Who, Why, What, Where?
Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Who should invest in individual bonds? Any investor that is not focussed solely on growth should maintain an allocation in individual bonds. Many asset classes rely on their total returns to build the portfolio’s wealth. Investors buy a $10 stock because they believe it will appreciate to a market price of $15, $20 or even more. Although individual bonds may benefit from the appreciation component of total return, the primary benefit is protection of wealth. Generally speaking, a portfolio of individual bonds can be diversified when it currently is or is likely to be $200,000 in value (no more than 5% dedicated to any one obligor).
Why individual bonds? Individual bonds offer a protection for wealth that does not exist in most other investment options: a maturity date. What is so magical about a maturity date? During the holding period of an individual bond, interest rates may fluctuate up or down, thus a bond’s market price may move up or down. Demand or lack of demand may shift market prices. Supply can lessen or become plentiful. None of these events change the cash flow, income or point in time that an individual bond will pay back its face value.
There are only two events that can prevent an individual bond from performing exactly as it is intended to from the moment of purchase until its maturity: 1) An outright default. This would be a highly unlikely event when purchasing high quality investment grade assets. 2) Selling a bond prior to its maturity. By selling ahead of a maturity date, an individual bond is subject to whatever the prevailing market price is (which could be higher or lower than the purchase price).
What bonds? Individual bonds, ETFs containing bonds and Fixed Income Bond Funds all contain individual bonds, yet only individual bonds have a stated maturity; therefore, only individual bonds provide the unique principal protection with defined risk when held to maturity. Investors always have the option of holding individual bonds to maturity, thus eliminating any market price risks. Market events become mere background noise which do not affect cash flow, income or the point in time face value is returned. This creates a very powerful impact on the base or portfolio’s investment foundation.
Where should I invest? This can be a moving target based on an individual’s specific situation, risk profile and overall objectives. A 26 year old may take on different market risks than a 76 year old. An ultra conservative investor will have a more narrow scope versus someone less risk averse. An investor with children may have unique liquidity needs.
Another advantage of individual bond investing is the ability to custom design the bond allocation assets to fit all these distinctive considerations. A team of fixed income experts stand behind your investment advisor to help guide the process.
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.