Bye, Bye to Bonds – Episode 018

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[00:01] Welcome to the prosperity podcast fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street Here’s your host best-selling author Kim DH Butler and no BS money guy Todd Strobel Hey everybody, welcome to another edition of the prosperity podcast. This is no BS money guy Todd Strobel. Once again We have our resident financial expert and my co-host best-selling author Kim Butler with us today Welcome Kim. Thank you, Todd. Glad to be here looking forward to this discussion on bye. Bye to bonds Yes, bye. Bye to bonds. I guess first of all, we should just kind of you know We have all different types of listeners here. So let’s just start with a general definition. What is a bond?

[00:48] Hmm. Well, I think the the proper definition is a debt instrument So I’ll give my quick answer and you may have some things to elaborate on it But typically when people buy bonds, they’re actually lending money to a company or an Entity or a city or a state or a municipality and of course there’s federal bonds as well where you’re literally lending money to the federal government and People typically do that in order to get interest back from those bonds in the form of some type of payment cash flow Sometimes quarterly monthly even semi-annually depending on the type of bond There are also people that buy bonds in an effort to get some type of yield growth In other words where you’d put in a thousand dollars or a million dollars and expect to get back

[01:39] 1,200 or a million two or whatever the numbers would be so again a bond is an investment but you get it by lending money to a Company or to a municipality or a city or a state? Super and most of us today if we’re investing in bonds usually do it through a bond fund Which even though it’s a fund does a very similar function They buy a variety of bonds and one of the most attractive things about bonds has been That they were considered relatively low risk and a lot of times they did have some tax preferential treatment So just address that real quick sure, so Municipal bonds in particular are people’s go-to place for federally tax-free Interest and then sometimes if you buy a bond in your state

[02:34] You can even get state tax-free interest as well and they were people’s placed to store safe money because typically a state or a Municipality is not ever going to have problems because if they need to raise money They just tax the people and they get their money and the same could be said of the federal government and so muni bonds municipal bonds muni bonds and a muni bond fund and Sometimes people do buy them individually have been the default place of choice for my entire career over 25 years I’ve heard of muni bonds is the safe place to store money And of course our clients and listeners know that we believe very differently in terms of a safe place to store money But the reason that people have felt that this is a safe place is they typically don’t move around much

[03:22] From the yield standpoint so the value of the bond especially a municipal bond doesn’t move around much But the interest is pretty consistent now What we’re seeing as we head into the year 2015 is a completely different world Absolutely and in particular we’re going to be talking about these municipal bonds that again I think a lot of people just assume is the safer place to put money than the stock market But we really kind of have to challenge that assumption first of all we have to look at the stability of the place That’s issuing the bond so you know for example if we look at a particular city Or we look at a county or we look at a state we kind of have to back up to the year 2008 again and realize that most of these

[04:12] Revenues that come in are coming in from property taxes now what happened in 2008 to the tax base that these property taxes were coming in from Well not only did property values take a big dive But people were literally moving because either they had to or wanted to and that caused Many many properties to go in foreclosure of course as everybody knows and so when a property is in foreclosure The owner of that property is not paying the property tax so property tax revenues went down Drastically and one of the tricky things about bonds is the relationship of the Interest payment and the value of the bond and so not only were people not getting their interest payments But sometimes even the values of the bonds themselves

[05:04] Were decreasing because of what was going on in the economy at the time Got it so number one We’ve got the stability of the base in which the bonds is calculated took a drop there were less people paying into the bond funds or funding the bonds themselves And then we have to look at what were the Expenses of the individual borrowers in this case would be a municipality or a county now The reason that we’re bringing that up is just here in May 2015 there’s been a bankruptcy hearing that has determined that pension funds are To be paid ahead of bond holders now most of the pension funds in this country doesn’t matter where they’re talking about the private sector or the public sector are Underfunded massively underfunded and that just makes sense

