For the longest time it was conventional thinking that a “balanced” portfolio was a 50/50 portfolio. That is, in the securities world it was widely recommended that a “balanced portfolio” had 50 percent of the portfolio in stocks and 50 percent of the portfolio in bonds. This meant that many times when there were research pieces or sales pieces put together by money management firms that discussed “retirement portfolios,” it was the 50/50 portfolio that was used in the analysis. The use of the 50/50 portfolio was—at least partially—promulgated by the William Bengen four percent withdrawal rule study that took place in 1994 that most of us are familiar with. If you are not, email me and I will send it to you.
The 50/50 portfolio looked good for a good chunk of the last four decades because for those entire four decades bonds have not only been “safe,” but they have done quite well from a return standpoint. They have done well because prevailing interest rates have declined steadily and persistently over that 40 years. For instance, in September of 1981 the 10-Year Treasury Bond was yielding 15.84 percent and since then the yield has steadily declined to where it is today—at less than three percent. Because of the “inverse relationship” between bond values and interest rates, this period meant an almost 40-year bull market in bonds.
Furthermore, much of the historic research on retirement portfolios cite the lack of correlation (or negative correlation) that bonds have had to stocks over the last X years. When equities zigged, bonds zagged. Throughout a good chunk of history bonds not only contributed (past tense) a decent return to the overall portfolio but they also provided a hedge in recessionary times. It is no wonder that many consumers have grown accustomed to having bonds represent the “safe portion” of their retirement portfolios.
Then, some time over the last decade, the pundits started discussing 60/40 portfolios—as in 60 percent stocks and 40 percent bonds. Why the shift? Did the stock market get less risky over the last decade? Clearly I am being facetious here because although the last decade has been great in the stock market, we all know what happened the previous decade—it was chopped in half twice!
The reason for the shift to the 60/40 portfolio is because interest rates have gotten so low on bonds that a 50/50 portfolio looks very bad in the back-casting and the Monte Carlo models. So what did the pundits and money managers do in their sales literature and research pieces? They beefed up the stock side a little more to make up for the lousy yields consumers are receiving in the bond market today.
I understand that the conventional thinking of bonds representing the “safe part” of a portfolio is hard to buck, but if we know that bond yields are so lousy today that bonds seriously water down a portfolio, why aren’t the researchers looking at other options? Especially if we believe interest rates will increase eventually? Of course, I know the answer to that silly question as well. Because it is the money management firms that usually put out the research pieces! (Note: Folks like Roger Ibbotson have created great studies on bond alternatives.)
Let’s discuss the issue of rising interest rates for a second. Duration is a standard metric for bonds and bond mutual funds that measures the sensitivity of the price of the bond/bond fund to movements in interest rates. Typically, the duration of a bond/bond fund ranges from two years on short-term bond funds to 15 years on long-term bond funds. The chart above demonstrates the impact of rising rates given certain durations.
Example: If you are invested in a bond mutual fund with a duration of 10 and if rates increase by 1.5 percent, your fund will generally lose 15 percent of it’s value.
I am not the only one that questions the 60/40 rule. For example, I just got done reading an unnamed research piece by a very formidable bank that owns a very formidable wirehouse firm where they are stating that the “60/40 rule is dead.” One of the problems with the article is that they are suggesting the 40 percent bonds be replaced with vehicles like dividend stocks. Clearly, I agree with the fact that the bond math is getting very hard to justify, but ten years into a bull stock market and we are going to continue to suggest more equity exposure? Really?
It is interesting to me how today’s rules of thumb are tomorrow’s outdated misconceptions. When hindsight is 20/20, you have the tendency for “rules of thumb” and product development to revolve around how well that rule of thumb or product looks in hindsight. In other words, the rules of thumb and products many times are created as a result of the research on hindsight, instead of the other way around. This is flawed because the next crisis is always different than the last crisis that can make the previous assumptions and “rules of thumb” irrelevant.
I can think of a product that I would recommend for the fixed income side of the portfolio. Can you guess what it is?
A New Year, A New Resolution: Talk To More Clients About Disability Insurance
Happy New Year! Welcome to 2020 and a clean slate of new resolutions. If you are not talking to your clients every week about disability insurance, this is a great time to make it part of your new year planning. To start, you’ll need to make a list of clients who are good candidates for various types of disability insurance. To make it easier for you, we’ve given you a few scenarios that should be on your radar. Remember, everyone who needs to work usually needs some type of disability insurance. So, our number one request for illustrations is for individual disability insurance clients who work full time. The following list was designed to help you recognize opportunities that are sometimes not recognized and should be part of your 2020 planning.
Client: Business owner
Product: Business Overhead Expense Disability Insurance (BOE)
Think small business, usually a professional, such as a dentist, attorney, engineer, physician, architect, CPA, or any small business in which the firm is supported by an individual owner or two. You most likely have these clients in your database. When someone owns a business, they usually will have fixed expenses that they’ve obligated themselves to pay, regardless of whether they have the ability to work or not. The rent or mortgage still needs to be paid, the support staff still need their incomes, business equipment leases still need to be paid, the utilities, business loans, and other monthly obligations still need to be paid. Every business owner should look into BOE insurance. Be resolved to talk to your business owner clients about BOE coverage.
Client: Firms with multiple partners and a business operating agreement
Product: Disability Buy Out
Think about the firms you insure in which you have put in a life insurance policy to help fund a buy/sell agreement. I’m sure you can think of many cases in which you’ve put in life insurance, but didn’t even discuss the disability insurance aspect. Most operating agreements or buy/sell agreements have some type of disability provision…and if not, then there should be a provision to address what will occur if a partner is disabled.
Client: Business owner or individual client
Product: Loan Protection
If you have been selling life insurance for more than a few years, you most likely have been asked for life insurance to cover a loan or mortgage. This is a great entre to discuss disability insurance. Since most clients are more likely to suffer a disability than pass away before the end of a loan period, a plan should be in place in case of a disability. For a business, without some type of disability loan protection, even if the business owner survives, the business may not survive without disability coverage. For the individual who has a mortgage, having disability insurance is a must as well. For many people, full recovery from a disability may never happen and a permanent disability may become reality. If so, how will the mortgage be paid? In addition, most people have many other expenses that still must be paid regardless of whether they work or not.
Client: Dual income, no kids yet
Product: Personal Disability Insurance
These tend to be your younger clients who may be first time home buyers or clients requesting rental insurance or car insurance. You may have talked to them about some life insurance and perhaps they took your advice and bought a policy. Most people don’t realize that the risk of becoming disabled before age 65 is greater than that of passing. If one member of the couple gets disabled, the couple will have two financial pressures: First, the couple will naturally feel stress due to a decrease or total loss of income. The couple was relying on this income to pay their expenses and maintain their lifestyle. Second, due to the disability, many individuals will experience a sudden increase in unanticipated expenses. These include home and car modifications to accommodate the disabled partner, and extra medical bills for expenses not covered by insurance. An individual disability plan on one or both spouses will sometimes resonate better than some other types of insurance that may have been suggested.
This is not an all-inclusive list, as there are Key-Person DI policies, Retirement Security DI products, Guaranteed Standard Issue products, and Surplus Lines products that can fill many different needs. It’s essential to keep disability insurance on the top of your list of products to present.
If it hasn’t happened yet, there will most likely come a day when a client becomes disabled and wants to know the type of disability coverage they have with you. What will be your answer? Work with your manager, MGA, mentor, or just sit down and create a plan to review your book of business for disability insurance opportunities. It could be the best holiday gift you give your clients and their loved ones.
May you and your family have a happy and healthy New Year and a great 2020!