Here’s What You Need to Know About Bonds – Episode #362

No matter where you are in your investing career, bonds offer low risk and benefits—like income and capital preservation—that you need to understand. Bonds often don’t get enough attention, despite being an essential investment vehicle. On this episode of the Dentist Money™ Show, Ryan, Matt, and Rabih look at bonds and the role they might play in each investor’s portfolio.

 

 

---

 

Podcast Transcript

[music]

Ryan Isaac:
Hello, everybody. Welcome back to another episode of the Dentist Money Show brought to you by Dentist Advisors, a no commission, fiduciary comprehensive financial advisor just for dentists all over the country. Check us out at dentistadvisors.com. Today on the show, Rabih and I talk about a big question in today’s market, which is portfolios and the role that bonds play in portfolios. This year, 2022 has been very interesting for bonds because of the inverse nature they have with interest rates. And as we know, in this year, interest rates have been insane and going through the roof, so it has a pretty profound effect on bonds. However, it is a really unique year and circumstance and the question still remains, do bonds have a place in your portfolio? And if so, what role do they play? So that’s what we’re talking about today. Many thanks to Rabih for taking time. The guy is so smart. I love having him on the show for the insight. Audience love him all over the world. Thanks to Rabih for being here. Thanks to you for being here. If you have any questions, go to dentistadvisors.com, click the ‘Book Free Consultation’ button, let’s have a chat about your money questions today. Thanks for being here. Enjoy the show.

Announcer:
Consult an advisor or conduct your own due diligence when making financial decisions. General principles discussed during this program do not constitute personal advice. This program is furnished by Dentist Advisors, a registered investment advisor. This is Dentist Money. Now, here’s your host, Ryan Isaac.

Ryan Isaac:
Welcome to the Dentist Money Show where we help dentists make smart financial decisions. I am Ryan. I’m here with Matt, and I’m here with Rabih. What’s up, guys? Thanks for being here.

Matt Mulcock:
Dream team. Dream team.

Rabih Dimachki:
What’s up?

Matt Mulcock:
When Rabih is here, we’re the dream team.

Ryan Isaac:
It’s the dream team. Yeah. Yeah. It just is…

Matt Mulcock:
When Rabih is not here, we are just a team.

Ryan Isaac:
I was gonna… Yeah, okay. I was gonna say disappointing duo, but…

Matt Mulcock:
No. Oh, there you go. [chuckle]

Ryan Isaac:
Even lower. Just a team. That’s true. Matt and Ryan are a team. Matt and Ryan and Rabih are a dream team.

Matt Mulcock:
Dream team.

Ryan Isaac:
Thanks for being here, guys.

Rabih Dimachki:
I’m blushing. Thank you so much.

Ryan Isaac:
Yes. Okay. We’re recording this today coming off the heels of, for those who are not clients, you won’t know this, but we did our quarterly client only huddle where we basically just talk about what’s going on in portfolios, and the economy and markets. This conversation follows that nicely. I feel bad for those who missed out on that. Hey, just become a client. If you’re a client, then you can join.

[chuckle]

Rabih Dimachki:
Become a client.

Matt Mulcock:
Done. It’s that easy. There you go.

Ryan Isaac:
Then you can do that. But we’re geeked up on the economy and all things just economy right now. That’s just on our minds. Today, we’re gonna talk about an article that was posted by… Who did this? IShares, I think that was it. If anyone’s listening in the future, Matt, recap, where are we at in this October 2022 generally speaking, economy market for someone’s listening in the future? So this is still a helpful episode in the future. What’s going on? What are we battling with right now?

Matt Mulcock:
Yeah. Lots of things. Wild volatility right now. The biggest, I think, topics of conversation right now are, in no particular order, is inflation ever going to stop? Housing market…

Ryan Isaac:
No.

Matt Mulcock:
Turning around on the… I think the fastest increase in rates ever from where, what… Lowest point to highest point, it’s moved up faster than [0:03:15.4] ____ I would, ever seen ever. And it’s just completely flipped the housing market. People are talking like, “Is this ’08, ’09 again?” It’s not, spoiler alert.

Ryan Isaac:
Yeah, yeah. That was in the quarterly client huddle if you were there. We addressed that.

Matt Mulcock:
Yeah, that was in the huddle, yeah. [chuckle] If you were a client. Yeah.

Ryan Isaac:
Be a client…

Matt Mulcock:
We’re really leaning into this… The scarcity, like you’re this, like FOMO, it’s FOMO. We’re really leaning…

Ryan Isaac:
We’re just trying to FOMO you guys into working with us.

Matt Mulcock:
We’re trying to FOMO you.

Ryan Isaac:
Yeah. Dentistadvisors.com.

Matt Mulcock:
Probably those are the big things. Well, and then obviously, there’s this tiny little war going on in Ukraine with Russia that’s dragging on, a lot of geopolitical tensions. We’ve got very contentious midterm elections coming up in November. There’s a lot of little…

Ryan Isaac:
Lot of stuff.

Matt Mulcock:
It’s a lot of stuff that could happen, a lot of straws that could break the camel’s back.

Ryan Isaac:
Yeah.

Matt Mulcock:
People talking about recession. “Are we in one? Is it coming?” All this kinda stuff. Oh, and the market just happens to be down 25%.

Ryan Isaac:
We’re in a bear market. Yeah, we’re officially…

Matt Mulcock:
Yeah, we’re in a bear market.

Ryan Isaac:
Although, I guess if you’re going technically, Rabih, correct me if I’m wrong, we hit a bear market, went out of it and went back in it.

[chuckle]

Rabih Dimachki:
That’s right.

Matt Mulcock:
Yes.

Ryan Isaac:
Like a week later. [chuckle] I don’t know… Is there a grace period when they measure bulls and bears?

