The Five Most Common Misconceptions By Clients – ValueWalk Premium

The Five Most Common Misconceptions By Clients

Some clients are surprised at how I look at critical financial decisions. But when I reframe them from the conventional way of looking at those decisions, I can get them to shift longstanding beliefs and make changes. Here are a few decisions and starting points from the client.

Q2 hedge fund letters, conference, scoops etc


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1. Client: I don’t want bonds because they produce little income. Interest rates have to go up from our current all-time low.

Me: Real after-tax rates are nowhere near an all-time low. The purpose of fixed income has never been income.

I advise the client to “get real.” By this I mean that they should think in terms of inflation-adjusted after-tax returns since it is spending power that matters. In 1980, nominal rates were 12% which translated to earning $12,000 on a $100,000 bond. If a third went to taxes, that amount was closer to $8,000 or an 8% return. Clients sometimes remember those days fondly until I point out that inflation averaged 12.5% and they lost roughly 4.5% of their spending power. Rates are much better today than a few decades ago.

I remind them that the purpose of fixed income is to stabilize one’s portfolio and to keep up with inflation and taxes. When stocks tank, those boring high-quality bonds act as a shock absorber and allow one to rebalance to buy stocks while they’re on sale. As far as predicting intermediate-term rates goes, the top economists have called the direction of the 10-year Treasury bond correctly about 30% of the time over the past few decades. A coin flip would have been more accurate.

2. Client: Why should I pay off my mortgage since my rate is only 3.5%, while my portfolio is doing better? After the tax-deduction, I’m only paying 2.5%.

Me: Because you don’t want to borrow money at 3.5% and lend it out at 2.26% (the annualized yield of the Vanguard Total Bond fund).

A mortgage is the inverse of a bond. And most bonds are taxable, while munis yield far less and have risk (possible defaults from underfunded pension and healthcare liabilities). You want to compare the after-tax ultra-low risk investments to paying off the mortgage. Paying off the mortgage is a risk-free return since it has no impact on the ultimate sales price of the house.

The pushback I get includes:

  • What if rates go up then my mortgage will look good, right? Yes, but your bonds will have gone down.
  • Why should I put more money into my house? You shouldn’t – I’m not suggesting a remodel. I’m only suggesting a change in how you finance the house.

Admittedly, one needs to have enough liquidity, since you can’t easily get this money back. I’m not suggesting paying taxes to get the money out of a tax-deferred account to pay down the mortgage.

Remember that a bank makes money by lending it out at a higher rate than it pays depositors. When you can disintermediate the bank, go for it!

Read the full article here by Allan Roth, Advisor Perspectives

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