Bonds have historically been a good way to balance a portfolio and negate stock market volatility, but 2018 may prove to be the year to exercise caution and diligence.
“As a 40-year veteran in the investment industry, the current environment is probably the most precarious I have ever experienced,” says Clifford Caplan, a certified financial planner at Neponset Valley Financial Partners in Norwood, Massachusetts.
That’s because the Federal Reserve has indicated it could raise rates in December and possibly several more times throughout 2018, says Dean Myerow, a municipal bond portfolio manager at Las Olas Wealth Management in New York. If that happens — say, up to a full percentage point — then bonds purchased today may be less desirable in the future. And that means you’d be better off buying new bonds in the marketplace than maintaining the low rate locked into a bond today.
[See: 7 of the Best Stocks to Buy for 2018.]
Still, bonds should be part of anyone’s portfolio, advisors say.
“A couple benefits of holding bonds is they provide you with portfolio stability and income,” says Michael Shea, a financial advisor with Applied Capital in Nashville, Tennessee.
“Typically, they are less risky, and therefore less volatile, when compared to stocks,” he says. “Bonds can be used in conjunction with stocks, as there is less correlation between the two, dampening the ups and downs of your portfolio. As with anything else with investing, diversification needs to be a top priority.”
Before selecting or buying bonds, however, consider the following suggestions from investment analysts and experts:
Analyze all the options. Like any security, there are many options when it comes to bond investments, and they are not right for everyone. When compared to a low yielding money market fund, interest bearing bonds are attractive to some investors, Myerow says. Others prefer short-term bonds, or those with maturities in less than five years. Longer term bonds will yield more income, however.
Some investors prefer kicker bonds, which tend to “absorb interest rate moves better due to their short durations,” Myerow says.
Higher coupon bonds, while priced at a premium, can offer better market protection and value preservation when interest rates rise, says Jason Ware, co-founder of 280 CapMarkets in Silicon Valley.
Create a bond ladder in your portfolio. Buying individual bonds with maturity dates is a good way to know your capital will be returned, and the current yield is about 2.1 percent.
“As rates rise investors will be able to capture even greater yields,” says James Demmert, founder and managing partner of Main Street Research in Sausalito, California.
Because long maturity bonds (15 to 30 years) don’t return capital for a long time, these bonds often decline in value, rattling even the most disciplined long-term investor, Demmert says.
Bond laddering means that a client would have a bond maturing every year for a period of time, therefore balancing the risk and returning capital gradually, