new fiduciary rules make fee-based accounts more desirable for brokers and other fee-based advisors. These types of accounts will become even more prevalent with the disclosures required for retirement accounts under the new rules.

There has been a movement towards fee-based accounts in the brokerage world for several years now, likely in anticipation of the eventual issuance of these rules. This movement should accelerate in IRAs. In some cases, this will be a good thing as clients will fully know what they are paying in terms of fees.

In other cases, clients will find themselves paying 100 basis points or more in wrap fees for accounts where they were formerly trading infrequently on a commissioned basis. Whether the fee-based account will be a better deal will vary.

If all they are getting is an expensive managed account filled with bad to mediocre mutual funds that charge high fees on top of the wrap fee, this is not a good deal. If the advisor does little more than collect a fee, this sounds like the definition of reverse churning based on my understanding of the term. Much will depend upon the level and types of advice clients receive for the fees they will now be paying.

Buyer beware 

If you are working with a stock broker or registered rep and they propose moving to a fee-based or wrap account, you should take a hard look at what you are being offered. What is the wrap fee? What types of investments are used in the account? Are they expensive actively managed mutual funds that throw off 12b-1 fees in addition to wrap fees? What is the track record of the manager of the account that the advisor is proposing? What types of advice and service will you receive for the fees you will paying?

The Bottom Line 

I can’t recall hearing about a case of churning in recent years. Reverse churning is a new term to me, but from the perspective of a broker or registered rep, fee-based advisory accounts make a ton of sense. They provide ongoing fee income and frankly require little attention from them. If your broker proposes a wrap account, make sure you understand how this arrangement benefits you the client.

Approaching retirement and want another opinion on where you stand? Has your broker proposed a fee-based option and you aren’t sure if this is the right option for you? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services. 

 

How is My Financial Advisor Compensated?

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Many investors do not understand how their financial advisor is compensated. With the initial implementation of the new DOL Fiduciary Rules mandating that advisors put their client’s interests first when working with their retirement accounts upon us, the issue of financial advisor compensation will be front and center. It is important that all clients fully understand how their financial advisor is compensated and how much this relationship is truly costing them.

The three basic compensation models 

Commissions: The advisor is compensated for the sale of investments, insurance, or other financial products. Compensation is paid by the firm that provides the financial product, usually a mutual fund or an insurance company. This may be in the form of an up-front charge, trailing (ongoing) fees or a combination of both. Other names for commissions include front-end loads (A share mutual funds are an example), 12b-1 fees that serve as trailing commissions on some mutual funds and commissions paid to advisors for the sale of insurance products.

Fee-based: Typically the advisor will charge a fee for putting together a financial plan for you. If you chose to implement the recommendations in the plan, such as the purchase of insurance, an annuity, or investments, the implementation will typically be done via the sale of commissioned products.

How is My Financial Advisor Compensated?

Fee-based has taken on a whole new significance in light of the new DOL fiduciary rules. Many firms have moved clients to fee-based or brokerage wrap accounts. The fee part arises from the wrap fee (typically a percentage of assets) charged to the client. Many of these accounts use mutual funds that throw off 12b-1 fees or other types of revenue sharing to the brokerage firm.

Fee-only: The advisor charges a fee for the services rendered. This can be one-time or ongoing based upon the nature of your relationship and the services rendered. Fees may be hourly, flat or retainer based, or based upon a percentage of the assets under advisement.

Why should you care how your advisor is paid? Because his/her compensation can impact the choice of the products recommended to you and your return from those products.

An advisor who is paid via commissions will likely recommend those products that offer him a commission or sales load. Sales people generally sell what they are compensated to sell. Commissions can therefore result in a huge conflict of interest for your advisor. Does she suggest the very best and lowest cost products or does she suggest those products that pay her the highest commission?

Fee-only advisors do not have this inherent conflict of interest because they are paid by the client, not the financial product provider. They are free to suggest the best investment vehicles and financial products for each client’s individual situation.

Should compensation be the only metric used to select a financial advisor?

Of course not, but the advisor’s compensation should be made crystal clear to you. When interviewing an advisor ask very direct questions.

Ask them to detail ALL sources of compensation. These might include up-front commissions or sales loads; deferred or trailing commissions; surrender charges if you opt out of the mutual fund or annuity too early; a wrap fee on your overall investment account; or a myriad of other fees and charges in various combinations.

