Segment Wealth ranked in the “Top 20 in Texas” by Barron’s.

Once again, Segment ranks among Barron’s Top 1200 Advisors in America, landing in the “Top 20 in Texas” for the second year in a row.

For many reasons, Segment is a bit of an anomaly in the advice business. We just do things a little differently. One of those things is the minimal amount of bonds in our client portfolios. Some explanation for that small allocation is how unattractive bonds were for years, with yields approaching zero. Another reason is our confidence that stocks will outperform over time. Our clients either absorb that confidence or maybe we simply attract clients with a minimal aversion to stock market uncertainty.

Another unattractive feature of bonds is the heavy taxation on interest, which is taxed at the highest rate as ordinary income. It is not much compensation to have a 5-year 4% coupon bond mature and provide your money back and then, looking back, have 5 years of aggregate coupon payments of, say, 20%, only to lose nearly half of that return to taxes. That 12% remaining of total return will have been devoured by five years of inflation, rendering no true “yield” at all; It is merely treading water. It is thus no wonder that we keep our bond holdings to a minimum. Instead, we use them primarily for staging liquidity, not to provide a real return.

Many advisors create their client asset allocations by determining client desired income level and then apportioning bonds to match that run rate with bond interest, keeping all principal intact. With 4% returns abundant, it would take 25 times the annual burn rate as a bond allocation. This might be wise for nominally wealthy investors who cannot afford a wider range of outcomes; good outcomes notwithstanding, but good times breed bad.  However, this approach could cause very large percentage allocations to the bond market with near-certain dismal returns. We follow a different guidebook.

We think it is a better idea to allow a sequentially maturing (laddered) bond portfolio to be consumed fully by the burn rate of, say, seven years and then replenish the liquidated bond holdings after a big run in the stock market. Since this could cut bond holdings by 75%, it would likely provide 3x the rate of return with half the taxes, due to compounding and the favorability of the tax rate on capital gains or stock dividends versus interest.

This philosophy would allow much higher stock allocations for those willing to accept the inconsistencies of the stock market. But considering stocks go up in 8 out of 10 years, the odds are favorable, and the tax differential would increase the odds even further. In this scenario, you can see how the systematic consumption of maturing proceeds, rather than simply a coupon return, could significantly reduce the required bond holding for a near-decade of consumption. Meanwhile, bond allocations over the past decade have produced more taxes than returns, while many of our clients’ equity allocations have instead enjoyed 8-10% annual returns with minimal taxes.

Ride the Slipstream Video – As a fiduciary firm, Segment advocates for the best outcomes for our clients and focuses on optimizing investment performance.

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