Matt Mulcock:
That’s what I wanna know too.

Ryan Isaac:
There’s gotta be a grace period. ‘Cause you can’t hit…

Matt Mulcock:
There has to be.

Ryan Isaac:
20 and be like, “Bear market.” And then it goes back to 19, you’re like “Non-bear market,” then the next day it’s 20, you’re like “Bear market.” You can’t… There’s gotta be a grace period.

Matt Mulcock:
What do you think, Rabih?

Rabih Dimachki:
I think it has to be validated by the economy. If the economy doesn’t go into a recession and some miracle just happens, we’ll call it a very strong correction. [chuckle] But…

Matt Mulcock:
Got it.

Ryan Isaac:
Alright.

Rabih Dimachki:
If the economy goes into a recession, it’ll be, “Oh, that’s the bear market… ”

[overlapping conversation]

Ryan Isaac:
[0:04:44.6] ____ It’s on it.

Matt Mulcock:
Right now we’re at 21.76% negative on the S&P for the year.

Ryan Isaac:
S&P, but the Dow is less than 20. Dow’s 16, 17?

Matt Mulcock:
Yeah, I think so. Yeah, yeah.

Ryan Isaac:
You can find a 17 maybe. Okay. Here’s the topic, the title for today… Well, this is the… The title from this article posted by iShares owned by BlackRock is, “Why Bonds Still Have a Big Role to Play in Your Portfolio.” Now, the reason I thought this was interesting is because bonds have been a longstanding traditional piece to add to stocks in a portfolio for a variety of reasons. We’re gonna get to some of those today that are being argued in this thread. But what’s interesting, Rabih, jump in at any point here, this is my easy explanation. What’s interesting about the relationship of stocks and bonds is typically, usually, they act in opposite ways. And bonds are usually added to a portfolio of stocks to dampen volatility. So when stocks are doing well, bonds typically won’t be performing as well. And oftentimes when stocks don’t do well, bonds will be a safety place people go to. What’s interesting is…

Matt Mulcock:
Can I teach Rabih what this means technically?

[laughter]

Ryan Isaac:
Yes.

Matt Mulcock:
I wanna give Rabih the technical term ’cause I think maybe he’s not following you very well, Ryan. [chuckle]

Ryan Isaac:
Yeah, and explain to Rabih what I’m saying.

Matt Mulcock:
I just want Rabih to know what this means. I don’t think he knows, but the word that Ryan’s explaining, Rabih, is called correlation…

Ryan Isaac:
Yes. Yes. Uncorrelated.

Rabih Dimachki:
Oh. Okay.

Matt Mulcock:
A negative correlation. Yeah. I just wanted to make sure you knew that, Rabih, ’cause I wasn’t sure…

Rabih Dimachki:
Yeah. Got it.

Matt Mulcock:
Yeah, just… You’re welcome. Yeah.

Ryan Isaac:
For all those listening who don’t detect the heavy sarcasm that always constantly drips out of our mouths, Rabih is what’s called a… Well, can you legally be called a CFA? Rabih is a CFA.

Matt Mulcock:
I guess you can.

Ryan Isaac:
Level three? You’ve done all three?

Rabih Dimachki:
No… Yeah, I’ve done all three exams, but at this point, to make it easier for everyone, we’ll just say I’m a CFA Charterholder, and we’ll go from there.

Matt Mulcock:
There you go.

Rabih Dimachki:
Okay. Just…

Matt Mulcock:
Let’s just say this, Rabih has forgotten more about investing than I will ever know.

[chuckle]

Ryan Isaac:
Ever, ever. It’s bonkers difficult to become a CFA, so that’s why we’re teasing him about this. Yeah. What’s interesting about this year that people are feeling is that, in a year where stocks were in a bear market, where stocks have come down, bonds have not been the safe haven because bonds are greatly affected by interest rates. So we are in this year where stocks have taken a hit, but also interest rates have been, like Matt said, dramatically increased quickly, and bonds act inversely to interest rates. Interest rates go up, bond prices go down, and we won’t get into the mechanics of that. Although, Rabih would probably love to dive into that. The formulas and everything.

Matt Mulcock:
Right. Rabih’s like, “What are we here for then? What are we doing here?”

Ryan Isaac:
Yeah. So it’s a weird year where the safe investments like bonds… People keep bond portfolios for safe conservative money, emergency funds, maybe short-term projects that are coming up in the next few years, and they have not done very well. They’ve gone down quite a bit actually for what they are, for being bonds. So, that’s why I thought this article was… I guess the smart people with billions of dollars in marketing power at BlackRock and iShare also thought this was a timely [chuckle] article to put out. And that’s probably why I ended up seeing it on Reddit, yeah.

Matt Mulcock:
Just for quick context, Rabih, tell me if I’m wrong, but I’m pretty sure the bond market as a whole, like the US AGG, the worst drop since 1980, right? I’ve read this somewhere.

Rabih Dimachki:
Yes. And I believe…

Matt Mulcock:
Probably on BlackRock.

Rabih Dimachki:
And if I’m not mistaken, since the 1970s where the US AGG as a famous ETF or an index showed up, Q1 of 2022 was the worst for bonds. And there are reasons. The main one is the fact that interest rates increased dramatically at the fastest pace ever. But also, given the major reason is that interest rates were at an incredibly low level to start with.

Matt Mulcock:
They had nowhere to go, right?

Rabih Dimachki:
They had nowhere to go. And if you were already at a 5% interest rate and you increase interest rates by 1%, that’s a 20% increase, right? But if you are at a 1% interest rates and you increase by a 1%, that’s a 100% increase. So, the fact that where you are currently standing in terms of the interest rate level puts you at a different sensitivity to when the Fed Re decides to change the policy rate, you can expect bonds to react differently. And that’s why we’ve never been at an extended period of zero interest rate for as long as we’ve been now. And now we’re understanding it better, and how it reacts to an increase in interest rates.

