How Do You Build a Bond Portfolio?
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I'm Cathy Jones and I was and Sanders, and this is unexpected, an original podcast from Charles. Each week, we analyze what's happening in the markets and discuss how might affect your investments.

Well, hi, Kathy. I hope that you got a bit of a break last week with the thanksgiving holiday. It's hard to believe we are now into december.

And as you i'm sure remember, the theme of our last episode was uncertainty in the market. So let's take off this episode by asking whether you're seeing any changes in the dad in terms with the market is expecting or maybe expectations around. But the fed might do, especially with the jobs s numbers out this week and then some inflation data coming next week as well.

Well, so far, the market seems to be looking for a rate cut at the december meeting. IT looks like the odds as we're speaking right now or in the seventy, seventy five percent area, which I find a little surprising given some of the commentary that we've heard, including comments from fetch here, pool about, well, you know, keeping an open mind about all this. So i'm a little surprise that the conviction is that firm.

But as we've seen, convictions go up and down very quickly. So there's a lot of volatility around what people expect in. And I think that, that will probably continue. As you know, we can some employment numbers coming out, uh, fairly soon, and that's going to be important. I think in terms of the fed thinking and IT will certainly be interesting to see if some of the other data when we get to that inflation data coming up, what about you isn't what are you .

expecting from here? Try to know what we should expect at this point. There are so many cross current, but part of our job is to not as successful PPT unities, but assess risks.

And I suppose worse case scenario, particularly f because IT would happen in advance of any knowledge we have with regard to the things we've been talking about, tariff and, uh, immigration and the effect on growth and inflation. But I suppose thinking about the next week of data coming in A A little bit of a worst case scenario be a weaker jobs report, but a hotter inflation report. And I I think that would easily move the fed into the pause a camp, at least on the inflation front.

But then the question is what they had they approached from the other part of their Mandate, the employment front. So I think that would had a little bit of a epical versus a backdrop of stronger than expected job report and benie inflation. That would be the ideal scenario, could be supportive of the fed moving to lower interest rates without attendant concern about inflation reigniting.

So we'll have to see, as we look ahead to the policy changes that could have the biggest impact. What we can go by, based on the two thousand and eight playbook, is an administration that likes to announce policy via social media. So it's government policy at times by tweet.

And we, of course, have a fed that's also data dependent, making the market data dependent and business leaders that are dependent. So you've got government policy being, you know, tweet dependent and monetary policy being data dependent. And IT really does sort of shorter time horizons and add to the uncertainty, making our jobs, both of us a little bit tRicky. One overarching theme, as I think I had to next years, that when we think about the tales of outcomes, both the left side and the right side, meaning, you know, positive risks and negative risks, I don't know about you, but I think that the tales might be a little bit fatter in this environment and maybe a Normal environment to the extended.

There is such a thing. Yeah one thing that we've mentioned in our outlook is just A A wide range of potential outcomes, right? You have all these potential changes. You don't know if they will actually materialize and if they do, in what form none materialized and that gets really difficult, then they kind of model out well, you know where where will we go from here or, well, you know if if you see these three things, we go there. If you see those three things, we go somewhere else.

So I do think that I will take some time to kind of figure out, you know where we're going to end up with some of these potential changes. But you know the dark market keeps marching higher. So there is optimism in your world. As always.

certain ly at the index level, there continues to be a lot of violation tions happening under the surface. And I think that's likely to continue in part because of all of these cross current. So uh, that is something that we will go into detail in our outlook.

Quid comes out shortly. So this week, Cathy episode is about building a bond portfolio. And this is maybe something unique about our show, which is that we look at both stocks and bonds, but bonds tend to get generally less airplay in the media, although in the past year, I I might argue a little bit against that. I think that's where the volatility action has been more in the bond market than the equity market. But tell us about our guests and the discussion you had.

sure. So the guest this week is my colleague, Cooper. Howard Cooper is a charted financial analyst and a director at the swab center for financial research.

He is an expert on the municipal bond market with a really important market for a lot of individual investors. He'd been quoted in many financial publications in your times, plumber, bonfire and cnbc. And I really looking forward to this conversation as a bond.

