As an investor, you need to adopt a Yin Yang Investor Mindset. In other words, always recognize that whenever one asset class is booming, another asset class may be suffering. If you feel like you missed the boat with one investment, just know there's another boat somewhere in the world waiting.
My investment mindset as a retiree since 2012 has always been to protect principal first. Losing principal when you no longer have a day job is a terrible thing. But at the same time, back then I felt we were in the middle of a potentially strong recovery so I had to invest in equities.
The solution: I invested in plain vanilla S&P 500 and Dow Jones structured notes with downside protection. In return, I'd forego some or all of the annual dividend.
Unlike some retirees, I wasn't focused on generating income from my investments because I had enough to live on largely through rental income and a growing online business. In a bull market, you want to invest in principal growth to maximize returns. But now, I've slowed down my additional equity investments and am now focused on bonds because they are finally selling off.
Why Are Interest Rates Rising?
Take a look at this chart of the 10-year yield post Donald's victory. The rate increase looks like an internet stock from 2000! Now in 2024, interest rates have skyrocketed after the Fed raised rates 11 times since 2022 to combat inflation.
Why did the 10-year bond yield jump by over 20 basis points in one day? The reasons are Donald plans to cut taxes, increase infrastructure spending, and throw up 35%-45% tariffs for imported goods, which will increase the federal budget deficit and increase inflation.
Whenever there's higher expected inflation, rates go up to counteract increased monetary demand. Further, investors tend to sell existing lower yielding investments in favor of higher yielding investments until there's market equilibrium.
Who gets hurt when interest rates go up:
* REIT holders
* Potential homebuyers due to higher borrowing costs
* Home sellers during the initial interest rate ramp
* Borrowers with variable rate loans
* Future borrowers
Here's who benefits:
* Cash rich investors looking for income generating assets
* Retirees who depend on income generating assets
* Homeowners over the longer term who see their property values inflate with inflation
* Equity investors if higher inflation expectations is a harbinger for higher earnings
* Lenders – just look at bank stocks
There's always an adjustment period that happens during any large interest rate jump. Investments move quickly, but the repercussions of such moves take time to play out.
California Muni Bond Case Study: Yin Yang Mindset
Take a look at the California Municipal Bond (CMF) below. This is a security I've been eyeing as interest rates were starting to slowly creep higher pre-election. I've been looking at double tax free securities since I've run out of legitimate business expenses to lower my taxable income. I also thought Hillary was going to win, thereby keeping the status quo of higher taxes.
CMF has declined about 5.8% from its recent peak to now $116.83 after interest rates ramped post election. At $116.83, CMF provides a ~2.6% double tax-free yield for California residents. As I stated in a previous post, my trigger point for aggressively buying bonds is when the 10-year yield hits 2%. Now that we busted past 2%, I've started the process of more aggressively building my bond portfolio and have deployed roughly 60% of my planned allocation.
I plan to slowly deploy the remaining allocation the higher the 10-year bond yield goes. If we get to 5.5%, then I'll allocate 100% of my funds and then work to rebuild my cash hoard again.
Everybody needs to come up with their own investment game plan or an investment thesis in order to stay disciplined. Structure an investment outlook that makes sense to you. Or, you can just have a digital wealth advisor manage your money.
Note: Other attractive investment opportunities I'm looking at that have sold off post election include MUB, AGG, and OHI.
Focus On The Positives
You can focus on the negatives of higher interest rates or you can be opportunistic. The opportunist in me sees a scenario where I can finally build a sizable bond portfolio so I can continue enjoying the fruits of early retirement. Focusing on the positives will not only make you happier, it should also make you wealthier as well.
My original plan was to try and work as much as possible to take advantage of a potential three year or longer window of lower taxes. But honestly, it was a little depressing thinking about having to commute in rush hour traffic again. And for what? To attend a meeting to hear an insecure colleague fluff his feathers? That's terrible.
But now that rates have moved higher, I'm coming around to the fact that maybe full-time work is no longer necessary. What a goldilocks scenario where stocks AND yields move higher.
I've been somewhat dreading the expiration of my 3% – 4% yielding CDs starting in 2017. But if I can now earn a relatively low risk 2.5% double taxation free dividend yield, that equates to a ~3.7% – 5.3% pre-tax yield, depending on your type of investment and tax rate. Asset allocation solution achieved.