[06:04] Because we have more people of the population retiring than we have coming into the workforce Simple economics so a lot of people retiring and they’re retiring under Pension plans versus the new form of retirement we have now Which is basically the 401k 403 B market if you would Kim just kind of address the difference of those two Sure, so the larger companies and the municipalities had set up what is typically known as a defined Benefit pension plan, so it’s defined benefit whereby the company says okay We’re gonna pay you three grand a month when you retire or whatever your numbers are and then they work Backwards to figure out how much money they need to put away in order to make good on that promise

[06:53] That’s a defined benefit pension plan and those are largely out of favor today because it is a promise It’s something that the municipality or the company had to basically guarantee to their their people their employees or their workers so What happened over time is the companies and the municipalities? shifted the responsibility for quote retirement savings from themselves To the individual workers or employees and that’s where the whole 401k for the Private sector and 403 B for the public sector and you hear other terms, but that shift from Defined benefit pension plan to a 401k, which is technically called a defined Contribution plan so the people are defining their contribution rather than defining the benefit on the back end and that’s caused

[07:45] Numerous companies to be rid of that pension obligation but other companies either couldn’t get rid of it entirely had to still maintain it for an existing class of workers or still hold on to it for certain reasons of their own and they didn’t have enough money the Underfunded concept means they didn’t have enough money to actually pay out those promises and so they’ve been Scrambling for higher rates of return for their investments in order to make up the difference They didn’t want to put more money in because that would have solved the problem They wanted to get a higher rate of return in order to get enough money to make good on those promises And as you can imagine a lot of times when you go after a higher rate of return

[08:31] What actually happens because you are taking on more risk is that your? Dollars in this case the pension plans dollars ended up being less which hurt them even more So it was a wicked cycle there that occurred in 2008 and 2009 and really hasn’t rectified itself since Got it and just to back up just a little bit if we go back to the 1940s and 1950s 60s even 70s we’re seeing the kind of the influx of unions and organized labor and While all of these negotiations are going on There was a chance to make a promise for tomorrow to solve a problem for today And that’s really where pension plans got to be so popular is it cost less to promise to pay you? $3,000 a month when you turn 65 until you die now

[09:23] The other thing that’s going on is lifespans were shorter back then to the baby boomers were working they weren’t retiring So everything is kind of come together people are living much longer and the you know number of people retiring versing the number of people of working has changed and like you mentioned before The rates of return inside the pension plans are dictated by interest rates Which were at these incredibly low interest rates, which are good for some things bad for others But it’s created this crisis where nearly every pension plan is Massively underfunded all right, so we were talking about pension plans and kind of the perfect storm That’s hit here And the thing that we were trying to summarize was the fact that these pension plans were promises made a long time ago

[10:12] never fully Understanding the impact of what was going to be happening in the future the baby boomers were working which was generating money for pension plans not yet retiring Lifespans were shorter so the number of years of retirement that were anticipated that need to be paid were actually Less and interest rates were higher meaning that the money would grow faster than it actually did But now we fast forward and all of a sudden we’re in a situation where we are today and Because of the bankruptcy ruling that happened for the city of San Bernardino We’ve now set this precedent that pension plans must be properly funded ahead of Bond holders so now instead of having a guaranteed rate of return. We’re seeing a potential loss

[11:08] for Bondholders let me give you another example city of Chicago no matter where you live in the country I would imagine you know where the city of Chicago is just this week Their bonds have been rated as junk bonds the lowest rating Possible for one of the largest and what I feel is one of the greatest cities in the country. What do you think Kim? That’s amazing and this quality issue is coming up all over the place I’m aware of two or three years ago Ventura, California They had a similar situation occurred days Before the city shut down Literally, there were no more stoplights. All they did was blink. There were no more police department There was no more fire department. The mail was not delivered

[11:55] And I don’t know what has happened to that since but that’s a very scary thing to have a city have that kind of financial trouble and yet I think we are gonna see more and more of it the last five or six years I have been questioning clients when they say they have municipal bonds or muni bonds to Really look at that portfolio and make sure that’s something that they still want to have and this issue of The pension overriding the individual investor. Holy cow. I mean, okay, that’s great for the pensions But who are we protecting here? We’re protecting retirees that do deserve a promise I understand that but the fact is the promise is faulty and so now as an individual Bond holder you are put in second place