So Cooper, thanks for being here.

Thank you for any Cathy.

This is a topic we get a lot of questions on. Some really excited to have you want to talk about IT, the idea of how to build a bond portfolio or something. I think a lot of people wonder about, but they are not really sure where to get started. But before we get into the nativity, let's just start with the question. I think that we should tackle and that's why should you even be interested in investing in bonds?

You know, I think that that's a great question to start with. I'd really boil IT down to three reasons why you should invest in bonds. The first one is the income bond can be confusing, but really they aren't.

If you've invest in the C D. In the past, for example, a bond is very similar to A C D. So a bond can provide steady, predictable income stream, and that's something that's pretty good for a planning purposes.

So if you know that you have a known expense in the future, say it's a child's education, say it's retirement, you're needing that income from IT. That's where bond can be a pretty good investment, assuming they've in your rist tolerance. The second reason is capital preservation.

A bond cafe is really just a contract between you and the issue or now it's not something that you actually have to sign or into into a formal agreement, but that issue agrees to pay you back a certain amount over a certain time period, barring default. So you know what you're going to get when you're going to get IT and you know that known amount in the future. So that capital preserve, that's the second point.

The third point that I think a boner fairly good investment for his diversification. Now many boner uncorrelated to destruct. What that means is that when stocks move up, maybe bonds moves lately down.

Or when stocks move down, maybe bonds moves lately up. And I want to highlighting example of that. And let's go back to cove IT, for example, and i'll Cherry pick some data here.

So for mid february twenty twenty to mid march twenty twenty. Now over that scary period of time, stocks were down about thirty four percent. But over that exact same period of time, high quality fixed income that was only down about point eight percent. So you can see there's a significant decline in a portfolio if IT would be all stocks, whether that decline would be much less if IT was a mix of bold stocks and bonds.

Yeah, those are a really good point, especially the point about, you know knowing what you're gonna when you're gonna get IT. That's what really distinguishes bonds from most other investments as manufacture of illegal right to those payments, those interest payments and getting the principal back at par. Okay, let's just jump into IT. Where do you even start when he comes to building a bond portfolio? What is the first step be?

yeah. So the first step, I think, is that you should have a plane or road map. And this is really in line with kind of what else we do in terms of life.

So let's say that we're going on a road trip. You want to first determine what is my destination and then how i'm going to get there. And that's really gonna dictate what what you're going to do in terms of your born portfolio.

So you have to understand, well, what is the purpose of this money that I want to invest IT for? Is this something that i'm saving for a grandkid college i'm using for my retirement or i'm going to be living off of this money? So overall, that's gona be your first step.

And then what types of bonds to an investor focus on? So sam, a retirement, and I want to use my portfolio to supplement my income on retirement. Can you tell me how I might go about approaching that?

yeah. So if you look at the global bond market, it's about twenty percent larger than the global stock market. So I know that the stock market gets a lot of the attention, but the bond markets actually much bigger.

So for a lot of our clients, that can really raise kind of a question of, oh, where do I even start and I mean, retirement, I need to kind of understand how do I build a born portfolio. And from a basic standpoint, this is really gonna depend from investor to investor based off of a number of different factors. But a general guideline for retire is we usually like to start with one year of cash after accounting for predictable income sources. So if you know that i've got some money coming in from dividends, interest payments, other retirement income sources, they attention or something of that nature, also security, then figure out your budget, set aside enough money and put that in the cash so that you know that that's going to be written available and you really don't have to think about your spending over the next year. From there, we suggest putting two to three years worth of spending in high quality short term bonds, and then finally, you can build out the rest of your borne portfolio by focusing on higher rated investment, great bonds, either corporate bonds, treasury bonds or things like municipal bonds.

So the idea there is to keep the high quality, in other words, not be doing a lot of speculating and junk bonds and things like that.

That's correct. And I think one of the things that i'd like about that strategy of having a year in cash, the next two to three years of spending in short term fixed ed income and then building out the rest in high quality fixed income investments and maybe a doubling a little bit into more aggressive income sectors is that IT accounts for two things of risk that we like to focus on. The first is your risk tolerance and then your risk capacity.