The key to building passive income has always been to amass enough capital to generate a livable income stream in order to never have to work again. That's hard to do in a super low interest rate environment. Now that interest rates have moved higher, there's no need to save as much to produce the same amount of income.
Instead of $3,625,000 of capital required to generate $50,000 a year from a 10-year bond earlier this year, you only need $2,358,000 today. What a wonderful thing! That's positive thinking my friends.
Invest In Private Growth Companies
As an investor with the Yin Yang mindset, consider diversifying into private growth companies. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
Check out the Innovation Fund, which invests in the following five sectors:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. You can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
Track Your Network Carefully
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After you link all your accounts, use their Retirement Planning calculator that pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
I’ve been using Empower (previously Personal Capital) since 2012 and have seen my net worth skyrocket during this time thanks to better money management.
Readers, do you have the Yin Yang Investor mindset? What are some other Yin Yang investor mindset examples you can think of? Are you looking at the bright side of higher interest rates by taking advantage of the bond market sell-off and looking to become a lender in instruments such as P2P, real estate crowdsourcing, and hard lending? I'm seriously looking at doing all these things more aggressively now.
Yin Yang definition: In Chinese philosophy and religion, two principles, one negative, dark, and feminine (yin) and one positive, bright, and masculine (yang) whose interaction influences the destinies of creatures and things.
I definitely like the possibility of peer to peer lending as a way to diversify away from a traditional stock/bond portfolio. I opened a Lending Club account a few months ago, and I have been pleased with the results.
Sam, why not just buy BND which gives you 2.4% yield plus the diversification benefits? I am worried about buying any CA bonds given that we live in the Bay Area and are too concentrated
Sam, how do you figure that you’ve “run out of legitimate business expenses”. I thought you said you were going to be the next Forbes? I think you should hire reporters. They work for cheap, you can afford it.
“As an investor, you need to adopt a Yin Yang Investor Mindset. In other words, always recognize that whenever one asset class is booming, another asset class may be suffering.”
I also want to point out that it is sometimes advantageous to go after the assets that are suffering, knowing that they will have the most upside potential. Many consider this to being a contrarian investor, which is someone who goes after assets that are least desirable in hopes of catching the next wave up before everyone else is on board. We all know that asset classes go through waves, good times and bad times. We all know to “buy low and sell high” but most people don’t actually do this simple advice. Most people are buying stocks right now while they are at all time highs.
I have always been told to “buy when there is blood running in the streets.” I am looking for assets that are extremely undervalued and that have big potential to turn around in the future. If you can get in while the majority are in other assets you will beat the crowd and have the most gains when the tables turn.
I like the idea of a yin yang investor mindset. I used to only think of downturns as disaster scenarios but now I like to think of them as buying opportunities. There are always positives when something turns negative.
Great table on needing less capital as rates go higher. What a difference small movements in interest rates can make!
I disagree with this statement on when interest rates rise:
* Homeowners over the longer term who see their property values inflate with inflation
This is assuming there is inflation. You can have interest rates rise without inflation. Home prices are based on available income and interest rates. And they work like bonds if income does not rise with interest rates. Therefore, if interest rates rise, and their is not inflation income, housing prices will crash across the board.
What are your thoughts on why interest rates would rise long term without inflation? You can see short term disconnects, but longer term, everything is rational in finance.
Do you rent or own?
Thx
Thanks for the wisdom as always Sam. Another Yin Yang concept I find compelling is the simple yet profound balance between saving and spending. That was on my mind when I clicked on your post. I personally believe that happiness and general contentment with money exists between the balance of saving vs. spending. Most people either spend too money and save too little, or save too much and spend too little. Money like most things in life is about balance. As you have illustrated here with interest rates – there it is important to adopt a Yin Yang mindset to see opportunities.
Hey Sam,
Thank you for another great article. Something caught my mind when I was reading the passage in which you say that when inflation expectation goes higher, the interest rates go up as well which is totally normal. However, shouldn’t we be focusing on the real rate instead of the nominal interest rates that go up or down with inflation. My point is that isn’t it better if we have a bond paying 1% in a market where there is 0.5% inflation than having a bond that pays 2% when the inflation is 2%?