[12:43] Because this promise was made to retirees that still need to get their money. That’s gonna cause a huge uproar. I would think well, I kind of picture this loop because Pension plans tend to love holding bonds. So they’re now in second position Behind Adding more money to the pension plan. So you’ve got this giant loop of decreasing values that’s going to increase the amount of money that needs to be added to the pension plan because of the ruling that was Supposed to put money in it Yep, typical of when people that don’t understand how The free market works get involved in making decisions and how unfortunate it’s gonna be it will be very interesting to watch this play out And finally before we wrap up

[13:34] I just want to if you talk to anybody across the country Everybody is under the assumption that interest rates will increase. I’m not convinced of that. I’m convinced they should I’m not convinced They necessarily will but what happens to a bond that you’re holding if interest rates increase? The value goes down There is an inverse relationship and this is something that we all learned in econ in college in high school But boy is it going to be prevalent if interest rates do go up and I agree I question whether they will or not very soon and very fast But if they do then the value of the bonds go down and then we’ve got both individuals and pension plans in an even worse situation and it’s a huge catch-22 because

[14:20] There is a need for interest rates to go up They must go up to have our economy be functioning at a more proper level But if that does happen and the value of bonds go down then that’s going to cause an underfunded pension plan to become even more underfunded and It’s gonna cause our clients that do want to store cash in municipal bond portfolios to have those portfolios Decrease and it’s one of the reasons why we recommend so strongly That people use cash value of life insurance as a place to store cash as opposed to a municipal bond Portfolio or a bond fund because cash value of life insurance never goes down even if interest rates do go up Super and again our purpose here is not so much To tell you what to do with your money. Although in case-by-case basis

[15:11] We love to do that at partners the number four prosperity comm we want to educate you on how bonds actually work or don’t work in the case as the case may be because you know 20 years ago what you know when your father or maybe your grandfather Was setting money aside in bonds and building bond ladders and shoot 10 years ago I was helping my clients build bond ladder so you have to change the techniques and the strategies that you use with the times and certainly in today’s economy the bond market is just not that attractive the risk reward ratio is Completely off the charts in the wrong direction And again just before we finish up Cash value of life insurance currently is a much better Alternative to bonds what type of rate to return are we seeing there Kim in today’s marketplace four or five percent?

[16:12] Without taxes so you still get the tax benefit and a decent rate of return and the life insurance cash value will always Be two or three points above banks So if interest rates do rise dividend rates at the insurance company will rise as well Just like when interest rates fell dividend rates fell But they don’t fall as far and the most important thing that Dividend may or may not change well will change we know but what won’t change is the cash value the cash value Can only go up a new floor is set Every single year of guaranteed cash value and it cannot go down No matter what interest rates or dividends do inside the cash value of a life insurance policy We should be clear what we’re speaking of. It’s a whole life insurance policy

[17:02] Whole whole life that has the type of guaranteed cash value that will never go down no matter what interest rates do Super and Kim I think you might even have a book on the subject you could tell us about I do live your life Insurance a simple little book. I always say it’s 50 pages. I actually looked at it the other day I think it’s something like 36 So it’s super fast to read and it’s at live your life insurance calm as well as on Amazon in all forms Kindle audio print you name it grab it help yourself. It’s good reading and good learning about a product That’s been around almost 200 years Super anything you want to add before we wrap up? No, but thank you and I’m grateful that we were able to share this with our clients today

[17:44] I hope it’s been helpful information about realizing what’s going on in the economy around the bond arena Super this is no BS money guy for the prosperity podcast. Take care everybody Thank you for listening to the prosperity podcast to take control of your money and have it work for you Visit us at partners for prosperity comm if you liked this episode, make sure you subscribe and leave a review