Earning season has come to an end. Corporate profits were decent and interest rates have risen. Now, if the economy and jobs begin to pick up, we may begin to see the Federal Reserve “take its foot off the gas,” slowly pumping less money into the financial system.
I am not going to predict what is going to happen. But just as you would be prepared with an umbrella if there was a chance of rain, you should take the necessary precautions in your asset allocation strategy if certain scenarios play themselves out. One such scenario is the possibility our economy is beginning to create jobs which lowers the unemployment rate. We thus become less reliant on the Fed. The market is already hinting that this is going to happen as the 10 year bond has increased to 2.85% since Bernanke’s “taper” talk. Money has begun to flow out of fixed income, and either into equities, or into cash for future opportunities. Obviously if all the outflows from fixed income were to be invested in equities, we would likely be much higher than 1650 on the S&P 500. That means many investors are sitting on cash.
While we currently recommend an underweight position in some fixed income sectors, in our view the fixed income asset group continues to play a key role in well-diversified investment portfolios. Not only do fixed income investments help to offset volatility in other asset groups such as equities, they also have delivered significant long-term returns over time and are an important source of income for many investors. Further, the fixed income sector has become more attractive recently as bonds have begun to offer returns that exceed the inflation rate.
To understand interest rate risk on bonds, you first need to know that interest rates act inversely to bonds prices. So when interest rates go up, bond prices go down, and vice versa. In order to minimize interest rate risk, you can actively manage duration. By investing in shorter duration bonds, investors can capitalize upon opportunities to reinvest at higher rates when interest rates rise. Establishing an individual bond ladder will lessen interest rate risk, especially if you hold your bonds until maturity. At maturity you will receive principal plus any interest earned along the way. Having a bond ladder will spread out the maturities so as the short term bonds mature you can reinvest at higher rates. At RMR, we can create a customized bond laddered portfolio just for you.
Please contact John J. Fiorito at 212-785-4377 to find out how setting up a bond laddered portfolio can mitigate interest rate risk, especially in this current low yet rising interest rate environment.
John J. Fiorito
Securities offered through Dinosaur Securities, LLC Member FINRA, SIPC, NFA.
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