I think that you might think of your personal inflation rate as something you can control because you can mostly avoid the goods that become expensive. However, in my opinion, if you calculate your personal inflation rate over the long term, it will be higher than the official rate because house prices(which is regarded as an investment, so they are not included on inflation calculation), cost of higher education, cost of childcare and healthcare all increase almost double digits every year. What I suggest is that I think you should look for more than 2.5% net yield when you are investing.
Thanks again for this great article.
Hi Bora,
The 2.5% is a double tax free yield. Therefore, the gross yield is over 4% based on my tax rate. Then there is potential for principal appreciation as well.
It’s hard to predict the future, but as someone who has built a large enough financial nut to retire, I’m really only looking for about a 3% to 5% annual return. Everything is gravy above 0% right now.
Also, please be aware that I have many other investments in equities, private equity, venture debt, and so forth that may yield greater than 2.5% return. This article just focuses on one endeavor of building a bond portfolio for income, diversification, and lower volatility.
Thanks
Right now I’m focused only on growing my portfolio value and do not want any passive income from it. Its a growth stage. The more you hold assets that reinvest in themselves the less you pay in taxes and the more compounding growth occurs.
But that isn’t for everyone. Once you are in the “sustain” stage you can start living off the earnings.
Interesting post on how you plan to deploy new money.
Since we don’t have the stomach for the stock market or any other type of investments, we keep it ultra conservative. We only invest in tax free muni bonds. Our current portfolio of 4-5% bonds generate 84K a year. Our yearly expenses is 45K.
Prices of munis are dropping and one 4% bond I saw today is at $103.33 which is 3.6% yield to worst. In a 33% tax bracket, this yield is like a 5.4% pretax CD. Although 3.6% yield is OK with us, we are patiently waiting for a 4% muni bond to get closer to $100 or at most $102. we may deploy at most 400K for more bonds. Generating 100K tax free passive income is our next goal. Since I have less than 3 years until I retire at 55 to double my pension and to get 11K Yearly for health insurance, I need to have goals to moviate me to stay at work.
Adam
Hi Adam – Which muni bonds are you investing in that has a 3.6% yield to worst?
100K tax free passive income is a GREAT goal!
Work is great when you know there is an end goal. For me, it was an endless wheel to run as there was no pension or anything. But we did have profit sharing.
Hi Sam,
I generally buy MTA, water, dorm authority muni bonds 4-5% with YTW min of 3.5%.
The one that I saw on Fidelity is cusip 649451EU1 convention center. There are many listed yielding greater than 3.5%. I just want to illustrate that muni bond prices are dropping compared to the prior months. This morning, I saw many listed for Calif yielding greater than 3.6% but I am not familar with them. You should take a look at your self service brokerage site.
You did a great job getting a nice severance and manged to generate over 200K passive income all by yourself!
If i had to do it again, I am not sure I can work for a company for over 30 years again. The pension and medical coverage is moviating me to stay till 55.
I totally agree that work is like running on a hamster wheel. I work at home now 9-5 but I support many IT changes after hours and on the weekends. My wife just got laid off and many of my co-workers are gone. So although, I have no backup, I will not let it stress me out. I changed my way of thinking. With all the on going outsourcing of our jobs in our company back to India, mgmt is no where to be seen. When there are major application outages, mgmt does not seen to care or to be on the swat calls. So if mgmt does not care, why should I? I still do my job to fix the problem asap but I no longer stress out about. Therefore, I am just counting down and trying to transition to a retired life now while still employed. My wife will have to find her own retired routine since she had been working continuouly since age 17.
Adam
Thanks for the heads up on MTA.
I say enjoy your remaining work years. Take some sick days that are allotted to you (I maybe took only 10 out of the 144 allotted to me over 11 years and regretted it) and never let your vacation carry over days expire by using them. Also, read this post if you haven’t already, The Fear Of Running Out Of Retirement Is Overblown.
I figured that people always need MTA, water, and dorm authority to build schools and hospitals so I buy a lot of these muni bonds.
I rarely take any sick days except when I am really sick. Taking too many sick days are held against you in your evaluation. You can take 7 sick days but they are on a rolling calendar so the number does not reset to 0 at the end of the year. It may sound stupid but I don’t want to jinx myself for taking a sick day when I am not ill.
