Are Bonds the "Cinderella" of the Investment World?
February 16, 2021
Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
We often talk about the importance of investment discipline: balancing asset allocation, remaining within your risk profile, long term planning and creating personal plans to meet your own needs. It is so easy to get derailed when someone or some article comes up with a “better” plan. But are the tempting replacements really ill-disciplined alternatives that hijack your long term plans in order to seek short term payback?
Bonds to a portfolio are much like a well-fitting comfortable shoe is to your foot, providing comfort, protection and purpose. The right characteristics cannot easily be duplicated by alternatives.
The process of bond allocation does not need to be complex or inventive to be effective. We find ourselves in a low rate environment, one that may remain low for a lot longer. Low rates can trigger an urge to drift from long term planning in order to seek better instant gratification. However, the simplest of strategies, a bond ladder, may deliver all the attributes you need to satisfy long term fixed income necessities.
The fears of inflation and or lack of yield may disregard the realized protections of a simple ladder. A ladder strategy places bonds across a maturity spectrum. As an example, let’s say your fixed income allocation strategically matures 10% of the bonds each year for 10 years. This strategy creates a 2-way hedge against interest rate movements. If interest rates rise, the longer maturing bonds lose market value but the short maturing assets are reinvested at higher rates (which will increase the average portfolio yield over time). If interest rates fall, the longer maturing assets appreciate in value while reinvestments go into lower rates.
Yes, the glass is half full. Investors have the option to hold their investment until maturity, dismissing price appreciation or depreciation. When you hold the investments, the market price only affects paper changes. In other words, moving interest rates/prices do not alter the income, cash flow or date of redemption from day one until maturity if the bond is held to maturity. Therefore, if/when inflation and/or higher rates do surface, the price depreciation may not negatively affect your overall return due to the interval reinvestment of funds at higher interest rates.
Individual bonds are a clean fit for your fixed income allocation at any hour or moment in the interest rate cycle.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.