Strategic vs. tactical

Doug Drabik discusses fixed income market conditions and offers insight for bond investors.

You are trying to assemble a crib. It’s a nice crib with all the looks and functionality expected. You’re also handed assembly instructions, only to find that they are for assembling a table and chairs. There’s nothing wrong with the instructions, nor is there anything wrong with the crib. They’re just not the proper match to get your crib functioning appropriately.

A significant amount of public financial information is disseminated, but knowing the intended audience is crucial before digesting its content. The volume of Armageddon-like articles seems to be on the rise, and the general underlying assumption often implies that all investors are thinking tactically 100% of the time. Tactical investing is aligned with a trader’s investing mentality. Timing the market is crucial, and outperforming an index is often the goal. Constant price observance and accurate predictions about the future will hopefully enable the skilled participant to outperform the averages by actively buying and selling at the right time.

The truth is that many investors utilize fixed income (bonds) as a ballast for their portfolio, primarily to protect their wealth (strategic use, not tactical plays). This typically means that they are holding investments to maturity. A recent article highlighting a well-known and successful financial pundit mentioned that in September 1994, a significant portion of the bond value was lost due to market movements. What they should have said is that a substantial amount of paper value was lost. Those who continued to hold bonds saw no disruptions. Bonds continue to pay the same interest and provide the same cash flow despite interim price changes. Only a default or the sale of the bond disrupts this process. Since most Raymond James investors utilize high-quality investment-grade credits, defaults are unlikely. Selling ahead of maturity is controlled by the investor. This highlights the difference between strategic and tactical investing. These economic phenomena create a challenging environment for profitable tactical trading yet have no discernible impact on strategic investors who hold individual bonds to maturity as part of their long-term strategy.

When articles quote strategy from well-known, successful financial minds, it is natural to cling to their advice with the assumption that mimicking their behavior sets you on an equally prosperous path. However, persons of great financial wealth can withstand losses and pullbacks that can make an average person bankrupt well before reaping the benefits of a tactical financial move. They often address trading strategies, which can differ significantly from long-term strategic portfolio positioning. What they are saying is likely sound and appropriate, but for a particular audience. In essence, they may be the wrong instructions for the fixed income allocation that best suits your long-term strategic goals.

If you are certain that future interest rates are headed north, it is tactically better to stay short in anticipation of getting higher yields down the road. However, most of us can’t predict the future given the enormous number of variables, including economic data, fiscal and monetary policies, consumer sentiment, geopolitical events, and domestic politics. What we do know is that rates have been elevated for the past 1.7 years, compared to the previous 15 years. We know that locking into 5% to 8% taxable equivalent yields is comparable to long-term growth (equity) returns. This level of income can help to grow wealth while also protecting capital.

The matching strategic plan for many investors often uses a strategic plan. One where holdings perform the same way on day one, day one hundred, and every other day - predictable income, cash flow, and a known date when the face value is returned. Strategic and tactical language may be correct, but before putting this advice into action, ensure it is tailored to address and match your situation.

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.