I get 5 weeks of vacation and 3 personal days each year. I always carry 5 days every year. I gotta take more vacations! But you are right, I will need to change my thinking and will take a sick day or two as mental health days to recharge my batteries each year. Also take sick days instead of vacation days when I get my checkups. So thanks for that advice!
Yes, I have been reading all of your posts since 2014. I read the fear of running out of retirement is overblown. I am ashamed to say that WE are guilty!!! We will have passive income 3.3 times current expenses including health care with munis, pension at 55 and 401K at 59.5. Our immigrant families worked in sweat shops. As a result, it is extremely difficult for us to walk away from a pay check. I would like to just walk away now but the wifey wants me to try my best to reach 55 but I do agree with her. Happy wife happy life…you know the drill. Also, once we stop working we NEVER want to worry about money ever again or to even work any more after retirement.
I remember what you said in a prior post to me. Something like when I retire with our financial run away, I will wonder why didn’t leave sooner. You are right but WE are afraid of the future cost of healthcare. Working until 55 will bring more financial security. If the next 3 years of working affects my health then I will quit.
Adam
The good thing Adam is that it’s always better to end up with too much than too little. But you also have to hedge for a truncated life. It’s one of those things that I worried about. I did have a niggling fear that if I died earlier, I would be extremely pissed off for having worked so long. Therefore, I cut the cord I don’t earliest age that was responsibly possible.
Sam,
This morning I brought 65K of 64990CJC6 muni bond Dorm authority for private university. 4% bond below par and YTW a bit above 4% triple tax free. Matures in 2043. I am happy with this 4% yield since it is like a 6% CD to us. I suspect bond prices will continue to drop in the near future. If so then we will buy more bonds with higher yields. Getting a 5% at par which be NICE!
Adam
Thats such a great table at the end of the article. An incredibly important point with consequences for everything from saving to retiring.
Interesting spin on sound advice. Always a pleasure to read!
Isn’t it still too early to start buying bonds? Won’t interest rates and inflation keep rising over the next few years.. making bond purchases now lose value?
It certainly could be too early to buy bonds, which is why I’ve only deployed 60% of my target bond portfolio capital so far.
Everything is part of a diversified portfolio between stocks and bonds. I’ve been heavy equities for a while and have finally shifted to a 50/50 mix.
Related: The Ideal Mix Of Stocks And Bonds By Age
Main reason for interest rates rising: ZIRP is ending. Zero-Interest-Rate-Policy in the U.S. has been going on for eight years. Interest rates have been kept artificially low, at or near Zero. This, combined with $trillion dollar stimulus packages and an eight year federal spending debt increase of $10 trillion, was intended to stimulate employment and economic growth.
ZIRP hasn’t worked as intended. Wages have been flat, real household income is lower today than 20 years ago, good-paying middle class jobs have disappeared while the jobs created are part-time low-paying, low-skill service jobs. Economic pain has been delayed for eight-plus years, and real market forces are no longer being artificially denied.
Interesting article Sam. But, it seems like the obvious fact missing here is that while inflation is great for increasing cash flow it also increases your spending. I guess the question is wouldn’t the cost of living inflation wash out any increase in interest rates you gain from your investments?
Your costs do go up in an inflationary environment, and that is the negative. The positive is that all your amazing cash generating assets will also start generating higher income. Given we all spend less than we make, the basic math states that we should all be better off in an inflationary environment.
It’s not just our ability to build a bond portfolio in this example. It’s the fact that landlords can now increase rents more at the margin, corporations must issue bonds at higher interest rates for prospective investors, REITs will pay higher dividends eventually etc.
The key is to be on the right side of inflation buy buying as many inflationary assets as possible over the long term. This is why renting is a long-term losing proposition.
Sam,
I’ve been thinking about inflation recently and I wonder if people are worrying too much about it. Let’s say for example that inflation is a steady 3% overall. For me, housing costs are fixed since I already have a mortgage, my commute is under 10 minutes so oil prices have next to no impact on me, my food costs (groceries anyways) are a tiny portion of my income. I guess what I’m saying is I would bet that the impact of inflation on my own personal budget is very near zero. In fact, I should put together a spreadhseet to see exactly how the numbers shake out.
What do you think? Would you say it is common for people to allow consideration of inflation to push them away from safe and valuable investments?