And risk tolerance is basically, I opened up my account one day, and I look online and I see a bunch red. How does that make me feel? Is that can make me panic, have to sell out early? And am I going to have concern for the rest of the day?

The other piece of IT is your risk capacity. And naturally, is a question of how much can my portfolio go down without me having to change my lifestyle. So I like that when we build out a portfolio that way, for somebody who is living off of their portfolio, IT takes into account both the rist capacity and the rist tolerance. Yeah.

I I think that second peace that rise capacity is really important because a lot of times, we focus on what's the best return we can get, right, and we end up taking a fair amount of risk.

But if we're going to have to dip in to part of the portfolio because they declined very much and we need that income, we need that cash at a time that isn't a good time to do IT, then we are losing out in the overall you know, capital value, and it's really hard to come back to the starting point if you do that. So keeping some of IT but isolated from that sort of a risk seems to me to be a really important component of an overall portfolio. okay.

So now I have a good idea of why I want invest in bonds and how to approach from kind of a allocation point of view. But now let's get into another aspect that often gets fusing. What products do I use so their individual bonds are bond fans to C, T, F. Is there one choice that makes the most sense? What are the tradeoffs between those various ways of investing in the bond market?

Yeah, I think this can also add the complexity of the fix income market is that there is no single way to invest. And I think if you look at IT, we don't have a preference on our mutual funder etf Better than individual bonds. IT really comes down to the characteristics of each.

So if you look at the mutual funder etf at the bottom line, it's just a portfolio of a bunch of individual bond. So it's very similar to a portfolio individual bonds if you were ability at yourself. However, if you're going to build a portfolio of individual bond yourself, generally speaking, it's going to require a larger dollar amount to get adequate diversification.

So we usually recommend, Kathy, that you invest in at least ten different issues with differ credit risks. So depending on how much money you have to invest, that can be difficult with individual bonds. Now the flip side is that for mutual funds in E E T F, for every dollar that you're investing, that generally spread out across multiple different bonds so you can achieve diversification a little Better, easier.

However, one of the downsides of mutual fund s is that, David, net us at value that fluctuate to our Price that you would look at on your account statement or online that's gonna up and down now depending on the types of bond you invest in, that Price might move a little bit more or a little bit less. But for some individuals, they don't like to see that Price fluctuation ate when they look at their bond portfolio or the portion of their portfolio that they believe is kind of the safe, conservative part of their allocation. Individual bonds.

You mentioned this earlier, but there are contract really between you and the issue are of that bond, they agree to pay you back a stated coupon rate plus give you back the principle at some time in the future. Now the other thing that considers what types of bonds are you investing in. So if you're investing in more risky, your types of bonds, maybe going the rave and neutral fund or n etf makes a little bit more sense because you have that broader diversification and potentially an active manager that can do some of that credit research .

and watch over IT. Yeah, I think that that's something that I often talk IT with clients about because we'll talk about building portfolios, individual bonds, and we do have people who can assist with that. But you do have to kind of monitor and stay on top of IT over time.

And a lot of people don't really want to be bn fu N D managers in their free time theyd. Rather you play tennis or golf, you have lunch with their friends. And so sometimes having a manager, even though that comes with the fee, can make a lot of sense because doing credit research is it's rather involved.

It's a skill. It's a full time job for a lot of people. And as we both know, IT can be a chAllenging one at time.

So I think that's kind of a good distinction for people to think about. When I thinking about individual bond verses using a mutual funerary etf or some other sort of product, where is managed for you? okay.

So then we get down the different accounts. You know, what kind of accounts should investors think about when they're holding bonds? Do they just go into, you know, OK you put them in an I R A. Can you put in your general broker account? What do you have to think about when you decide what account to allocate them to?

yeah. So this is a whole another level of complexity on things. And I think this is very important to go back to the original question of why are you even investing in bonds to begin with?

When do you need that money if you're in retirement and you need that money right away, then you have to plan out to your required minimum distributions or consider your taxes with distributions from your iras. So I think that that's another thing to factory. The other thing that a factory is, is tax considerations.