Matt Mulcock:
Well, and there’s also an aspect here where, probably extra jarring, everything you just said, Rabih, but also we’ve basically been in a bull market for bonds since the 1980s, right? Because rates have been doing nothing but coming down, ’cause it was basically the opposite environment. We went from rates in the ’80s of in the teens, and then from that point to just until 2022, dropped down to, like you said, basically 0%. And in that environment, as Ryan was explaining earlier, you have that inverse as rates are coming down, bond prices are going up. So almost more jarring, right? ‘Cause we have a whole generation of investors that have never seen bonds do what they just did in 2022.

Ryan Isaac:
Matt, I was just gonna say, you might have clients like this. I have some older clients who actually made their entire investing career solely in bonds.

Matt Mulcock:
Yeah. Right. If they could, easy. Yeah.

Ryan Isaac:
From quite a long time ago. They could because the rates were so good that they outperformed almost anything else by investing in bonds for a long time. And very different scenario today. So, this thing starts with a few takeaways before we dive into stuff, that’s what it outlines here. I’m gonna read these here and then we’re just gonna read a few of these and then react to these. If you guys are cool with going that way. So…

Matt Mulcock:
Got it.

Ryan Isaac:
Here’s their three takeaways. Number one, was despite a first rough half of this year, 2022, it states that bonds can still have an important role to play in the portfolio, and for a few reasons, they list income, diversification, and capital preservation. So point number one, is that bonds still play an important role because of income, diversification, and capital preservation. What do you guys think about point number one? Agree? Disagree? What do you like? What you don’t like?

Matt Mulcock:
Want me to go, Rabih?

Rabih Dimachki:
Yeah.

Matt Mulcock:
Yeah. I would say, I would think of this just like if someone had it… Coming off the heels of a rough year for stocks, and someone saying like, “Oh man, stocks are down 20-plus percent, depending on which index you’re looking at.” And I’d say, “Well, yeah, of course, but they still have an important role to play… ” That’s how I look at this, same way as like, yeah, bonds have been rough, but I’d almost look at this as like a reset. And the fundamental aspects of what bonds provide for you has not changed, just like I have the same reaction to stocks having a rough year. That’s the first thing that comes to my mind.

Ryan Isaac:
Cool.

Rabih Dimachki:
That’s right. And on top of this, I would say that the income role of fixed income has actually been revived now, that interest rate is higher. I know there’s been a hit to the actual price of bonds, but going back to 2018… In 2019, you guys remember, we would have clients who are wanting to find income streams coming from their portfolio.

Matt Mulcock:
Good luck.

Rabih Dimachki:
And we’d be looking around, like interest rate is at zero, you need to take excessive risk to be able to generate that yield. But now even at Treasury, which is amongst all the other bonds out there, the most, the safest, it’s yielding 3% to 4%, depending on the duration you’re taking. So I would say the income role is now back to the table and strongly, if you wanna compare it to the other roles bonds take.

Ryan Isaac:
Yeah, I like that. And if someone’s listening to this years from now, maybe the income role changes because rates change, but the role of bonds in a portfolio still plays out. The other… What was the other one? They said income… Oh, diversification. What I hear when I hear diversification in terms of bonds in a portfolio is just adding a different experience than stocks are gonna give you, which is usually in terms of volatility. And then they said capital preservation because how far can bonds go down, a high quality short-term duration bond versus a stock? Yeah.

Rabih Dimachki:
That’s right. To…

Matt Mulcock:
Well… Oh, go ahead, Rabih.

Rabih Dimachki:
Sorry. To go back to the correlation conversation Ryan started…

Matt Mulcock:
Oh, do you… Did you understand? You got that? Okay.

Rabih Dimachki:
Yeah. Now that I put my thoughts together, I’m able to bring up a coherent sentence.

[laughter]

Ryan Isaac:
You got it. He got it.

Rabih Dimachki:
So, going back to the correlation conversation and the role of diversification in the portfolio that’s coming from fixed income. Usually, bonds and stocks have a negative correlation, but that negative correlation comes from the underlying of our economy. When our economy is going through a rough time and the Federal Reserve needs to stimulate the economy, the Federal Reserve would cut interest rates. And by cutting interest rates, bonds will go up while stocks are going down. And because now they are going in an opposite direction, you would see this negative correlation between stocks and bonds, you would harness this free lunch of diversification that we see. However, it’s rare that the Fed increases interest rates. And when they do increase interest rates, that correlation actually turns positive, the diversification effect gets depleted, but there is a good evidence that it’s not as long-lasting as when the Fed actually cuts interest rates and keeps diversification on the table.

[music]

Jess Reynolds:
Hey, everyone. It’s Jess Reynolds with Dentist Advisors. You’ve heard us talk about Elements, our system that provides a scorecard to monitor your financial health. Well, Elements is now a cutting-edge mobile app recently featured in Financial Planning magazine. And we wanna give our listeners a chance to try it for free. So here’s what you need to do. Go to dentistadvisors.com/scorecard and book a free financial assessment. We’ll send you an invitation for you to download the Elements app. And then after you enter your info, you’ll have a free, no obligation meeting with one of our CFP advisors to understand if you’re doing okay financially. Again, to get your free financial assessment, all you have to do is visit dentistadvisors.com/scorecard. Do it today.

