Of Junk Bonds And Redwoods, Portfolio Don'ts And Shoulds: Financial Advisors' Daily Digest

by: SA Gil Weinreich

Summary

Turns out the retired couple we mentioned yesterday with concerns about their portfolio are mostly invested in junk bonds.

Your humble correspondent is now concerned.

In other matters, Ronald Surz offers retirement advisors three steps to upgrade their fiduciary practices.

A reader named Jane shared her concerns about the longevity of her portfolio in a comment on my post two days ago. I quoted her comment in yesterday's post, making the point that our crowdsourced effort to help Jane struck me as an unhelpful rush to judgment because we did not have enough facts to make an intelligent determination about her portfolio. Jane added a further comment (see yesterday's post, or below), and with this addition of facts, I admit to feeling much more judgmental, i.e. concerned. I quote:

"BTW, having looked over our portfolio, I have found most of our money is in various funds which appear to be 'junk bonds.' I have difficulty understanding the information, but am realizing that is how he is getting the yield. These funds have been throwing off 6-8%."

Dear Jane,

The higher yield of 'junk bonds' can play a role in a portfolio; certainly, the asset class has many admirers on SA. The attraction of course is that high yield you mentioned.

I am not a financial advisor - just a financial journalist, but journalists like telling stories, so here's one that springs to mind. Nearly 20 years ago, my wife and I were driving back to our California home from a summer trip to Oregon. Even with the passage of time I still remember my wonder at the seeming eternity of redwood trees as we drove down the Mendocino coast; they seemed as numerous as the grains of sand at the beach. At one point, noting that my gas meter was below a quarter of a tank, I passed a gas station where the price seemed insanely high. I kept on driving. I figured I had enough gas to make it to the next gas station. As I continued to drive through an endless forest, the majestic trees started to lose their charm for me. The sun was setting, the next highway I needed was nowhere in sight, I was now on fumes and, needless to say, was wondering what I'd do if I ended up stuck in the middle of nowhere - far from food, people, hotels and…gas!

That is when I learned a lesson about markets I never since forgot. The outrageously high price of gas was a signal to me that there was no gas anywhere for miles and miles. I was too inexperienced at that time to know this when I passed that station. My reaction should have been glee at the opportunity to pay for such a vital product and gratitude that these folks were in business in such an isolated place! The market was telling me that the abundance of risk (in this case, the lack of alternatives) justified such a high price.

And so it is with junk bonds. In this case, you're the gas station owner collecting a high fee because there isn't a decent yield in safer instruments for miles, as it were. But some of the issuers are thrilled to pay the high rates because they're desperate to have one more chance to stay in business (e.g., shaky energy companies) or their corporate treasurers are eager to buy back more company stock so their share prices can rise and they can receive performance bonuses at work. Some of these companies' debt offerings actually offer value. But this asset class (which some analysts regard as overvalued) hardly seems like the right place for "most" of a retiree's money.

Does this analysis seem fair? Readers, financial advisors among them, are encouraged to offer Jane their cogent and considered judgments on this question on our comments page. Jane: I eventually got the gas I needed in the nick of time and am certain you can get through this too - calmly, purposefully and successfully. All best wishes - GW.

Meanwhile, today's news and views for advisors: