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®

Comments

Popular posts from this blog

Sound Advice: March 10, 2021

The ABCs of Stock Picking After decades of analyzing stocks (and funds) and investing for clients, I'm happy to share in plain English what's involved, what works, and what doesn't.  Keep in mind the reality that successful stock picking is an effort to maintain a good batting average. In baseball, a batting average of .300 or better is considered quite good.  With stock picking, you need to do better than .600, which means you have many more winners than losers. No one gets it right all of the time.  It's not even close.  Wall Street shops all have their recommended lists and the financial media regularly hawk 10 stocks to buy now. Following that road usually is a direct route to disaster.  Don't be tempted. Let's begin with the big picture: The stock market goes up and down over time, but the long-term trend is up.  When there's a rally under way, everyone feels like a genius.  When the market hits an air pocket, though, with few exception...

Sound Advice: January 3, 2025

2025 Market Forecasts: Stupidity Taken To An Extreme   If you know anything about stock market performance, you can only gag at the nonsense “esteemed forecasters” are now putting forth about the prospective path of stocks in the year ahead.   Our cousins in the UK would call this rubbish.   I would not be as kind. Leading the Ship of Fools is the forecast from the Chief Investment Strategist at Oppenheimer who is looking for a year-end 2025 level for the Standard & Poor’s Index of 7,100, a whopping 21% increase from the most recent standing.   Indeed, most of these folks are looking for double-digit gains.   Only two expect stocks to weaken. In the last 30 years, the market has risen by more than 20% only 15 times.   The exceptional span during that time was 1996-1999, which accounted for four of those jumps.   What followed in 2000 through 2002 was the polar opposite: 2000:      -9.1% 2001:     -11.9% ...

Sound Advice: June 17, 2020

Rock and a Hard Place Regardless of your age, impressions from childhood linger.  As the first days of summer approach, we all remember the feeling that accompanied the end of a school year.  Yet as much as many of us would like to believe we again have the summertime freedom to do as we wish, the reality is quite the opposite. Although months of confinement and limitations on social interaction have increased our personal discomfort and severely impacted the business community, our current situation is not analogous to the end of any school year.  It’s quite the opposite. There is every reason to continue wearing face masks, social distancing, and avoiding close contact with others.  Nothing suggests that we can modify our behavior significantly or resume patterns of daily living we enjoyed only a few months ago. There are no meaningful advances in medical treatments.  At best, there are attempts to combine different approaches...