Ryan Isaac:
Let’s just put some story to this. Someone’s a 40-year-old practice owning dentists and they have a 401k and they have a brokerage account and maybe some IRAs and they… In their brokerage account, which is liquid, it’s accessible money, they consciously want to leave a chunk of it a little less volatile than the stocks because they might need to buy some chairs, or have a down payment for a new building and they say “When we’re building a portfolio and an investment plan,” they’re saying, “Look, there’s a certain amount of money I wanna keep around that’s liquid, I want it to be invested in something, but maybe not the most aggressive something because there’s a certain amount of money I might need for practice or business growth.” And so, to me, that’s why things like this conversation will always be relevant, it’s not just about today, although the details of it will change, the income portion of it, or the relationship they’re having in any certain year, are they both going up, both going down? Are they inverse?

Ryan Isaac:
Well, hey, Rabih, when you’re talking about this, there’s something that comes to mind. Is this gonna be an interesting situation where, and who knows on the timing, but we’ve got markets down right now and we’ve got bonds down because rates are up, but as economy recovers and then assuming rates can come down as the economy recovers and stocks continue to go up, that’s gonna be an interesting scenario, right, to have stocks growing at a time when rates come down and then going…

Matt Mulcock:
Bonds going back up.

Ryan Isaac:
Prices going back up with stocks, any… That’s… Who knows how they all are gonna work together and coordinate, but that’s an interesting situation, probably doesn’t happen that often, I would assume.

Rabih Dimachki:
That’s the scenario of the bull market from 2008 until 2019, I would say. Stock market was hitting all-time highs every couple of months…

Ryan Isaac:
Yes. Right. And rates coming down.

Matt Mulcock:
[0:17:14.2] ____ Yeah, you’re right.

Rabih Dimachki:
And because inflation wasn’t showing up, the Federal Reserve decided to keep rates at the very low level. So, both of them…

Ryan Isaac:
We have seen that over the last decade basically. Yeah, you’re totally right. I guess the… So looking back then… ‘Cause I was thinking of something more dramatic in my head. Looking back, bonds did grow and they did increase in price, but it wasn’t that dramatic. But we also weren’t sitting at the rates that we’re sitting at right now and cutting back down, which I guess also depends on how far we cut rates, right? And how fast and how far.

Rabih Dimachki:
Yeah. But that’s okay, because if you think about it, the last bull market, which happened in between 2008 till 2018, we were at a level where interest rate was at between zero to 2%. But the bull market that was before that, and let’s go even before to, between the late ’80s and late ’90s, that bull market, while we were sitting at 5% or 6% interest rates. So the actual level of interest rates doesn’t really harm the economy in terms of constricting it from being in a bull market. But the fluctuation in the interest rate will actually have an impact. So, when…

Matt Mulcock:
And the speed in which it moves, right?

Ryan Isaac:
Yeah, speed. Yes.

Matt Mulcock:
Yeah.

Rabih Dimachki:
Correct.

Ryan Isaac:
Yeah. Okay. I gotta really keep us on… I’m gonna end up turning this into my own personal learning session with Rabih, and then totally forget…

Matt Mulcock:
Every time I talk to Rabih, that’s what this becomes.

[chuckle]

Ryan Isaac:
Totally forget that other people are gonna be listening to this as well. So we’ll keep going. In those first points, I think I’ll just leave it there because point number one was they still have an important role because of income, diversification, and capital preservation. Point number two is we…

Matt Mulcock:
Can I…

Ryan Isaac:
Oh, yeah, yeah. Matt, go ahead.

Matt Mulcock:
Can I hit one thing on the capital preservation that I think…

Ryan Isaac:
Oh, yeah, please. Yeah.

Matt Mulcock:
Is a key point to this that I just wanna throw out there really quick. There’s mul… And I don’t wanna… This could go down a rabbit hole, but I wanna hit this high level. There are multiple ways to hold a bond, to invest or own a bond. And so when we talk about capital preservation, someone might be sitting there saying, “Wait a second, capital preservation. I hold iShares bond aggregate ETF, and it’s been down.” It’s down 13% this year. What do you mean, capital preservation?

Ryan Isaac:
Totally.

Matt Mulcock:
So, that is true. When you own bonds in a fund or an ETF, mutual fund, or an ETF, that is vastly different from a capital preservation standpoint than owning the bond physically in your portfolio. Like you going out and you buying a government treasury bond, or a municipal bond, or whatever, and you actually owning it.

Ryan Isaac:
Directly. Yeah. The actual bond.

Matt Mulcock:
You’re directly owning it. So when we talk about capital preservation, there is some nuance to that of whether you own that in a bond fund, or you own that…

Ryan Isaac:
Individually.

Matt Mulcock:
You own the bond directly in your portfolio.

Ryan Isaac:
Yeah, or like a ladder. Also, I want Rabih to weigh in on this. In my head, I always hear, it’s always like, “Compared to what? Capital preservation compared to what?” Well, compared to stocks? Okay. I’m still preserving capital to some extent, compared to stocks that have taken a bigger hit than some of these more conservative bonds. So, yeah, I think it’s like, how do you own them? What are they? Compared to what? Rabih, what do you say?

Rabih Dimachki:
You guys hit on two important points. The first one is “Compared to what?” Because if you are holding it compared to stocks, you are actually focusing on the volatility and trying to preserve your capital from fluctuating. But if you are comparing it relative to inflation, then you are trying to preserve it from losing real value. And each of these is a strategy by itself. And on top of what Matt said regarding being in a fund that might have turnover in it and you really don’t have control on what’s inside of it, or being in a bond ladder, buying the individual bonds in them, there is risk management involved in capital preservation strategies for bonds. Just like how in stocks you decide to buy a low beta stock because it’s not that sensitive to the market versus the high beta stock, in bonds you can reduce the duration or increase the duration based on where interest rates are and how they are expected to move.

Rabih Dimachki:
And for the example of AGG, which was down double digits this year, well, for our clients that we needed to preserve their capital, way ahead, the moment we started noticing that this is the trajectory and the policy messaged by the Fed, we moved to shorter duration and we moved to floating rate notes and we moved to tips. So when we are talking about bonds, we’re not only talking about the treasuries or the corporate bonds that are down this year, there is a good portion of the bond market that preserved its value this year. And this is where the value of the advisor comes in to know what to be in, to actually achieve your financial objective.

