Chart of the Month: Fixed Income Yields & Returns

What happens to my fixed income when interest rates rise?

The bottom line is that many bond mutual funds own MANY different types of bonds and various maturities. If you don’t know what is inside your bond mutual fund, you should ask your advisor so you don’t get whipsawed by a rising rate bond market and a declining stock market!

How a normal bond pays you

When you purchase a singular bond and lend a company money, for say $10,000 for five years at 3%, you are issued a bond certificate indicating you will get paid $300/yr until the bond matures in five years. If you hold the bond until five years, you will get repaid the $10,000 you lent the business.




If you sell the bond before that, you will have to sell it to another investor wanting that bond and its “coupon” payments. This is where interest rates start to affect your bond. If you sell your bond about two years in and interest rates have now moved from 3% to 4%, your bond isn’t as attractive because someone else can get 4% on a new bond so your fair market value goes down. If you choose to sell your bond at this time before maturity, you may only get $9,700 back instead of $10,000 because it’s less valued by other buyers. If you just hold it to maturity, you get your $10,000 back and you can reinvest it.

The rule of thumb is for as many years of your bond’s maturity (or duration), it will decrease in value as much as a percent with a 1% rise in interest rates. So a 1% rate hike on a five year bond may likely deliver a loss of paper value of about 5%. I say paper value because you may look like you’re losing money but that only becomes reality if you SELL it before it matures.

So the bottom line is that in a rising interest rate environment, you can expect the paper value of your bonds to go down.

Here are some ideas for how to invest in a rising rate environment:

• Buy individual bonds that you can hold to maturity and you can avoid selling the bond at a discount.
• To diversify, buy baskets of bonds that all mature in the same year and hold that basket until maturity.
• Keep your maturities shorter if you are holding to maturity and reinvest in higher rates as they mature.
• If you are actively buying or selling, then try to buy around the fulcrum of the yield curve so you can hold to maturity if you want or sell if the pricing works in your favor.
• Ladder your maturities and spread out their diversity so you aren’t concentrated in just a few issues.
• If you own a bond mutual fund, KNOW what it owns. Not all bond funds are alike and typically the higher the yield, the higher the risk. Some bond funds can carry almost as much risk as an equity.

At Caissa, anything we put into our fixed income allocation is meant to act like a core bond and have minimal risk. It’s there to earn income, preserve capital and hedge the stock market as a Tranche 1 investment. All other types of bonds will fall into an alternative category and Tranche 2 for investments because they carry different risks and will act differently in a rising rate environment. In a rising rate environment, we do not own bond funds and are holding our short term bonds to maturity.

Different kinds of bonds do different things in a rising rate environment (see below)

This chart shows how a 1% rate increase affects various types of bonds (on the right). As you can see, bonds will react very different depending on the type of the bond. Convertibles have the best total return while 30-year treasuries are having the worst. Some of the best “types” of bonds for return are the convertibles, floating rate and high yield. However, these bonds do not come without risk so understanding the yield spread is essential. For example, high yield bonds have a .72 correlation to the S&P (that is HIGH). Whereas a 2-year treasury has a negative correlation to the stock market. The shorter the maturity, the less the impact on the bond.

The bottom line:

Many bond mutual funds own MANY of these types of bonds and various maturities. If you don’t know what is inside your bond mutual fund, you should ask your advisor so you don’t get whipsawed by a rising rate bond market and a declining stock market!

Investment Update: Tranche 1- Why Seven years

Chart of the Month: Why do we use seven years for our first Tranche term?

Written by Kelly S. Olson Pedersen, CFP®, CDFA

At Caissa, we use a unique Tranches of Income approach when building our clients investment portfolios. This approach segments future withdrawal needs into three ‘Tranches,’ or timeframes, reducing clients’ anxiety about getting through the next market dip. The first Tranche includes one to seven years of cash flow needs.

While one year volatility can vastly swing in either direction (up 50% or down 50%), as you extend the time used in your rolling average returns, the volatility SIGNIFICANTLY drops. The average downturn in a bear market lasts about 24 months (the 2008 financial crisis was only 17 months, long believe it or not!) and, on average, it take about 36 months to recover those losses. The total cycle takes about five years.

