I Changed My Investment Strategy This Year and Prepared for How It Went

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In recent weeks, I’ve gone from passive investor to a sort of living room corporate treasurer, scrounging for ways to boost the yields of my portfolio by a few basis points.

I’ve had to wrestle with the big questions, think hard about the bond market, and guess where inflation is headed, all to keep my retirement nest egg from getting scrambled in an uncertain economic environment.

I’d like to tell you I’m doing this because I’m a wonderful proactive guy who jumps on problems early. Afraid not. I’m doing this because my portfolio has done so poorly this year.

While that’s mostly because of an awful market, I think it’s partly my fault for being too detached.

A year and a half ago, I decided to put most of my retirement portfolio into a single Vanguard fund that mimicked a 60% stock/40% bond global portfolio, the

LifeStrategy Moderate Growth Fund

(ticker: VSMGX). I’m 65 years old and my rationale was that the fund would protect me from myself by automatically handling the parts of investing where I often dither—such as buying stocks when the market is plunging. I knew markets were frothy, but I figured this was the strategy that would serve me best over the next 20 to 30 years.

My logic might have been defensible, but my timing was horrid. The fund managed to capture almost every part of the market that got killed this year. The fund is down 16% year to date, as of Thursday’s close, and its losses were worse a few weeks ago. As it stands now, it is the fund’s worst year since 2008 during the financial crisis.

With 40% of its stock investments overseas, the fund’s equities were hit hard, walloped by the rising dollar. I was more or less prepared for that and I don’t have big regrets there.

I wasn’t prepared for my bond losses. Instead of cushioning me from those stock losses, my bonds added to them.

The Fed hiked short-term rates by about 4 percentage points this year, producing big losses. The fund’s bonds had a duration of more than 6 years and were hit hard by rising rates. Its biggest fixed-rate holding, Vanguard’s Total Bond Market II, is down more than 12%, a lot for the safe part of my portfolio.

I don’t blame the fund; it did exactly what its investing strategy called for and I knew what I was buying. I blamed myself.

When the interest-rate curve inverted earlier this year, I should have exited my Vanguard fund and gone into short-term bonds or cash to protect myself.

Had I moved to shorter-duration bonds, I would have averted a decent chunk of my losses this year. A move to cash would have avoided losses entirely.

This is why some experts advise leaning on cash more than bonds. William Bernstein, author of the Four Pillars of Investing, a handbook for do-it-yourself investors, has been saying for years the entire fixed-income part of your portfolio should be in cash. He notes that is what Warren Buffett does with

Berkshire Hathaway
,

which has $104 billion in cash or cash equivalents.

And because my nest egg was invested in a single fund with an investing strategy that relied on medium-term bonds, I couldn’t move into shorter-term instruments without selling that fund and investing the proceeds in separate stock and bond funds.

Instead of doing anything, I dithered and kept hoping that interest rates would drop. They kept climbing, and my losses kept growing. I was doubling down, to borrow a gambling term.

I finally said enough and sold the fund, adopting a more defensive strategy that has my equities in three separate funds: a US total market fund, a foreign total market fund, and a US value fund. I am overweighting value stocks because I think they may outperform for a while in the current environment and because growth stocks enjoyed such a huge run-up for so many years.

My primary bond fund is now the

Fidelity Short-Term Treasury Bond Index Fund

(FUMBX). It has an average bond duration of 2.54 years. Because of its shorter duration, it will gain less if rates drop. But it will also lose less if they go up again. And for the moment it is yielding a lofty 4.4%, much higher than medium-term bonds.

I didn’t stop there. I sold off half my bonds to buy 3- and 4-year brokered certificates of deposits yielding 4.9% and 4.95%, respectively. They yielded more than comparable Treasuries, but are federally guaranteed and just as safe.

If rates rise, the market value of these CDs will drop, but since I’m holding until maturity I will continue to collect nearly 5% interest, which isn’t awful. And if rates fall, 5% interest will look increasingly attractive in a lower-rate world.

I’m taking other actions to increase yield. Outside of my retirement account, I keep a fair amount of cash in a Vanguard money-market fund. I took some of the cash and bought 4-month Treasuries that yielded over 4% to juice my yields a bit.

All this searching for yield is a lot more work than my single-fund strategy. And I still run the risk of not coming out ahead in the end.

But if interest rates rise some more, I won’t get hammered nearly as badly as the last time. And if they fall, I’ll do everything right for several years.

I’m calling that a win.

Write to Neal Templin at neal.templin@barrons.com