Drew O’Neil discusses fixed income market conditions and offers insight for bond investors.
- Now is a good time to review the credit quality of your fixed income portfolio to ensure that it still aligns with your risk tolerance. The COVID-19 pandemic has affected various fixed income product types and sectors in different ways. If you own positions that have been downgraded or are currently under increased stress, now is a good time to swap out of these credits and into higher quality names to realign your investments with your risk tolerance. The current high level of demand for fixed income means that many bonds can be sold at relatively attractive prices (remember, lower yields reflect higher prices), making now an opportune time to swap out of unwanted positions.
- When purchasing bonds, keep an eye on the overall maturity structure of your portfolio and how it will be affected by new purchases. Having maturities concentrated over a relatively small timeframe can expose an investor to undesired reinvestment risk. For example, if you have a one to ten year ladder, you’ll probably want about 10% of the portfolio maturing each year. If for some reason, you have 40% of your portfolio maturing in a single year, you are exposing yourself to reinvestment risk, in that if interest rates happen to be at a low point in that year, you will have to reinvest a large portion of your portfolio in a low interest rate environment. Laddering maturities more evenly spreads out this risk.
- For cash flow oriented investors, do not be afraid of high dollar prices on bonds. All else being equal, a higher dollar price means a larger coupon which means more cash flow to the investor. You are not losing money, you are purchasing larger cash flows. The yield quoted on a bond tells you what you will earn annually, so unless the quoted yield is negative, you are not losing money by purchasing a high premium bond.
- Industry-wide holdings in money market funds are near all-time highs while yields on these funds are approaching historical lows. In addition, the FOMC is projecting the Fed Funds rate will remain near zero through at least 2022. As money market yields typically track very closely to the Fed Funds rate, there is a high likelihood that money market yields will remain very low for the next few years. For money that does not require money market levels of safety and liquidity, consider purchasing bonds in the 3-4 year maturity range to increase yield by two to ten times over what many money markets are currently paying.
- Remember the reason you are allocating money to fixed income. If the goal is principal preservation (which for many investors is the #1 objective for their “fixed income dollars”), do not let low interest rates convince you to take unnecessary risk in other asset classes in a search for yield. Chasing yield with dividend stocks or other higher risk/growth oriented assets classes is putting your primary objective (principal preservation) at risk in an attempt to achieve a secondary objective (total return).
- In uncertain times, having known aspects about your investments can be a breath of fresh air. When you purchase an individual bond, you know the yield you will earn over the life of the bond, you know the exact amount of cash flow that you will receive over the life of the bond, and you know the exact date that your principal will be returned to you in the future (barring default). These are highly valuable things to know that very few other investment vehicles can provide.
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.
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