You can probably count on one hand the people you trust to give you sound investment advice. For a number of reasons, talking about money even with them isn’t always the easiest thing to do, and often it’s worse than talking about religion and politics. Trust is paramount.
Two companies that have gained the trust of individual investors are Vanguard and Fidelity (disclosure: Richard C. Young & Co., Ltd., invests in some Vanguard funds and uses Fidelity as a custodian for client accounts). Billions of dollars have poured into both firms while less desirable firms have dealt with net outflows. You may have seen Vanguard’s advertising campaign called “Vanguarding.” It deals with trust, and among other things reminds investors that “Reacting to the stock market is just investing. Taking stock in the long term is Vanguarding.”
This week’s Wall Street Journal feature, “Small Investors Flee Stocks, Changing Market Dynamics,” by E.S. Browning, tells the story of how Karen and Roger Potyk lost $75,000 on a Lehman Brothers bond, leveling a devastating body blow to their confidence. “In the military, you learn that you want people you can respect, trust—who have integrity,” Mr. Potyk says. “Over the last five years or so, I find that our financial institutions have no shred of the character I describe.” The Potyks sold their stock mutual funds in May.
The problem for the Potyks and investors like them is where to go with all that cash. The Potyks and a large herd of investors seem to think bonds are the answer. Vanguard CEO William McNabb warns in a recent interview with Fortune that “The single biggest tactical investment issue I’m worried about is that we as an industry saw $400 billion flow into bond funds.” The following chart from the Investment Company Institute (ICI) illustrates this point. Note how investors have chased the low-hanging fruit of above-average bond returns seen in 2009. Bond returns like that are never going to been seen again in most investors’ lifetimes. Also, note how over the course of the series investors often chase returns by increasing inflows to bonds after performance turns up, missing out on early gains, and how they experience the worst of the declines by selling too late.
Bonds need to be in your portfolio. It would be a mistake, though, to leave your bond holdings exposed to the inevitable sharp upswings in interest rates. Vanguard’s Mr. McNabb concludes, “We hope that investors remember that if interest rates go up, bond prices go down. We’ve tried to be very aggressive in education about that.” The Potyks may have made another mistake—one that could have been avoided if all along they’d been working with someone they trust.
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