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Speaking About Fixed Income Thumbnail

Speaking About Fixed Income

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I have been invited to speak at the “It’s Your Money!” seminar series several times over the last 10 years. These workshops cover the basics of financial planning, equity investing, fixed income investing, mutual funds, annuities, and more. Because the classes are taught by invited fee-only advisors, attendees are spared the predatory sales practices commonly used in the industry. (Sorry, no “free” steak dinners are provided.) The founder of the IYM series, Pete Kote, received the Financial Planning Association’s “Heart of Financial Distinguished Service Award” for his role in creating and running these workshops.

This month I was asked to teach their Fixed Income Investing course in both Fullerton and Mission Viejo. The facilities were very comfortable and there was a good-sized group of attendees. Each site has a moderator who makes introductions, keeps the speakers in check, and provides additional insight into the topic.

Fixed income (aka bonds) investing is admittedly not the most exciting topic. However, given today’s low interest rates and the public’s hunger for safe returns, I see many folks that are reaching for yield without understanding the risks they have added to their portfolio. This makes this topic one of the more important ones in the series!

Allow me to highlight some of the most important points I made during these talks:

  • Bond returns are lower when interest rates rise

The chart above shows the historical interest rate of 10-year government bonds. The numbers are too small to read, but rates were close to 4% in the 1960s, jumped to over 15% by the early ‘80s, then dropped to 2% by 2012, and have since risen slightly to today’s 3% rate. Total returns in the rising-rate environment were around 3.2% (during the yellow lined period). Total returns in the falling rate environment were around 8.1% (during the green lined period).

  • Many bond alternatives are not good alternatives

Frustrated investors have reduced their bond positions and purchased what's been sold as “bond-like” investments in hopes of getting better returns. It’s true that there are investments which provide income that is higher than most bonds, but they do not have the same safety characteristics that bonds provide. You can see in the chart above how bonds performed well in our last bear market (2008) while the bond alternatives lost 23% to 48% of their value. Bonds provide the safety net in investment portfolios - do not work without a net.

  • Bond market returns are predictable

This is one of my favorite charts from the presentation. The blue line shows the 10-year bond’s interest rate while the yellow line shows the total return of these bonds over the subsequent 10-year period. As you can see, the lines are nearly identical. When interest rates are high, subsequent returns will be high. When they are low (like today), subsequent returns will be low. This chart tells me that bond returns will be around 3% over the next 10 years. 

The bottom line: pay attention to your fixed income holdings to make sure it's going to do its job when the stock markets get bumpy again.

Are you looking for professional advice on how to manage your fixed income investments?  Get in touch with me.

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