by Jeremy S. Mitchell, CFP®
A recent jump in interest rates has caused bond values to decline, prompting investors to re-evaluate the use of bonds in their portfolios.
- Remember the purpose of bonds in the context of a fully diversified portfolio
- Review and recommit to financial goals
- Take risks worth taking: focus on high-quality, short-term bonds to mitigate unexpected interest rate moves
Investors’ bond holdings have been hit by a jump in interest rates this spring. As equity markets continue to reach new highs, investors are naturally attracted to better-performing stocks. Both taxable and municipal bond funds experienced net-outflows for the quarter ending June 30, 2013 for the first time in years, reflecting a meaningful shift in investor appetite for risk.
Despite a rising-rate environment presently, investors would do well to follow a few meaningful steps when evaluating their use of bonds in their portfolio.
- Remember that bonds play a key role in diversifying one’s investment portfolio. Bonds tend to behave differently than stocks in different market and economic environments.
- Bonds’ reputation for principal safety cause them often to be less volatile in price than stocks over time, and can thus reduce a portfolio’s overall volatility. Risk-averse investors who have been frightened by the stock market gyrations of the last several years may find a meaningful allocation to bonds helps them endure stock market storms.
- Investors would do well to take risks worth taking when considering the bonds they choose to include in their portfolio. Studies have shown that allocating to short-term, high-quality bonds has historically had a better risk-reward profile than longer-term, lower-quality bonds. Further, today’s uncertain economic and interest-rate environment compounds the case for focusing bond allocations towards short-term, high-quality bond holdings.
- Investors are uneasy about maintaining purchasing power with their bond allocations due to current low coupon rates. If inflation in the future is higher than expected, purchasing power could suffer. The solution to this risk may be to include Treasury Inflation Protected Securities (TIPS) as a part of one’s bond allocation. TIPS are issued by governments around the world and generally have a lower coupon payment when compared to other traditional bond holdings. Issuers of TIPS compensate investors by guaranteeing additional payments of interest and principal adjustments based on actual changes in inflation measurements. Thus, investors who choose to own TIPS can protect their purchasing power against unexpected inflation.
While investors cannot escape all forms of risk in their portfolios, they can choose to take measures to mitigate those risks through prudent allocation decisions. Remember that diversification across different kinds of assets is key to prudent risk management across all market conditions.
Securities and advisory services offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Diversification and asset allocation do not ensure a profit or protect against loss in a declining market.