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®


Popular posts from this blog

Sound Advice: May 13, 2020

Reality Check

On the heels of the market plunge of late February and most of March, investors did a sharp about-face in April, bidding up shares at one of the fastest rates in recent history.  Although this recovery probably provided at least temporary comfort from the plunge, it would be unreasonable to view the rebound as a sign that things are all better.  They are not.
For one thing, we are now in the midst of earnings reason, when companies report their quarterly results.  Some may have good news for the March quarter, but as we move through the current calendar quarter, only a few will be able to show continuing improvement.  Against the broad backdrop of U.S. business history, the months just ahead will almost certainly prove to be among the worst, from the standpoint of year-to-year comparison.
With more than 30 million people filing claims for unemployment insurance, it would be difficult to expect anything other than bad economic news.  Who knows how many of these folks will go…

Sound Advice: July 15, 2020

“An ingenious modern game of chance in which the player is permitted to enjoy the comfortable conviction that he is beating the man who keeps the table.” Ambrose Bierce
One can only marvel at the broad scope of insurance schemes created in the pursuit of fat commissions for insurance agents.  From the simplest plans, such as whole life, to the ultracomplex, which no one understands but promises to provide rewards beyond one’s wildest dreams, it’s an area where fear and greed work together to soften the brain of the buyer and enrich the pocketbook of the seller.  
There are certainly risks requiring the protection of properly selected insurance, but the range of products developed to generate hefty ongoing profits is ever-expanding.  The industry continues its efforts to stay ahead of people who are struggling to understand what these products are and why they need them.
One example is life insurance, which has numerous permutations.  Life insurance is needed to provide protection…

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 that might speed up recovery.  The hoped-for vaccines are st…