Now municipal BBS, for example, they pay interest income that generally exempt from federal, possibly state income taxes. IT really does not make sense to hold those in A I R A or attack shelter account right now. IT makes sense to hold them in a taxable account.

And if you're comparing corporate bonds, which are fully federally taxable to muncie bonds, thinking well, at what rate does that make sense to invest in corporate bonds versus municipal ones that all in tax rates about thirty five percent? So that's saying that if you have a federal tax rate, state tax rate in any other applicable taxi rates that's above thirty five percent in you're investing in a taxable account, IT probably make sense to use municipal bonds. If you are in a tax bracket that below thirty five percent, then IT probably makes sense to invest in things like corporate bonds.

The other thing to consider is that corporate bonds, they are not too tax sufficient, so the interesting they pay is fully subject to income taxes. Usually, income tax rates are higher than dividend tax rates. So IT makes sense to hold corporate bond things like that in a tack shelter account, like an ira, or like a four one k however, the bottom mine on this is that IT depends on when do you need the money. So if you need the money very soon and you're looking at taking the tributes from an ira, probably make sense to focus more on the attacked able accounts, which are fully liquid. And you can draw a little bit easier than something like an I, A great point.

And when that gets confusing, IT does tend to get confusing because you have to sit and kind of figure out, well, what's the yield ld i'm getting on this bond? If it's an attack shelter account, can I get something comparable? Attacks is am fond in a taxi ble account, and we can help do the math with that.

But IT is something that really is important, because, you know, what important is how much you keep right of your investment, not just how much you make so good points on those accounts. So you know what they our team often talks about is latter's bond latter's. And we do this because it's kind of a go to strategy in our view that a lot of people can you use and can make sense for them. So can you explain what a bond letter is? Yeah.

IT is a very good go to strategy, that kind of an all bet weather strategy that takes a lot of the guest works out of things. And the way I like to describe IT is if you were to go to a hardware store and you see a latter, a latter is going to have multiple different runs on IT. And that similar to building the latter of individual bonds or bond mutual funds, you can do IT with mutual fund or etf as well.

And what a latter is, is you would invest incremental amounts to incremental time periods. So let's assume that you just had fifty thousand dollars to invest. You'd buy ten thousand dollars into a one year bond, ten thousand into a two year born d ten thousand into three year bond.

Ea, all the way out to five years. Now what happens with that is that in one year, your one year bond is going to come due. So you can either take that money, you can spend IT, you can do what you choose with IT, or you can go ahead and you can buy a new five year bond.

So that's the strategy that constantly going to be kind of cycling through itself. One of the things that I really like about a bond latter strategy, Cathy, is what i've found with many of our clients is that IT automatically create a check in point of when they should reevaluate their portfolio overall to make sure that their goals and things are back on track. And what they're doing is kind of in line with what they want their money to be doing.

Now this is similar to something that we would do in Normal life. So for example, I always make sure that at the beginning of december, I know that in my family, our advent calendars es out, but I also know that it's time for me to go downstairs and to change my water filter. So how those two go hand in hand, I don't know, but somehow in my mind, I know that it's time to change the water filter as IT is time to bring out the advent calendar. So IT just create a natural check in point for me.

That's great. Yeah what I love about latter's, they're just kind of illegant their simplicity, right? So you break up the majorities of your bond evenly over time, whatever time frame you want to use, five years, ten years to name ment.

And you know when you're rotating like that, not only do you have that OK, i'm having to check in every six months or once a year when the water filter needs changing. You know, I take a look at my bonds and I say, is this still working for me? Is just making sense.

Do I have the right bonds at sea? But also then my ten year bond says a ten year bone letter becomes a nine year, and my nine year and eight year set to us. So then I invested a newton year bond.

And if yields go up, i'm actually gonna a generate more income as I rotate because i'll be investing in the higher yelling bonds. So particularly for somebody who's using this as a strategy to deliver income over a long period of time like retirement, IT gives you a little bit of an edge when rates actually do go up. Now the Price of the bonds fall.

But if you just doing that for the income and you're holding IT all these bonds to maturity over time and rotating, you actually don't mind if yields go up. It's a less disturbing kind of experience than when you're holding bonds for a total return and they they go down in Price. So love bond letters as I go to strategy.