Ryan Isaac:
Let’s talk about the role of bonds from an income perspective. Needed? Not needed? Necessary? Not? What do you think?

Rabih Dimachki:
It’s interesting. And actually, in that article we are reading, they mentioned income, diversification, and preservation of capital, but they did not mention growth.

Ryan Isaac:
Yes.

Rabih Dimachki:
And why is that? That’s because although you can use the income, the bond is generating and reinvested, and it’ll give you even more income and you’ll reinvest those. The rate at which they grow is really not that attractive when you look at asset classes like equity. And when you’re talking about a 401k that you won’t touch for 40 years, you are fine handling the volatility and you would rather, instead of waiting for the income to be reinvested, having it be in stocks where they’re gonna be issuing dividends that are gonna be reinvested doing… What’s the word? Dividendary investments, plan, share buybacks, those stuff that put this income back into the stock price, and having the balance sheets of companies grow and your stock portfolio grow with them.

Ryan Isaac:
Yeah, totally. Matt, what do you think of when you have a younger client, early career, and you’re having a conversation about building a portfolio, the role of more conservative investments like this in bonds? Let’s keep the conversation in a 401k where they’re like, this isn’t gonna be money that they’re planning on touching for a while. What’s the conversation like with a younger dentist?

Matt Mulcock:
Yeah. I think it’s meant… I look at our job as advisors, it’s just like, “Hey, we’re here to provide the education, we’re here to provide as much information as possible to you and then allow you to make the best decision for yourself.” And try to be as candid as possible of saying, “Hey, it makes… ” In this setting you’re talking about is, I would have no problem telling a young associate who’s just starting their career, who has the highest level of what we call human capital, your human energy to produce income over the next 30 years is at its highest point when you come out of school.

Ryan Isaac:
Yeah. ‘Cause you still have so much time ahead of you. Yeah.

Matt Mulcock:
You still have so much time in front of you. There’s just no need to hold bonds, to Rabih’s point.

Ryan Isaac:
To be a conservative portfolio.

Matt Mulcock:
To be conservative. Yeah. And this is where maybe someone would come in with a risk tolerance discussion and like, “What do you… How do you tolerate… ” I’ll be totally honest with the risk tolerance. I’m gonna maybe get in trouble on this one, but I’m just gonna say it. Risk tolerance questionnaires are simply a masterclass example of recency bias. If you ask someone what their tolerance to risk is after ’08, ’09, every single human on the planet is gonna say, “I’m a one out of 10.” If you ask someone their risk tolerance, let’s say eight years later at the peak of the bull market, they will come out 10 out of 10. This is easy work, right?

Matt Mulcock:
I bring it up to say, when you’re young, there’s different ways to approach risk and that role of risk in your portfolio, just meaning the ups and downs, really look at “What is my capacity for risk? How much risk can I actually take over the next 30 years?” Not really “How much risk can I handle?” ‘Cause you’re just gonna trick yourself if you talk about risk tolerance. It’s “How much risk can I take?” Or, sorry, “How much risk am I able to take in my portfolio?” And then also “How much risk do I actually need to take?” Meaning “How much growth do I need in my portfolio?” Those are the things I’d be looking at. And a 30-something-year-old associate who has a 30-year career ahead of them, they’re gonna need growth. And so there’s just no need to have bonds based on that criteria.

Ryan Isaac:
Yeah, totally. I think we could probably apply nearly the same argument for that mid-career person too. Just because if we’re talking mid-career and we’re saying 15, 20 years until you’re gonna be done working, that’s still an incredibly long time to grow assets. And you still have quite a bit of time to afford to take the risk of volatility in a more aggressive portfolio. Of course, all these things are very personal. This isn’t general advice because personality does play a big role in this stuff. I’d rather see someone have a more conservative portfolio, but they don’t… It doesn’t keep them up at night, so they’re gonna keep going with it for a long time. They’re not gonna be…

Matt Mulcock:
Sure.

Ryan Isaac:
Thinking about it and wanting to switch it all the time, then forcing them to be more aggressive than they wanna be. And then they’re just constantly worried about it.

Matt Mulcock:
Totally. But I will say, that’s a great point, Ryan. I totally agree. It’s like, the most important part of a strategy is obviously one that you can stick with, right?

Ryan Isaac:
Yeah. How long you can do it.

Matt Mulcock:
But I’m totally with you. But I think the key here that you referenced and you mentioned a couple of times here is 401k. And I think that’s why when we talk about a 401k, most people, of all of the investments that they are… Sorry, all of the accounts that they have, the 401k is the one of all of them that they’re like, “I don’t care about that. I’m not gonna touch that for a long time.”

Ryan Isaac:
Yeah. And why do you say that? ‘Cause every time someone panics or needs money, no one touches the 401k.

Matt Mulcock:
Very rarely. Yeah.

Ryan Isaac:
That’s why they’re so great is because it’s guaranteed you’re not gonna mess with it. You’re just gonna be like, “Okay… ”

Matt Mulcock:
Yeah. And they’re not even thinking about it. I’ve been having meetings to wrap up the year with clients last week or so. And almost every time they’re like, “I haven’t even looked at my 401k.”

Ryan Isaac:
Yeah, no, because…

Matt Mulcock:
I don’t look at my 401k…

Ryan Isaac:
That’s a 70-year-old problem.

Matt Mulcock:
Yeah. What do I care? Exactly.

