Skip to main content

Sound Advice: July 22, 2020


Fixed Income: In a Fix

Typically, the construction of an investment portfolio has begun with an approximate balance of 60% in equities and 40% in fixed income instruments.  Fixed income generally means bonds, but that includes bond funds and exchange-traded funds holding bonds.  The equity portion is intended to be the driver of capital appreciation over extended periods of time and the fixed income portion is supposed to provide stable, albeit more moderate ongoing rates of return.

The theory behind this approach is that as the time periods measured have lengthened, the relative risk of holding equities has diminished while the returns they have generated have been higher than those of other asset classes.  What equities do in the short term, even a year or two, is often anybody’s guess.  

To the extent that fundamental analysis can help toward determining future equity values, investors need to look ahead three, four, five years or more before reasonably expecting that the odds will be on their side.  In the short run, psychology is more likely to be the driving force behind stock movements.

Bonds and other fixed income instruments are more dependable, but not necessarily more promising.  There are several basic considerations to keep in mind.  If everything else is constant, the higher the quality rating, the greater the safety.  When safety is higher, however, the interest to be paid will be lower.

Bond ratings from Standard & Poor’s range from AAA down to D.  Although a school grade of B might have been OK, bonds rated at BB or below are known as bad bonds.  It gets worse going down the scale.

Another important consideration is maturity.  The longer the maturity, the longer the time when problems may develop, which is why longer maturities generally have higher interest yields.  That is the problem we face today.

Over the last 40 years, prevailing interest rates have fallen steadily from the mid-teens to just above zero.  Barring the unlikely possibility that they will go lower (and into negative territory), they will either stay where they are or rise in the future.  When rates rise, bond prices will fall. 

The problem for investors is that the combination of extraordinarily low current rates and the prospect of rising inflation suggests the likelihood of higher interest rates over the next few years.  So in the wake of the recent four-decade rally in bond prices as rates dropped, we are facing the probability of a marked about face and far more limited worthwhile opportunities in that asset class.

For that reason and despite the greater volatility of equities, there is a concerted movement toward an increased equity component and a proportionate reduction on the fixed income side.

N. Russell Wayne, CFP®
nrwayne@soundasset.com
www.soundasset.blogspot.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: September 30, 2026

Now what? For many women, there comes a time when financial confusion reigns.   It may come after a spouse passes or a marriage goes off the rails.   It’s the same situation for women who never married. The questions are many.   The answers may be few.   Toward the top of the list of concerns is the issue of understanding.   Although there are always complex matters, it’s essential that all of the elements are clearly presented in a straightforward fashion.   There’s more.   Presentation is one thing, but comprehension is another. If there’s a question, it must be asked.   Clarity is the key.   Don’t just say I get it when you don’t.   And, it’s essential to grasp how each of the items fits in the overall situation. In the absence of understanding, no decisions will be made. Here are some of the most pressing questions? What’s the smart way to handle my investments? Where should I go for advice? A bank, stockbroker, attor...
Post a Comment
Read more

Sound Advice: September 19, 2026

Is AI good news or bad news for investments? AI is potentially very good news for investors—but not automatically good news for every investment . The key distinction is between AI as an economic technology and AI stocks at today's prices . As of September 2026, there are compelling reasons for both optimism and caution: The bullish case: AI spending remains enormous. Gartner estimates global AI spending at $2.7 trillion in 2026 , up 49.5% year over year. If AI produces sustained productivity gains, corporate profits could expand well beyond the companies currently selling AI hardware. The valuation case: Investors have already priced in a lot of success. Valuations of major AI companies are elevated and expected long-term earnings growth is well above historical norms. The spending-risk case: The five largest hyperscalers are expected to spend more than $1 trillion on AI-related capital expendit...
Post a Comment
Read more

Sound Advice: October 14, 2026

Why your adviser must be a fiduciary   You should insist that your financial adviser be a fiduciary because a fiduciary is legally obligated, when acting in a fiduciary capacity, to put your interests ahead of their own and manage conflicts of interest appropriately. Key reasons: Your interests come first. A fiduciary duty requires the adviser to act in your best interest rather than simply recommending something that is suitable or profitable for them. Fewer conflicts of interest. Some advisers can receive commissions, bonuses, or other compensation for recommending particular investments or insurance products. A fiduciary must address material conflicts rather than allowing them to drive the recommendation. Greater transparency. Fiduciary advisers generally have obligations concerning disclosure, fees, conflicts, and how they are compensated. That makes it easier for you to understand what you're actually paying. Better alignment over the long term. A good adviser sh...
Post a Comment
Read more