Fixed income is different from many other types of investments yet it is difficult to recognize some of the differences or change the mindset required to prepare strategically for optimization of your investment portfolio. The following are a few thought provoking fixed income characteristics worthy of consideration.
Long term vs. short term planning: Many investments rely on the ability to move in-and-out of the market and capitalize on volatility in short order. Individual bonds are often purchased with the intent to hold-to-maturity where market timing and prognosticating are lessened in importance.
Income vs. total return: Many investments, such as stocks or real estate, rely on appreciation as the key component of return. Individual bonds held-to-maturity provide predictable income and are not reliant on price changes during the holding period.
Stated maturity vs. perpetuity: Many investments have no maturity and rely on the expectation of a favorable market price with no future guarantees. Individual bonds undergo pricing moves but gravitate to par as they approach their maturity.
Yields: Many quoted yields on equities and fixed income packaged products cannot provide an accurate holding period return because future prices and cash flows are unknown or fluctuate. Many fixed income securities have a constant cash flow and stated maturity and therefore can provide a much more accurate yield calculation.
Net vs. Gross: A transaction acquired individual bond reflects a net yield (what you see is what you get). Most other dealings reflect a gross yield, meaning the future fees and/or charges will reduce the quoted yield.
Tailor-made vs. packaged or grouped: Packaged products or managed money will often follow specific guidelines in pooling a portfolio with many bond characteristics which are intended to either match a broad range of investor’s needs or an index. Individual bonds can be very specifically designed to match exact investor needs. Moreover, the timing, selling, adjusting, purchasing, coupon choice, cash flow schedules, and credit exposure can be 100% controlled by the investor to meet very specific requirements.
Net Asset Value (NAV) vs. Market Price: NAV represents a share of a fund’s assets and an investor is subject to whatever the NAV is at the end of the day to calculate their worth. Although the underlying investments have stated maturities, the fund does not and therefore an investor’s principal is subject to the NAV indefinitely. Market price is where a bond can be bought or sold during market trading hours. Although an individual bond’s market price is subject to change, individual bonds have stated maturities and therefore if held to maturity and barring default, an investor will receive the face value of their bond at maturity regardless of the price fluctuations experienced during the holding period.
Tax Loss Swaps: As the year nears its end, many investors seek tax losses to offset gains. With both the stock market and bond market rallying this year, gains may be plentiful. Keep in mind that the price of comparison is generally between your cost basis and market price (not the purchase price and market price).
Actively Managed vs. Passively Managed: Actively managed portfolios (one with a manager making decisions) have shown no long term return advantages to passively managed portfolios that do not pay management fees or charges.
Perhaps the biggest hurdle some investors face is understanding the distinctions between different portfolio asset allocations. The media, and even many investment professionals, confuse investment choice by blending growth asset characteristics and goals with those of wealth preservation assets. The purposes of each are quite different as highlighted above. For deeper understanding and to adapt your investment goals and needs, please contact your advisor to explore and uncover your best plan of action for your portfolio’s fixed income allocation.
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.