Ryan Isaac:
Yeah, that’s a really good point. Let’s talk about, still on this subject of income and the role of bonds in a portfolio… I think, here’s a general takeaway, for the most part, younger people or people in the middle of their careers with years still ahead of them, are probably gonna be better off seeking returns out of growth from equities rather than income from bonds. I think that’s a general principle. It can be different depending on some situation, but that’s probably a general principle. However, at the end of a career, when that… When it does… You are done working, an older person going into retirement, that story might change. It’s probably… It’s way too complex to try to prescribe in a podcast like this exactly how someone’s portfolio is gonna look. But let’s just talk generally, what is the role of income to a retiree, and the role of bonds? And how do you interact with them in a portfolio when you are in retirement? Rabih, Matt, what do you guys think?

Matt Mulcock:
Do you want me to go?

Ryan Isaac:
Well, let’s go Rabih. Let’s go Rabih. Rabih. Rabih.

Matt Mulcock:
Let’s go Rabih. They’ve heard from me enough, Rabih, let’s go with you. I wanna hear you.

0:28:18.3 Rabih: Okay. I’m just trying not to talk and not shut up. Okay.

Matt Mulcock:
Are you kidding me? We want you to talk as much as possible.

[chuckle]

Rabih Dimachki:
Thank you. For retirees, it’s really a different story, because the reason they are called retirees is because they can’t depend on their human capital anymore. Their labor will not generate a paycheck. So, to compensate…

Matt Mulcock:
I thought you were gonna make an old joke there for a second, but I’m glad you… Yeah. Totally.

[laughter]

Matt Mulcock:
You got it.

Rabih Dimachki:
No, no, I’m totally focused on investments right now.

Matt Mulcock:
Yeah.

[laughter]

Rabih Dimachki:
So to compensate for the lack of flavor, you need to let your portfolio do the work for you. And to have a portfolio that’s in the right position to cover your living expenses and your monthly consumption on your likes and needs, you need to position your portfolio correctly, which means you need to make a portfolio that’s reliant, that’s not gonna fluctuate every month. And the way you do it is that you get out of volatile assets like stocks that their prices change very frequently, and go on assets where the price is relatively stable. And when you do that, you try to design the cash flow that’s coming out of those assets. For a retiring client, they will have to look at their future living expenses as an actual liability. And they will have to design their portfolio as an asset that will cover that liability. And over here, there’s this concept called “cash flow matching”. If you know that you spend $5000 a month, you need to design your portfolio in a way using bonds, because this is the asset class that provides income, to generate $5000 of income for you while maintaining its principal value. And this is where the advisors are doing their Monte Carlo, this is where they are assessing the asset class and looking at the current yields to see how much money you need to be able to design such a portfolio that can finance your retirement.

Ryan Isaac:
So if someone heard that and they said, “Okay, does that mean I just sell all stocks and buy all bonds when I retire, then is that the key?”

Rabih Dimachki:
That’s definitely not. The key sentence was, how much money do you need? When interest rate was at zero, you really needed maybe almost all of your net worth to be in bonds to be able to generate that cash flow. But now when interest rates are 4%, you might need much less to finance your future liabilities. And if you look at it from the perspective of, “Okay, I have a big bag of assets, a good portion of this is now allocated to my liabilities, which are my living expenses. What do I do with the remaining?” And here’s the role of charitable contributions, here’s the role of estate planning. And anything that’s above what is required to finance your living expenses doesn’t really have to be in bonds. And it can be in other asset classes that match that objective, which… Oh…

Matt Mulcock:
Well… Oh, sorry, go ahead, Ryan.

Ryan Isaac:
I was just gonna say, what a tricky conversation this is, because the state that you’re in, let’s say when you retire, let’s say it’s 65, is not how you’re probably gonna be when it’s 70 and 75 and 80 and so on, in terms of your spending, your net worth, what your assets and your life is like, what you need to spend. Those listening, I don’t know if anyone’s ever gonna actually see the video of this. Rabih’s sitting in front of a picture on the wall of our Elements, which if you don’t know what that is, you go to dentistadvisors.com and find the Elements. One of those scores on there has to do with the relationship between net worth and spending. And so, it’s really interesting to hear this conversation, and you… When we go to conferences or do CE, we read a lot about this stuff and dive into a lot of this research, but it gets… It’s just so nuanced, depending on every single person’s situation, and the relationship between their net worth and their spending. And is their net worth big enough to cover their spending for how long?

Ryan Isaac:
And then there’s questions like, “Well, what if your net worth is so big, you don’t need to actually take hardly any growth risk inequities of stocks at all. Should you?” And then that comes back to the person wanting to or not. And so designing all of this, I’m just thinking in a person’s situation when they’re post work and in retirement, designing all this is very complex, and it fluctuates based on how your assets, your net worth and your spending is fluctuating, which is usually a reflection of, especially in retirement, of your health, and how much time can you dedicate to living and shopping and traveling and all that stuff. And then, when does that slow down? And so, yeah, it’s a very… It play such a different role in retirement, but it’s still very complex on how you mix them with other assets in your net worth, which is, I think what Rabih was saying there. Matt, what were you gonna say?

Matt Mulcock:
Yeah, I was just, I was thinking the unique environment we’re in right now for someone who’s in the stage of their career where they’re thinking rightfully so, that the market is down, their equities are down, let’s say 20% to 25%, or if they’re maybe focused more on the tech side, maybe like 30%. But either way, their nest egg that they’ve built is deeply discounted right now and they’re probably really not very happy about that. I totally get that. But also this weird, like in some ways with what Rabih, what we’re describing with the bond market, it’s like in some ways you’re actually getting to a place where at this stage of your career, on the other hand, it’s actually a better environment for you to be in from a bond perspective, where you actually can now, like Rabih alluded to this earlier, where at 0% interest rates, good luck designing a portfolio to create fixed income for you, from the assets you’ve built.