As an extension of the recovery period, a typical bull market will last about five years (tacking on about three years post-recovery). So we build our portfolios to withstand five years of a down/recovery cycle and then add a couple of years’ cash flows to allow enough time for equities to recoup returns. This is one of the reasons we start with a goal of seven years of cash flows in our first Tranche for our clients.

Additionally if we look to history, a diversified portfolio has never had a negative five year rolling return (obviously never negative for a 10 or 15 year rolling return either). The stock market itself (as indicated by the S&P 500) has had as much as a -3% return for a five year rolling period and that reduces to -1% for the 10 year averages, while the 15 year rolling return for the S&P 500 market has never seen a negative rate of return.

This history gives us more support that having an investment plan than can sustain through at least five years will provide enough time for a market dip as well as recovery. Adding an additional year or two (like we do), adds to that level of security and allows our clients peace of mind knowing their personal paycheck will be safely provided for while the markets zig and zag. Having this strategy in place, they can ignore the noise and let us lean into and out of equities as we see opportunities arise.

Time, diversification and the volatility of returns

CAISSA’s Investment Update: Chart of the Month

Putting market drops in perspective

The chart below shows the annual return compared to the average intra-year drop (or largest market drops from peak to trough) for each year from 1980 to 2017. For example, last year the S&P ended up 19%, but at some point in the year the market had dropped 3%. In 2016, the market ended up 10%, but at some point in the year it was down 11%. So far this year, the S&P is down about 1%, but we have had a 10% drop from the peak in January until now.

What this chart tells us is that on average for nearly four decades, the market drops about 14% at some point each year. Much of the time, the market ends up higher for the year. In fact for 29 of the last 38 years, the market has been positive for the year despite these double digit dips.

What does this mean for your portfolio? If you can stomach the 14% dips and invest during them instead of selling, your portfolio will thank you in the long term. Going forward, we are planning for a lot more of these dips. We have already seen a 10% dip this year and we could likely rebound only to do it again. However, it does prove that if you have a good plan to get you through the volatility, you will likely come out ahead. So have a plan, stick to it, and keep calm.

A guide to deducting your Home Equity Line of Credit

Do you have a line of credit on your house or vacation house and wondering if you can deduct the interest on next year’s tax return? We have answers for you!

Written by Kelly S. Olson Pedersen, CFP®, CDFA

The Tax Cuts and Jobs Act of 2017 left many homeowners hanging on whether or not they could deduct their Home Equity Line of Credit (HELOC) going forward. The first interpretation was that it was NOT going to be deductible on the tax return in the future, which left many people with a loan that they could no longer deduct the interest they were paying.

The IRS came out this February to clarify the matter and there’s good news! If you used your HELOC for the benefit of the home securing the loan, you can still deduct those interest payments! If you had used the proceeds from the line of credit to buy new clothes and a fancy car, you will find yourself out of luck trying to deduct the interest.

Here are a few of the rules and a quick summary chart for reference (all numbers are for a joint return):

  • Deductible: A new or old HELOC used to repair the house that is securing the loan. Only the interest on a loan LESS than $750,000 will be deductible though (down from $1 million). That maximum amount takes into account the cumulative of all loans on the house. So if there are three loans on the house, they are combined to reach the maximum of $750,000. All interest on the loan amount above that is not deductible.
  • NOT deductible: Taking out a HELOC on your primary home to buy or repair your vacation home
  • Deductible: Taking out a HELOC on your vacation home to repair or upgrade your vacation home
  • Partially deductible: Taking out a $500,000 HELOC on your home AND a $500,000 HELOC on your vacation home to upgrade each house respectfully. Combined, the loans exceed $750,000 so the interest on $750,000 will be deductible and the rest will not.

Understanding Capital Gains Distributions

As a mutual fund owner, there are a few ways to get returns. One is by selling shares of the mutual fund at a gain. The other is to have internal gains the manager has realized and passed through to the investor, along with other dividends and interest. We call the latter a capital gain distribution.