This extends to fee-only advisors as well. Be sure to understand how much you will be paying for their advice and what types of investing costs you can expect to incur.

While you will not be writing a check for any commissions or product-based fees, make no mistake you are paying the freight. Excessive commissions or expenses serve to directly reduce your return on investment.

Once the new fiduciary rules go into effect, you may be asked to sign a form called a Best Interest Contract Exemption or BICE. The BICE form is used when the advisor seeks to use commissioned-based products, collect other types of revenue sharing or otherwise work with you in a fashion that is outside of the new fiduciary rules. Be sure to read this agreement carefully and to ask questions before signing it.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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Understanding Your Bond Fund’s Duration

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Interest Rates

For most of the past 30 years bonds and bond mutual funds have had the proverbial wind in their sails. Interest rates have steadily headed downwards. Bond prices and interest rates have an inverse relationship.

Last week, however, the Fed increased interest rates by 25 basis points (0.25%). They also indicated that they would continue to raise rates this year as, in their view, our economy has reached a new phase. This is part of an overall tightening of the money supply to keep the economy from overheating, including an effort to keep inflation in check.

Many investors may be wondering what this means for their bond mutual funds ETFs. A key number that all holders of bond funds and ETFs must know and understand is the fund’s duration.

What is duration? 

Bond mutual funds and ETFs are a portfolio of individual bonds.

According to Morningstar, “Duration is a time measure of a bond’s interest-rate sensitivity, based on the weighted average of the time periods over which a bond’s cash flows accrue to the bondholder.” A bond’s cash flows include the value received at maturity, generally $1,000 per bond, and the periodic interest payments received by the holder of the bond. A bond’s duration is expressed in years and is generally shorter than its maturity.

All things being equal, a bond with a longer time to maturity will have a higher duration meaning its price is more sensitive to changes in interest rates. Likewise, the higher the bond’s coupon rate (the stated interest rate paid by the bond) the lower the bond’s duration. Bonds with a shorter time to maturity and a higher coupon rate will have a lower duration and their price will be less sensitive to changes in interest rates.

The duration of a bond fund or ETF can be found on the fund’s fact sheet usually posted on the fund company’s site, or the portfolio tab on the fund’s listing on Morningstar.com.

What does bond fund duration tell us? 

The largest bond fund, Vanguard Total Bond Market Index (ticker VBMFX), has an effective duration of 6.05 years according to Morningstar. This tells us that if interest rates rise by 1% the value of the underlying bonds held by the fund would likely decline by around 6.05%.  Note this number is an approximation and bond prices are impacted by factors other than changes in interest rates. This fund roughly tracks the aggregate U.S. bond market.

By comparison Vanguard Long-Term Investment Grade (ticker VWESX) has longer duration of 13.31 years and would see a greater impact from rising interest rates.

The Vanguard Short-Term Bond Index ETF (ticker BSV) has a duration of 2.76 years.

The actively managed Double Line Total Return Bond Fund I (ticker DBLTX), managed by Jeffrey Gundlach who many call the “bond king,” has a duration of 3.98 years.

What should I do now?

As mentioned above, duration is a good indicator of the potential impact of a change in interest rates upon the value of your bond fund, but other factors also come into play. In 2008, many bond funds saw outsized losses and investors moved their money into Treasuries as a safe haven during the financial meltdown.

Many high-quality bond funds suffered major losses that year based only upon this flight to quality by investors.

Longer term the total return of a bond fund or ETF is driven by income payments as well as the direction of interest rates. Lower coupon bonds will be replaced by bonds with higher coupon rates over time.

Bonds are traded on the secondary market and prices are a function of supply and demand much like with stocks.

Bond mutual funds and ETFs offer the advantage of a managed portfolio.  On the flip side unlike an individual bond, bond mutual funds and ETFs never mature.

Is it time to get out of bond funds?  The point of this article is not to advocate that you do anything differently, but rather that you understand the potential duration risk in any bond mutual funds or ETFs that you currently hold or may be considering for purchase.

Bond funds and ETFs still have a place in diversified portfolios, but for many investors the characteristics of the fixed income portion of their portfolios may need an adjustment. This might mean shortening up on bond fund duration and looking at other, non-core types of bond funds.

The landscape of the financial markets is continually evolving and interest rates are a part of this evolution. As investors we need to understand the potential implications on our portfolios and adjust as needed.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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