Matt Mulcock:
Where now we actually have an environment, an ecosystem that allows us to build a portfolio for you to say, “Yeah, we’ll kick off 4% and maybe 5%,” it could be higher than that with this nest egg that you’ve built. So I just… It’s a unique environment we’re in, with, where we’ve seen stocks go down, where we’ve seen yields go up, and so you’re on the surface really sad about it, you’re like “Oh, bummed, I’m trying to retire right now.” It’s like, well, in some ways you’re actually better off.

Ryan Isaac:
Yeah. That income could be helpful. To do a little bond 101, Rabih, if someone’s like, “I don’t really understand how bonds work.” If I go spend a 1000 bucks and I buy a bond, and it’s gonna kick out 5%, what is that? 50 bucks, right? 5% of a 1000. Let’s say I might buy a 1000-dollar bond and it’s a 5% bond, it’s gonna kick me out 50 bucks of income. If bonds take a hit in prices and my bond is now, if I wanted to resell it, I’d have to sell it at a loss. Maybe it’s now worth 700 bucks. But my bond is still kicking out the original 5% of a 1000 or $50, and that’s… Right? That’s where, like Matt’s saying, this environment is really interesting because even if you’re holding bonds, maybe they’re in funds or individual or in some kind of ladder situation or design, if you were to go sell your bonds, yeah, the value of them might be less than what you paid right now, but they’re still kicking out the percentage of the original amount you bought them for. Which is the role of bonds in an income situation that we haven’t been able to really design around for a handful of years just because of, rates have been so low.

Rabih Dimachki:
That’s correct, Ryan. Not only are they still kicking out that 5% coupon that was first agreed upon, but if you decide to hold the bond till maturity, you’re gonna get your thousand dollars back no matter what the interest rate is.

Ryan Isaac:
Yes.

Matt Mulcock:
And then you could reinvest that into the higher rate environment. Yep.

Rabih Dimachki:
Yep. So when interest rates go up, the risk is that now it’s harder for you to resell at a profit. But if you hold to a maturity, you actually cancel out that risk.

Ryan Isaac:
Yep.

Matt Mulcock:
So this is coming back to what we were saying earlier in regards to, if you own the bond in your portfolio versus own a fund like that’s… Ryan, you were hitting on that exactly right. That’s the capital preservation of this part, is, you’re getting your 1000 bucks back, plus all that interest. So in reality, you don’t really care as the investor at that point of what’s happening…

Ryan Isaac:
Yeah. If you’re gonna hold it.

Matt Mulcock:
If you’re gonna hold it. And if you’re holding it for income, you don’t care ’cause then at the end of that maturity, you’re gonna take that, you’re gonna reinvest it.

Ryan Isaac:
Yep. Maybe let’s wrap this with a little bit of talk on, well, you touched on earlier, with the diversification assets. And if we go back to the story of these three people, early career, mid-career, and retiring, I think that’s a different conversation than the income. The income is probably not as relevant for younger people ’cause they can get growth out of other assets that are probably gonna be more efficient, and higher growth and trying to take income from conservative bonds when they’re younger. But this is where the personality of somebody designing a portfolio does come into play. And someone who is just now… Okay. I’m a fan of pushing people’s limits a little bit through education. In our firm, we’re a fee-only fiduciary, we don’t get commissions for anything, so it doesn’t matter if someone’s a conservative or aggressive investor. That doesn’t affect the revenue our firm gets. That doesn’t really matter. And so I don’t care about pushing someone to something they don’t wanna do, but if education can move the needle on someone, if teaching someone, giving them more context can help them shift their mindset and I can help a young person become a more aggressive investor, I’m a fan of that.

Matt Mulcock:
‘Cause it serves them better. Right?

Ryan Isaac:
Yeah. If it’s in their best… I’m a fan of that because I know the data and history is on their side to do that. I do that personally, in my own investing. However, if it’s just obvious when you’ve gotten to know someone really well and you’ve had discussions and they’re educated properly and the context is there and they understand, they understand their choices, which is what matters here is like, “Do you understand your choices?” And they’re still a very maybe nervous person or conservative investor. This is where the role of diversification from bonds, even in an early investor can mentally keep someone in the game, then pushing them to be a more aggressive investor.

Matt Mulcock:
If you’ve got your cash figured out from an emergency fund standpoint, both on the personal side and the business side, and you’ve got that box check, which should be one of the first boxes you are checking in your financial plan in life, then that even more so points you to the direction of saying like, “You don’t… ” And again, you’re in a place where you’re like 35, 40 years old, you’ve got a long career, you’ve got liquidity you need in case something happened…

Ryan Isaac:
Totally.

Matt Mulcock:
With your cash. Even more so why I’d push someone to say, “Hey, you don’t need to be holding bonds, you’ve got that figured out with your cash.”

Ryan Isaac:
Yep. Yeah, totally. And it’s so nuanced. When someone’s, after-tax investments, like in a brokerage account becomes so big, you have so many options to go get cash out of that thing, whether markets are up or down, you can choose to take a gain, take a loss, minimize your tax, impact…

Matt Mulcock:
Guess what? You could be your own bank. You can set up a security back line of credit. I’m just saying.

Ryan Isaac:
You could do a margin loan. You could be your own bank.

Matt Mulcock:
You could do a margin loan. You could be your own bank. It’s all I’ve ever wanted.

Ryan Isaac:
Don’t kill that sacred cow. Folks, you can be your own… You can lend your own money to yourself and be your own bank like you dreamed of doing when you were a child.

Matt Mulcock:
Without a permanent life insurance. Weird. Sorry.

[chuckle]

Ryan Isaac:
[0:40:04.6] ____ What do you know? What do you know?

[laughter]

Ryan Isaac:
Rabih, you get us going, man. Rabih, you gotta interject here. You get Ryan and I going, it’s gonna be…

Rabih Dimachki:
I’m gonna get back at you guys and say, whenever I hear you two veterans talking about financial planning, I’m learning. So, this was incredible.

