“Held to maturity” is a phrase that has been thrown around a lot in the days since the implosion of Silicon Valley Bank. Here’s what it means, why it’s important, and how you can avoid BLS‘s
VB
fatal mistakes in your own personal financial planning.
SVB received a huge amount of deposits from entrepreneurial VC firms in the post-pandemic boom of late 2020 through 2021. At that time, the fed funds rate was very high, zero, nothing. So, to earn something, anything, SVB invested in high-quality debt instruments with longer maturities, such as mortgage-backed securities, and placed them in its “held-to-maturity” investment book.
They knew that if interest rates rose, those debt securities would lose paper value, but if they waited for them to mature, they should still receive a return on their principal and some interest along the way. But as the Federal Reserve raised rates, SVB’s bank clients, mostly large institutions, began demanding their money back, forcing the bank to take significant losses on these “held-to-maturity” instruments. long before its expiration.
BLS
As losses mounted and withdrawals accelerated to a It’s a wonderful life passedthe mass panic resulted in a direct bankruptcy of the bank before you could finish filling your March Madness bracket for the office group.
The fundamental flaw here was that Silicon Valley Bank misaligned its assets and liabilities with its terms. They invested for the long term with money that might be needed in the short term and the end result was a high profile flop.
While your personal financial situation may not grab the national headlines, it could be a lot more painful for you if your investments and your timelines don’t match up.
For example, most investors know that stocks are long-term investments, not suitable for the money you might need in the short term. In fact, it’s reasonable to suggest that the money you need to access within the next five, or maybe even 10 years, shouldn’t be invested in the stock market.
Fewer investors are aware that bonds can also lose money. Or, at least, many didn’t know until they saw their year-end 2022 investment statements, when average common bond holdings posted double-digit losses. Sure, diversified bonds are less likely than stocks to find yourself in a decade-long slump, but especially in retirement, when portfolio losses can be compounded by income distributions, the risk that your investments won’t coincide with their objectives is greater. very real.
However, what are the instruments that make up most of the portfolios designed to generate income for retirees? Stocks and bonds.
And what has been the predominant financial industry response to this dilemma? Trust us; everything will be fine.
And in fact, it can be. Statistically speaking, a standard 60/40 portfolio is likely to survive a large number of market scenarios, assuming a reasonable withdrawal rate of, say, 4% or 5%. But statistics don’t put food on the table, and anything is possible, especially if retirees’ lack of confidence in the toughest of times results in a personal run on the portfolio: going to cash and missing the next market move. .
That’s why some propose a more creative approach that translates portfolio construction into more real language and matches investment objectives to appropriate timeframes.
For example, it could be argued that there are really only four different things you can do with your money:
you can 1) grow for the future; 2) protect in the case of emergencies; 3) give to the heirs, to the causes or to the tax collector; or, perhaps most importantly, 4) you can use it to live outside through the creation of income.
And while it may be possible to implement a single, diversified portfolio of stocks and bonds to achieve all of these, it may be optimal to have dedicated strategies for each of these four spending categories, each with its own risk exposure and time horizon.
“Historically, portfolios have been designed more for portfolio managers than for consumers who are investing,” says Tony Welch, chief investment officer at the Atlanta-based wealth management firm. SignatureFD. “The industry has been so focused on risk-adjusted return that we have neglected anxiety-adjusted return.”
In fact, no matter how conceptually well-conceived a portfolio is, if an investor quits at the wrong time, all the effort is wasted. Welch further explained that when you talk to real people about building portfolios that focus on both your well-being and your wealth, “you feel this overwhelming exhale and realize that your chances of sticking with the strategy are likely to be much higher.” “. .”
This practice combines the mathematics of investment theory with behavioral finance, and the notion of “allocating” investment dollars to address the more specific needs of investors is called “mental accounting.” For example, let’s look at just two of the goals above and how a strategy like this might be applied: Live and grow.
Due to the inherent volatility of investing in stocks, a retired investor might wisely reserve up to 10 years of income generation in a “live” bucket, investing conservatively enough to inspire abject boredom. Depending on the client’s risk tolerance and situation, this could include short-term Treasury bonds, FDIC-insured certificates of deposit, or even fixed or indexed annuities with principal protection.
The objective of this particular portfolio could even be to reduce capital [gasp]but that’s okay because it frees up the investor to be even more aggressive with their “growth” portfolio, knowing they don’t need to be touched for at least a decade.
With a simple strategy like this, an investor is more likely to ignore headlines screaming about the next financial crisis, pandemic fear, or banking meltdown, relying on their unsexy live portfolio for all their income needs instead. of the present.
The challenge for heady portfolio managers and well-intentioned financial advisors is that they may want to create beautifully constructed portfolios to maximize the risk-adjusted rate of return. But they don’t award Oscars for portfolios.
Ironically, the best portfolio is not necessarily the one with the highest rate of return, but the one that an investor can best understand and hold. Therefore, we must consider the application of behavioral science in portfolio construction as much as investment science to ensure the best possible outcome for investors.
