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Health & Fitness

Should bonds/fixed income still be in a portfolio?

Should bonds/fixed income still be in a portfolio?

This is a question that a lot of investors are asking themselves. With interest rates slowly rising from historically low levels, many investors are re-evaluating the role of fixed income in their portfolios. To help answer this question, the individual has to examine why do they have bonds in the first place?  The traditional role of bonds in a portfolio generally revolves around two key premises: income and/or diversification.

Income:

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1.       Bonds traditionally are a good source for generating cash flow or income from their interest payments.  Depending on how the investor owns the bonds, these income payments often come monthly, quarterly, or semi-annually.  This can be a great supplement to other sources of income that an individual may have to help meet monthly expenses.  Unfortunately some people have taken on extra credit risk or extra maturity risk to help raise their interest payments and those risks may become problematic.  

Diversification:

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2.       Bonds are an important component of a properly diversified portfolio and traditionally are negatively correlated to stocks.  Often these two asset classes compete for investment dollars.  Bonds can help serve as an important “shock absorber” to a portfolio to help even out the peaks and valleys and are a key component of most asset allocation models.

There is an inverse relationship between interest rates and bond prices.  Generally when interest rates rise, bond prices fall.  Conversely, when interest rates fall, bond prices rise. Rising interest rates normally occur when business prospects and economies are improving. Given the fact that we are coming off historically low interest rates, the direction in which rates will be going in the next few years is most likely in an upward trend.  The challenge of this is trying to determine how soon this will occur and to what extent?

The manner in which you hold fixed income is also a key consideration.  If you own the individual security, despite the market fluctuations, generally and assuming the security does not “default” you will get your principal back upon maturity.  If you own the bonds in a mutual fund or ETF (Exchange Traded Fund), there is no set maturity, so getting your principal back is not a given.

So what is an investor to do?   Remember a few key principles:

1.        Bonds are not traditionally as volatile as stocks.  Switching your bonds into stocks can mean taking on even more risk. In general terms, a bad year for stocks can be much worse than a bad year for bonds.

2.       Remind yourself why you own the bonds, (i.e. diversification, income).

3.       Watch your average maturities and durations.  Keeping the durations to a low level can help mitigate the potential drop in values when rates are rising.

4.       Remember, markets move in long term secular patterns.  We have been in a long term (>30 year) period of generally falling interest rates.  This has helped drive bond performance over that time frame.  We may be entering a new long term period of generally rising interest rates. This does not mean bonds will continue to have negative returns, but those returns may just be less generous than some investors have been accustomed to over the last few years. In a properly diversified portfolio, the goal would be for the stocks to make up some of the difference in return and help achieve traditional market level returns.

 

To discuss how this subject or other financial subjects may relate to your own financial circumstance, please contact me at the contact information below: 

Christopher N. Congema, CFP®

President, Investment Advisor

Core-X Wealth Management, LLC

900 Walt Whitman Road, Suite 208

Melville, NY 11747

631-923-2485 Phone

www.core-xwealth.com

chris@core-xwealth.com

This communication is from Core-X Wealth Management, LLC, a New York State Registered Investment Advisory firm. The information in this blog is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.  

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