Perhaps it is human nature, perhaps it is an American drive to to do better, to be competitive and to maximize a situation. After all, that spirit to escalate gains is engrained in the investing conduct associated with so many of our assets. No one purchases a stock at $50/share hoping or thinking it is going to drop to $20/share. No one purchases land believing that it will be worth only a fraction of the cost down the road. Investors expect and count on appreciation as part of the growth or return on their investment. This investment process is so embedded in our thinking that it is a no wonder why it is often mistakenly accorded to strategic fixed income allocations.
Some borrowed words of wisdom from Kevin Giddis, Head of Fixed Income Capital Markets, “fixed income should be measured in years, not moments”. The timing of these words is so apropos given the bond market’s volatility and falling interest rates. Many strategic fixed income allocations are purchased to buy and hold to maturity. The primary goal is return of principal, not return on principal. Unlike many portfolio assets counting on appreciation over the holding period, bonds held to maturity produce reliable income and do not rely on price appreciation and more importantly reduce or eliminate the probability of a loss. The primary purpose of bonds for many investors is to maintain wealth/principal. The expectation of growth is traded for a reduced probability of loss. This is contradictory thinking versus the buying rationale for growth assets.
Looking for quick fixes or alternatives to the portfolio’s fixed income allocation can lead to mistakes. Allocations exist for a reason and individual bonds provide a protection and/or hedge versus many of the portfolio’s other allocations. Individual bond portfolios are built to produce results measured in years, not weeks or months. If a stock doubled in price tomorrow, it might be enticement for an investor to sell and lock in the return. An individual bond locks in its return right at purchase. In other words, when an individual bond is purchased and held to maturity, outside of an outright default, the cash flow, income and date face value is returned is locked in and will not waver regardless of changing interest rates or market volatility.
An individual bond allocation is typically designed for the long term. The discipline and design is dissimilar to other portfolio allocations in that the intent is to buy and hold and can be accomplished because individual bonds have a stated maturity. The volatility and low interest rate environment baits investors to seek higher yields or immediate returns. The trade of the moment. This temptation can alter the purpose of return on principal to the risk of principal. Regardless of how low interest rates drop or volatility picks up, maintain the portfolio allocation dedicated to protecting your wealth.
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.