Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
An important distinction must be made between income and cash flow. Income is what your investment earns. If you put $10,000 into an investment and accumulate $11,250 over a 5 year period, you earned $1,250 ($250 per year or a 2.50% yield).
This math does not change when you pay a discount, par or premium for a bond. Income accumulated is the difference between what you put in and what you pull out of a security over any period of time.
When interest rates are low (like now), some investors require more cash flow than income can provide. Cash flow is coupon times the face value of the security. On a par ($100 price) bond, income and cash flow are the same. On a premium bond, cash flow represents income plus return of principal. A premium bond’s cash flow includes income plus return of principal; therefore, cash flow is greater than on a par bond.
A higher cash flow does not necessarily mean you are earning more income, it just accelerates the pace principal is returned. That means more cash flow to meet your needs. Those needs could include reinvesting more of your money sooner rather than waiting for it to mature or it could be providing sufficient cash to pay the rent. In the case of a premium bond, if you spend all of your cash flow, you are spending all of the income plus a portion of your principal.
You are using your principal, not losing it. IRA accounts are often strategically constructed to provide for your retirement needs. Using part of your lifelong savings to do this can be part of your strategic portfolio plan. For investors with higher cash flow needs than the market currently provides in income, high coupon bonds can deliver that cash flow, regardless of interest rates.
Executing higher cash flow plans can be done in many ways. Corporate traders’ insight reveals investment grade corporate bonds in the telecom and industrial sectors around 2028-2035 have been providing opportunities for greater cash flow in higher coupon bonds. Longer holding periods allow for continued cash flows.
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.
Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.