Fixed-Income Investment Selection

G.W. Henssler & Associates, Ltd., recommends that their clients follow strict guidelines when purchasing fixed-income securities. Our philosophy, the Ten Year Rule, states that any money a client needs within 10 years should be invested in fixed-income securities.

The first step in purchasing fixed-income securities is to estimate the client's liquidity needs for each of the next 10 years. Liquidity needs refer to the difference between after-tax income and desired after-tax spending for any given year. GWH estimates a client's future income from all sources, including earned income, pensions, Social Security, income from investments, income from real estate, etc. We also estimate expected spending, taking inflation into account when making these estimates.

Once liquidity needs are estimated, fixed-income securities (bonds) should be purchased in face amounts that match liquidity needs, maturing on dates that correspond to the dates of the liquidity needs. These bonds should be purchased with the intent of holding until maturity. This is called the "laddered bond" approach, in which we "ladder" each appropriate bond to come due when the funds are needed.

For example, if a client will earn $40,000 after-tax in 2010, but desires to spend $60,000, then he should need $20,000 of principal from his account. In this case, GWH would recommend the purchase of a bond with a face value of $20,000, and a maturity date of either late 2009 or early 2010. This $20,000 should estimate the difference between the client's after-tax income (including dividends and interest from investments) and his desired after-tax spending for that year. When the bond matures, the client is projected to use the proceeds to supplement income in that year to reach his desired spending level. This approach guarantees the bondholder the amount to be received, assuming the creditor makes good on its obligations. This is unlike bond funds, which have no specific maturity dates. Next, the type of bond to purchase must be determined. Based on the client's estimated future tax brackets, GWH recommends either U.S. Treasury securities or high-grade municipal bonds. We avoid corporate bonds, because there is a risk of default, even though in many cases the risk is quite small.

If it is most appropriate for the client to purchase U.S. Treasury securities, GWH recommends either U.S. Treasury Bonds or Notes if the bonds will be purchased in a taxable account, or U.S. Treasury STRIPs if the bonds will be purchased in a tax-deferred account. STRIPs are zero-coupon bonds that do not pay annual interest, but instead are purchased at a discount to their face value. If the client is projected to be in a relatively high tax bracket, we may suggest he purchase municipal bonds from his state of residence, rated AA or AAA. As the purpose of holding bonds is safety, we recommend clients avoid all bonds with lower ratings than AA. GWH also avoids bond funds, other than very short-term bond funds, such as Dreyfus Premier Short Term fund (DSTIX) as bond funds have no guaranteed maturity value or maturity date.

Initially, we recommend a client purchase bonds that cover liquidity needs for 10 years. In every subsequent year, the client should cover another year of liquidity. For example, in 2009, a client should consider covering his 2019 estimated liquidity needs. However, if the stock market's performance is poor, the client always has the flexibility to wait a few months, or even a few years, to continue covering liquidity needs. This is why the Ten Year Rule works. In most cases, it allows the client to avoid selling stocks during poor market conditions.