Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Sometimes things sound the same, look the same, or feel the same – but they are not. It doesn’t necessarily mean one is better or worse than another but uniquely dissimilar and serving unlike purposes. For long-term strategic financial planning, this may prove to be the distinction in delivering strategic success. Let me explain.
Everyone seems to be jumping on the bandwagon. The title of an ad caught my attention this weekend urging readers to diversify their portfolios by adding bonds into an ETF. There are many bond products and they are not all the same. At Raymond James, we talk about fixed income strategy and its role within your investment portfolio all the time. Bonds are part of many investors’ portfolios. Investors are usually advised to carry some mix between bonds and stocks depending on individual goals. There are many products that have bonds in them including ETFs, bond funds, and of course individual bonds. Yet, although these products seem the same, they have some very distinct differences. Perhaps the most defining difference is that individual bonds have a stated maturity. So what? Why is this so “defining”?
To answer this I’m going back to a basic concept of fixed income. As interest rates go up, prices of bonds go down. Conversely, as interest rates fall, prices of bonds go up. When held to maturity, this concept ultimately has no effect on only one of these product categories – individual bonds. This is because individual bonds have a maturity date. Here is the tricky part. Market prices on bonds continue to change over the life of a bond. So an investor holding an individual bond might see a loss or a gain on their monthly investment statement. However, as long as an investor holds that bond to maturity and barring an outright default, the investor will never realize that profit or loss and the income earned and cash flow received remain the same for individually held bonds from the purchase date to maturity. Equally as important, there is a specific date when the face value of the bond is returned to the investor.
Interest rates are at levels not seen in more than a decade so it is understandable that many mantras are calling for more bonds in the mix. Many portfolios comprise a percentage of bonds for the primary purpose of protecting the principal. With interest rates elevated, investors have the opportunity to not only protect the principal but to contribute meaningful income. Individual bonds have a stated maturity, thus a way to protect the principal in a way other products don’t. In addition, individual bonds benefit the same from elevated income opportunities. So you see, details do matter!
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.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.