The short of it…

Capital gains distributions must be made by a mutual fund manager because tax law dictates that substantial portions of investment income and capital gains must be paid to investors. Shareholders will pay long or short-term capital gains tax based on how long they’ve owned the fund. However, this doesn’t mean that investors are losing money. Investors can either take capital gain distributions in cash or reinvest them. If capital gains are reinvested, the number of shares in the account will increase, leaving the total value of the account unaffected by the distribution.

Here are a few tips for dealing with capital gains distributions:

  • If you already own the fund, do nothing! Enjoy your payout but know you will owe tax on the gain.
  • If you are going to buy the fund… wait! Otherwise, you’ll need to pay taxes on gains that you didn’t get to enjoy throughout the year.
  • If you are already planning to sell that fund, go ahead and sell ahead of the distribution. Don’t sell it just to dodge a distribution. There will likely be other tax consequences!

 And the long of it…

Another thing to consider is if your mutual fund is “tax-friendly” or if an Exchange Traded Fund (ETF) is better.

A mutual fund manager may rebalance the fund by selling securities to accommodate shareholder redemptions or to reallocate assets. The sale of securities within the mutual fund portfolio creates capital gains for the shareholders, even for those who may have an unrealized loss on the overall mutual fund investment.

In an ETF, the manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets that approximate the entirety of the ETF investment exposure. As a result, the investor may not be exposed to as much capital gains. Not all ETF index funds are immune though! For example, they may be forced to sell to hit rebalancing targets. So-called strategic-beta funds also construct their portfolios based on a set of rules that can result in more frequent changes and lower tax efficiency than broad-market index products.

CAISSA’s Investment Update: Chart of the Month

Market Downturns and Recoveries

The chart below is a great example of why we apply our Tranches of Income strategy to our asset allocations. Going back to the Great Depression, there have been 15+ major downturns in history. Only three of these downturns took more than 36 months to recover (one of which WAS the Great Depression). The others averaged about 18 to 36 months.

The Great Recession of 2008 only lasted 16 months, but to most investors it felt like ETERNITY. It then took about three years for people to make their money back. The whole process lasted about five years from start to finish. That’s why at CAISSA, we ALWAYS keep about 5 to 7 years of withdrawal needs earmarked in short term instruments. It may feel a little boring, but that’s the point! When the next market downturn happens, our clients will have the assurance that they will still meet their cash flows needs.

Even if you’re not retired, you can still rest easy because downturns are natural… but so are recoveries!

Tips For Charitable Giving With the New Tax Bill


There will be big changes in how people give to charities this year. The tax bill that was passed in December included many provisions that will likely have a lot of people changing from itemized deductions to receiving a much simpler $24,000 deduction (for joint filers). By doing this, people will likely think twice before making a charitable donation because it will probably no longer be deductible on their tax return since they don’t itemize. If you are one of those people, we have a few ideas for you.

One idea, if you are over age 70 ½ and receive Required Minimum Distributions (RMDs), is that you can choose to donate part or all of those RMDs to charity! The IRS has a provision that allows this donation to go directly from the IRA to the charity, counting as part of the required distribution. This is called a Qualified Charitable Distribution. This will have the effect of the income not hitting your tax return at all and so is actually better than a deduction.

Another option is to set up a Donor Advised Fund (DAF). This is an account that allows you to make lump sum contributions to the fund and claim the corresponding deduction on your tax return in the year made. Then, at your leisure over as many years as you would like, you can direct the DAF to dole out any dollar amount of your choosing to any charity. In order to make sure you can deduct it on your tax return, we suggest “bunching” your donations so that you make sure your itemized deductions are greater than your standard deduction. For example, you can donate 5 years’ worth of donations to the DAF to bump you into itemizing on your tax return one year. Then, you can divvy out the donations at your leisure over the next 5 years until you’re ready to do it all again!

And of course, you can ALWAYS give to charity without worrying about making it a tax deduction.