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: July 8, 2020

Jobs Are Up, But So Are New Infections Through the spring months, m ost of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent. We are now in a recession.   The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimo
Post a Comment
Read more

Sound Advice: December 13, 2023

What You Need To Know About Long-Term Care Insurance Long-term care insurance (LTCI) is a type of insurance that helps cover the costs of long-term care services, such as assistance with activities of daily living (ADLs) such as bathing, dressing, and eating. It can also cover the expenses associated with care in a nursing home, assisted living facility or at home by a professional caregiver. Here's what you need to know about long-term care insurance: 1. Not Covered by Health Insurance or Medicare: Long-term care services are generally not covered by health insurance or Medicare, which only provide limited coverage for skilled nursing care and rehabilitative services. Medicaid covers long-term care, but you need to meet strict income and asset requirements. 2. Costs of Long-Term Care: Long-term care can be expensive and can quickly deplete your savings. LTCI helps to cover these costs, providing financial security and ens
Post a Comment
Read more

Sound Advice: December 6, 2023

Some Suggested Financial Adjustments for Retirees Financial adjustments for retirees are crucial to ensure a comfortable and secure retirement. Here are some worthwhile financial adjustments and considerations for retirees: 1.      Create a Budget: Establish a realistic budget based on your retirement income and expenses. Categorize your spending and prioritize essential expenses such as housing, healthcare, and groceries. 2.      Emergency Fund: Maintain an emergency fund to cover unexpected expenses. Aim for at least three to six months' worth of living expenses. 3.      Healthcare Costs: Be sure to fully understand your healthcare coverage and consider supplemental insurance plans to cover gaps in Medicare. Account for potential long-term care expenses as well. 4.      Minimize Debt: Aim to pay off high-interest debt before retiring. This can significantly reduce financial stress and free up more of your retirement income. 5.      Investment Diversification: Div
Post a Comment
Read more