Allocating to fixed income within a financial plan that takes into account a client’s goals and risk tolerance should not be significantly impacted by a quarterly decline that happens less than 2 percent of the time.įinally, remember that forecasting interest rates is a game of chance. Also, they are one of the few assets that provide protection in a recessionary environment. They still are far less volatile than equities and provide diversification from credit risk (high yield, private credit and equities). The case for high-quality bonds in a diversified portfolio remains valid. This quarter has been difficult, so acknowledge it, put it in perspective and move forward. One bad quarter should not lead to wholesale changes to a well thought out financial plan.įor those who are a fans of the tv series Ted Lasso, you’ll know the phrase, “be a goldfish,” which roughly means forget about those things you can’t control and move forward (a goldfish has a short memory, so it moves past things quickly). However, overly focusing on a bad quarter is counterproductive to allocating risk and positioning a portfolio for the future. Any unintended underweight/overweight can now be discovered and remedied. A portfolio that performs in unexpected ways may be out of alignment on a duration, curve, credit, volatility or liquidity basis. However, if the portfolio was underweight duration and underperformed you should investigate further. If your bond portfolio had a longer duration than the benchmark and it underperformed, that is to be expected. This was the third worst quarterly return for the Bloomberg Barclays Aggregate Index going back to 1976, but it provides an opportunity to identify whether a fixed income allocation or portfolio performed as expected. As a result, if they are high-quality and mature at par, there is a natural progression back to the issued value of the bond. Keep in mind that unlike stocks, bonds have contractual maturity dates. How does it close the gap? It compounds at a 3 percent rate going forward. Yet we know the bond will still be redeemable at par ($100) on its maturity date. Your bond is now less attractive to buyers and the price declines to $95.398. Now let’s say rates rise the next day by 100 basis points to 3 percent. Assume you purchase a 5-year Treasury bond with a 2 percent coupon that matures on Apat $100 (par). This means that with every dip in price, a high-quality bond’s internal rate of return increases. In the high-quality fixed income space, impairment or default is extremely rare. In simple terms, the decline may be warranted because prospects for future earnings growth may have weakened and are unlikely to improve quickly enough to justify previous valuations. What do I mean by that? A correction in equities can be sparked by earnings impairment, as well as other factors. Here’s my take on buying the dip: if buying the dip in equities has become a meme, buying the dip in fixed income is math. Also noteworthy is the way equity drawdowns have evolved during the past 10 years as “buy the dip” has become common practice for many equity investors. A correction in fixed income is significantly shallower and tends to be over much sooner than an equity correction. Differences in drawdownsīeyond the size of the drawdowns, there are a few other differences to highlight when looking at high-quality fixed income versus equities. So, while investors may feel burned by the recent move in fixed income, it is more like a sunburn compared to the scalding stocks have occasionally delivered during the past two decades. For example, since 1999, the S&P 500 has had two drawdowns of greater than 50 percent and several more of 20-plus percent. Compared to volatile asset classes such as stocks, the drawdown is an unpleasant blip rather than a seismic jolt. While the immediate sting felt by bond investors is real, it is important to view it in the broader context of a diversified portfolio. Educational Resources About Family & Work.Educational Resources About Everyday Money.Educational Resources About Financial Planning.Disability Insurance Calculator Money Parachute icon.Disability Insurance For Doctors and Dentists.
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