The Investment Scientist

Should Retirees Be Worried About The Market? (Part 2)

Posted on: October 4, 2022

My last newsletter illustrated an actual example of a client portfolio that had fallen 17% in value over the previous 12 months.  Despite that, the portfolio’s projected income had increased by 10%.

This client’s portfolio is a 50/50 portfolio, with 50% in bond funds and 50% in stock funds. The same factor that drives the portfolio value’s fall also drives the increase in income. The factor I’m talking about is the long-term interest rates. 

Don’t mistake this for the Fed’s interest rate hike. The Fed only controls the overnight Fed fund rate, it does not control the long rates like the 5-year rate, 10-year rate, etc. It is the market that sets the long rates. When the market believes that the Fed needs to tighten up a lot more to control inflation, long rates increase across the board, causing both stock and bond values to fall. (If the central bank will pay high overnight interest long into the future, all existing investments become less valuable.)

With a bond fund, there are always some bonds that are maturing and the principle from these investments is being paid out. The fund then takes the payout and uses the money to buy new bonds that pay higher interest. That is why the interest income from bond funds has increased and will continue to do so.

With a stock fund, there are no maturing stocks, pe se, but many stocks do pay out dividends, and dividends are reinvested back into the stocks. Since there are now more shares of stocks, the total dividend payout amount has also increased. 

This process happens not just inside the fund, but also at the portfolio level. In other words, if a fund has a payout, the payout is reinvested in the same fund, so the portfolio has more shares of the same fund, leading to a higher payout in the next round. 

So you see, a fallen market allows investors to accumulate shares (stocks, bonds, and funds) at a faster clip and thereby increase portfolio income also at a faster clip. Now that you know this fact, do you still feel like you need to panic?

Now you may ask, “but, but, but what if those stocks, bonds and funds fall all the way to zero?” What good is accumulating more shares of zero? That is a very good thought-provoking question. And that’s a good segway to introducing the concept of enduring assets, which I will write about in the next newsletter.

Schedule a 2nd opinion financial review, buy my wealth mgmt books on Amazon.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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