So let's like a little bit about when yeah what opportunities might come along, how you know that there were opportunities a good time to be looking at bond at sara. So when the yellow ver is inverted and that means the shorter, milder above longer term meals, is that a good time, a bad time? Do I only look at short term bonds when I do that? Or should I still consider longer term bonds? How do you make that decision?

yes. So I think that you should still consider longer term bonds. And one of the reasons why, and we know that for a lot of our clients, they say, well, why should I buy a bond of IT is going to pay me less and i'm gonna to lock up my money for a longer period of time when I can get something north words of a four percent on a cash or cash like investment. And the reason that you would buy a longer term bond in that type of an environment is that you're locking in that yield.

One of the things that we discuss earlier that by buying a bond, you're entering into a contract between you and the issue and implicit contract, there's nothing design um but you're guaranteed assuming that they don't default that coupon payment and that principal back at some point in time, whether if you're invested only in cash, cash tends to be highly correlated with what's the federal reserves doing so as expected, they're going to likely lower interest rates later this year and potentially further into next year. And if they do investments on cash, the yields on those are likely to move lower. So by buying some longer term bonds, you're capturing that yield ds for the life of the bond, boring a default. And you're making sure that even if yids do move around, you still know exactly what you're going to get when you're going to get IT.

Yeah, that's a good point in just a thrown on a little bit of jerk and hair. If you just stay very short term and cash or cash like investments, then you have reinvestment risk, right? If we are three months to bill and rates go down in three months, you'll be investing at lower and lower rates.

Another fancy term for this is path dependency. So you're depending on the path forward of the federal reserve in terms of short term rates. And as we all know, paths go up and down and all around, and you're really very dependent on exactly following that path of short term interest rates in terms of the income that you're generating.

Well, it's been great. I really appreciated. I do hope that we now have people Better prepared to think about building bond portfolios going forward. Thanks a lot, Cooper.

Thanks so much for any cutting.

So let's look ahead time that part of the podcast episode, thy what is on your radar for the next week yourself.

Well, we have those inflation reports. I think those are the really big ones will have gotten the jobs numbers by next week. And so we'll have that other bets.

Then the last pieces is the inflation numbers, and that should give us a pretty good ideas to what the fed is leading towards at the december eating the sixth meeting where markets still expects A A rate cut. But i'm a little bit less confident that it's going to materialize. So a lot of other data about I would pick that out, those inflation numbers as the really big ones. What about eliza? Besides those inflation numbers, what are you looking at?

We also get the entire y be dead, a national federation of independent business. Not that always has really interesting and nuggets. That's a federation for small businesses.

And we have seen an immediate pop in optimism in the aftermath of the election. And that's not uncommon to see, particularly because the business leaders incorporated by the antique be tend to be a little bit more republican leaning. So you did see something similar happened in twenty sixteen.

I'll have to see the longevity of that, but i'll be focused on things like what is the single most important problem. Inflation is kind of been raining supreme, but have to see what happens with other concerns, whether its growth concerns or quality of labor. So some of those subcomponent questions are are interesting.

We also get the productivity and unit labor costs data out. And I think that as a guide, both on the inflation side of things but also the productivity aspect of GDP could be important. And then we get the federal budget baLance. I think that's increasingly in a lot of investors sites, given what we, you and I hear all the time.

Concerns about the debt and deficit in and maybe import export Prices could start to have some interesting trends, not much maybe in advance of some of the tariff news that will inevitably start to get in more detail come to and you worry. But that's what on my rare. Well, that's IT for us this week.

As always, you can keep up with us in real time on social media. I'm at liza thunders on x and linked in, by the way, i'm not on facebook. I'm not an instagram.

I'm not on WhatsApp, although i've secured a handle blue sky. I'm not on there yet. And just today I found out that there's now a rack of imposters that have me via I on camera, speaking and telling you all about my odd crypto and stockbroking club. Those are all and posters, even if you think you see me and hear me IT is not me. So that's yet again another PSA on my part to beware of the amplius and .

on at Cathy James, that's Kathy will OK on x and linked in. And if you've enjoyed the show, we'd really be grateful tude leave S. S.

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