[chuckle]

Rabih Dimachki:
You’re great.

Matt Mulcock:
You’re just so nice. You’re so nice.

Ryan Isaac:
This article wraps up with a pitch to buy their ETF. So we’ll skip that part.

[laughter]

Ryan Isaac:
But I appreciate having seen this in my newsfeed one day because this was a relevant question. I’ve had clients ask me that like, “Hey, stocks are going down. Should we put money in bonds right now?” And unfortunately, I gotta be like, “Hey, bonds are going down too.” [chuckle]

Matt Mulcock:
Yeah, sorry. [chuckle]

Ryan Isaac:
So, not the best if you’re just trying to make sure nothing goes down at all. Which I think, probably ties this all back to the marriage, the beautiful undivorcible marriage between risk and return. The number one law of the universe that will never separate between risk and return in that, if you’re looking for a higher return in something, you’re gonna have to take a risk in one way or another to get that return. Rabih, what are you taking away from this conversation? Probably nothing you learned actually. But what are you taking from it?

Matt Mulcock:
No. Bullcrap. You learned about correlation. You learn about correlation.

Ryan Isaac:
Oh yeah, you taught him. Yeah, you taught him that. Yeah. What are you taking from this, Rabih?

Rabih Dimachki:
What I take from this is that financial assets are really impartial to whether we feel happy when they go up when they go down, but financial assets at the right time with the right advisor actually serve a specific role. And if you are at an age in your life where bonds are needed in your portfolio, whether interest rates are zero or 10%, they have a role. And whether you are young and you don’t need bonds, they are still there from a behavioral perspective that can help you out.

Ryan Isaac:
We should just conclude with that…

Matt Mulcock:
How do I follow that?

Ryan Isaac:
But, [chuckle] Matt, go ahead and follow that up.

Matt Mulcock:
How do I follow Rabih? Why did I have him go first? That was…

Ryan Isaac:
Don’t do that next time.

Matt Mulcock:
Yeah, I did that.

Ryan Isaac:
Next time you go first.

Ryan Isaac:
That was my fault. No, I love these conversations. They’re so great. And I really don’t know how to follow Rabih. What I’ll say in general, as we talk about this, the one thing that I’ve been thinking about from just a market standpoint, or market perspective is, I feel like we came out of an unprecedented environment with the low interest rates, the ridiculous bull market. And now we’ve followed up with an unprecedented almost reset in a certain way. Like we were just talking about earlier with bond rate… Or, sorry, interest rates going fastest rate… Or, fastest rate hike we’ve ever seen. And it created this environment where we went from TINA, there is no alternative to stocks to like, there is no option to invest that’s not going down. But I will say I think like anything, it’s a really healthy reset, a very normal reset in the long… If you have a long-term mindset. And I guess that’s my biggest takeaway is as we talk about this, we’re still very focused in what’s happening right now, what’s happening in the short-term, but all this conversation has been around the importance of understanding the nuance of your situation and the importance of having a long-term mindset.

Ryan Isaac:
I’m also coming away from this conversation feeling just a little bit more encouraged to help people, especially younger people who have years ahead of them to try to push it a little bit. Especially when if your business has enough cash, you’re minded as Matt, and you have a personal emergency fund and you have any cash on hand that’s needed for an upcoming project. Long-term investing is long-term investing. And if you’re building a bunch of practices or real estate portfolio or a bunch of stocks, if you’re young and you’ve got time, you’ve gotta push it to the edge of your comfort zone to maximize your opportunity for the highest possible returns. And I’m feeling pumped on that again.

Matt Mulcock:
Pumped. I’m ready to run through a wall right now.

Ryan Isaac:
Yeah. Yeah. Ready, ready. You guys, thanks for being here. This was great. I had a lot of fun. And hope you had some fun too.

Matt Mulcock:
Dream team. It’s so much fun. I love the panels with Rabih. It’s the best.

Ryan Isaac:
Dream team. Yeah. That’s so great. All of you listening, thank you for tuning in. We appreciate that you’re here. And we like that we have an audience to speak to ’cause this is fun for us. If you have any specific questions about, even the smallest question about your own financial situation, any money questions at all, go to dentistadvisors.com, you click the ‘Book Free Consultation’ link. And you can get on the phone with a dental-specific fiduciary CFP financial advisor just for dentists and ask them your specific money question. And we love answering that stuff.

Matt Mulcock:
Can I throw this one thing out just on the website and just leave a little teaser?

Ryan Isaac:
Yes. Yes. Leave a tease.

Matt Mulcock:
Leave a little teaser. There are new developments on the website, new development with Dentist Advisors. New ways to engage with us. Literally more than ever before. I know that sounds like an infomercial. Buy that right now…

Ryan Isaac:
If you act now. If you act now.

Matt Mulcock:
Yes, if you act now. There’s only four left now, but serious…

Ryan Isaac:
Okay. Tell us what we get if we act now. What do we get? What do we get?

Matt Mulcock:
If you act right now, you will get 10%. No. But seriously, we have been working very hard over the last 12 to 18 months of creating different ways for people to engage with us across their whole career. And so I just wanna bring that up to say, when you go to our website, again, we’ve made these changes just recently to our service models and the way we engage with clients and the dental community. Please check it out if you have any interest, or maybe you were on our website six months ago, even…

Ryan Isaac:
Go back. Return.

Matt Mulcock:
Go back to it now and just go check it out. We’ve got a lot of different ways you can approach working with us.

Ryan Isaac:
Yup. Love it. Thank you, guys. Thanks for everyone for being here. We’ll catch you next time on another episode of the Dentist Money Show. Take care now. Bye-bye.

Investing