So we’re playing a game and your score is higher than mine. Time to celebrate? Not so fast. What if the game we’re playing is golf? Of course knowing the game was critical to your evaluation. In the investment world, keeping the right score is imperative and that is best done when knowing what you’re evaluating. Things sound the same, terms are used loosely and sometimes it can mess with how we assess the situation.
One common mistake is the direct comparisons between stocks and bonds. For many investors, stocks represent growth assets; assets with potentially more volatility, ups and downs, risks and rewards. A stock is often purchased with appreciation in mind (buy low, sell high). If we are scoring, we want total return rewards: income + appreciation. Bonds, on the other hand, are often bought for their more conservative characteristics which provide defined cash flow and income. They are regularly held to maturity. If we are scoring, we want the fixed income and cash flow (notice the absence of appreciation). This is not typically a total return holding. It’s not that one wouldn’t welcome a nice looking market price showing a gain on paper, it’s just that a buy and hold strategy dictates that we seldom take the gain (or loss for that matter) and instead hold the bond for the healthy income it is providing (as well as the hedge or offset to growth assets).
The crazy scoreboard often has us focused on scoring what is not really important for our financial well-being. As yields start to rise, there is plenty of attention brought to how the bond portfolio prices will fall. If you’re keeping your scorecard meticulously, this just isn’t where the focus should be for many fixed income investors. Although it is true that rising interest rates will lower the prices on bond holdings, it won’t matter if those holdings are held to maturity. In other words, the market movement will not affect the cash flow or income on your holding as long as it is not sold prior to maturity. This upholds our methodology of focusing on the important aspect of why many of us hold fixed income.
Perhaps what most buy-and-hold investors should be focused on is not that prices have fallen on bonds intended to be held to maturity, but that higher interest rates are creating a new opportunity for cash flow and additional funds be invested in higher yields! Rising interest rates translate into higher future income, a welcome attribute for most investors.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.