In my last blogpost, I reflected on one of Warren Buffet’s famous quotes about investing being a simple process but one that is not easy to implement. I covered how our emotions continually challenge our ability to stay rational, particularly in the fast-paced, sound-bite, and catchy-headline driven world we find ourselves in today. I’d like to start this post with a quote from another thought leader in the field of economics and finance, economist Paul Samuelson.
Mr. Samuelson was the first American to win the Nobel Memorial Prize in Economic Sciences. The Swedish Royal Academies stated, when awarding the prize in 1970, that he “has done more than any other contemporary economist to raise the level of scientific analysis in economic theory.” Economic historian Randall E. Parker calls him the “Father of Modern Economics,” and The New York Times considered him to be the “foremost academic economist of the 20th century.” In addition to his Nobel Prize, in 1996 he was awarded the National Medal of Science, considered America’s top science honor.
Regardless of one’s economic persuasions (Samuelson was a self-described “cafeteria Keynesian”), most would agree that he was a very influential economist during the latter half of the 20th century. Hence, it is appropriate that we turn to him for a nugget of wisdom and inspiration about investing successfully. On investing, he once said the following:
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
Mr. Samuelson also said that “politicians like to tell people what they want to hear – and what they want to hear is what won’t happen.” This, however, is a subject for another day.
As I think about investing, I can think of nothing that may more closely resemble watching paint dry or grass grow than investing in investment grade municipal bonds and holding them to maturity. Let’s face it; municipal bonds just aren’t that exciting. The industry has even coined labels for those that delve into them – “bond geeks” or “bond nerds” – in part because of the high degree of math that one needs to truly understand them as an investment vehicle.
Municipal bonds have, for decades, been a staple of our investment philosophy. We consider them a core holding and appropriate, to some degree, for all but the most aggressive investors. We think municipal bonds don’t get their due in part because they just aren’t exciting. The brokerage world has long had a saying “sell the sizzle, not the steak.” Let’s face it; there just isn’t much to sizzle when it comes to municipal bonds.
With the Federal Reserve recently beginning its process of “policy normalization” or raising short-term interest rates and removing some of the unprecedented amounts of liquidity they have injected into the economy over the past decade, many are expecting all bonds, including municipal bonds, to perform poorly. It is true that bond prices move inversely to interest rates (i.e. if interest rates increase, bond prices will, holding all other things equal, decrease). However, in the real world, there are usually multiple moving parts (meaning all things aren’t usually equal). Thus, here are two key points to remember about bonds:
- If held to maturity, bonds will mature at their face value regardless of the change in interest rates. Thus, if interest rates were to rise and prices move lower, it will only reduce the value of one’s individual bonds on paper or if those bonds are sold before maturity. In other words, holding the bonds until maturity makes the price change irrelevant. This is why we believe it is so important to structure one’s portfolio so that bonds can be held until maturity.
- Just because the Federal Reserve raises short-term interest rates doesn’t mean that all interest rates will rise. Contrary to popular opinion, the Federal Reserve does not control all interest rates. It influences rates by changing the short-term (overnight) rate it charges to its member banks. The longer a bond has until maturity, the more it is impacted by market expectations about future rates and less directly by the actions of the Federal Reserve. In fact, the Federal Reserve has increased its benchmark rate twice this year but intermediate and longer term interest rates have actually declined.
The bottom line is that we don’t know exactly where interest rates are headed, or when. Even though the bond market seems to be forecasting that rates will be “lower for longer,” the fact is that future interest rates may be higher or lower than current rates. We just don’t know.
Our decision to own individual investment-grade municipal bonds is not dependent on interest rates alone. Rather it is based on many factors, including the ability to purchase them inexpensively relative to other types of bonds.
Purchasing investment quality municipal bonds and holding them to maturity – it doesn’t seem to get much simpler than that. But, again, it is not easy to do for many reasons, not the least of which is access to the information and ability to execute at scale.
For these reasons, we believe investment-grade municipal bonds are likely to play a key role in diversified investment portfolios for years to come, regardless of the interest rate environment that lies ahead. I encourage you to keep these points in mind the next time your emotions are being tugged at with headlines about bad bond returns and rising interest rates. And, given that owning municipal bonds and holding them to maturity is about as exciting as watching paint dry or grass grow – we believe Mr. Samuelson would concur as well.
If you have any questions or would like to hear more about the role we feel municipal bonds can play in helping you or your family’s overall financial and investment plan, please feel free to reach out to one of our advisors.
Brad Cougill, CFP®, CIO
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