Real estate crowdsourcing has been on my radar for a while now. For now, I’m sticking to P2P lending, and planning to transfer another of my IRA accounts to Lending Club. Obviously I don’t want to put too many eggs in that,. or any, basket, but I still have some room to expand that investment class.
That’s a great way to see both sides of the picture. I’ve always enjoyed looking at your passive income reports and being able to eek out more percent interest is always helpful to get yourself some guaranteed income. Now I just need to keep saving and investing until I can get that level of capital!
It’ll be interesting in my next passive income report how much actual income I will be able to earn from municipal bonds. Maybe I’ll start doing these reports every six months instead.
Do you think someone who plans to fully retire (early) in 4-15 years, with no need to increase current income for current consumption, should invest in tax free bonds now?
Bonds allow for good diversification with now extra income. I do believe they should be part of a diversified investment portfolio. For tax-free muni bonds, the higher your marginal federal tax rate the more interesting they are.
Hi Sam,
I like your flip side mindset – always look at the glass as being half full, NOT empty. I was planning on deploying some more $$$ into REITs, but I guess I’ll buy some bonds instead or maybe do a 75/25 split.
Although I am worried a bit about the interest rate spike since I’m in a 7-year ARM for my home. I just got into it this year so I have a lot of time until I revisit it again for re-financing, but still.
Seven years is ages. I wouldn’t worry. In that time. You might sell your house, have another opportunity to refinance, or definitely pay down extra principal. I really wouldn’t worry. You’re saving a lot more money with a seven year arm that a 30 year fixed.
Sam,
Would a potential increase in mortgage rates change your plan to buy real estate next winter? Or would you see it as even more reason to buy since prices may go down?
The rise in mortgage rates will exacerbate the weakness in the coastal city real estate market, making me MORE interested in looking for good opportunities around the country through real estate crowdsourcing and specific properties in SF before Uber and Airbnb go public.
I’m not borrowing as much as before because my cash hoard is very stronger now. I may even just try and pay cash for the property instead to really try and make an offer look more enticing.
Great post!
I have a similar mind set between my passive and active portfolio of stocks. When I don’t see too many opportunities, I don’t invest and the cash builds up. When I see something I like, I invest and my cash goes down.
I haven’t owned any bonds in over two years because interest rates have been pathetically low. If rates continue to go up, I would have to seriously consider looking at bonds again :)
Great article, I like the fact that you already have (had) a plan to follow when the rates rise. Do you find it unlikely that bond yields might go even higher than 2.5% within a year or 2? Or if it happens you’d just keep on buying from the income your recent bond purchases generate?
Who knows for sure. I think now with the new president, the 10 year bond healed has a 65% chance of hitting 2.5% within a couple years. But if it does, I will carry out my plan and probably build an even larger bond portfolio if the rates go even higher. The worst bond performance since 1989 was in 1994 when the aggregate barn market was down 2.9%.
I have a follow up post about the situation.
I have my elephant gun ready with the pending volatility. I have been storing up cash since August of 2014 and last deployed some in February when the market tanked. When oil fell out of favor I finally pulled the trigger and have seen 25%+ increases this year. So I definitely got lucky there.
I also bought Chipotle and that’s still a falling knife. So clearly I don’t always pick the right stock/asset class.
This was a nice summary Sam. For me, I’m hoping that my portfolio allocations will see me through a rising interest rate environment without too much anguish. I’m about 70% equities, 10% bonds and 20% alternative. I’m sure the bonds will take a hit, but hopefully commodities will come to the rescue!
You raise a good point about the benefit of rising interest rates and how much less money you will need to generate the same income. Anyone interested in retiring early should be very happy!
If you refinanced or took out a mortgage this year, or if you have rental property, then this is exactly what you want. Low interest rate and minimal inflation have been suppressing the monthly cost of housing, subsidizing borrowers, and punishing savers.
Great read Sam! From what I’ve read recently it seems you have a fairly conservative investing strategy as you’re more trying to preserve wealth than accumulate it. I’m curious where you fell on the aggressiveness scale before retirement when you were still building your nut?
As for me, I already had goals to continue diversifying my portfolio by increasing investments in real estate through Fundrise and increasing my current small P2P portfolio. I’m still in a growth phase in my investment timeline so I’m still keeping the bulk of my investments in equities for the long haul.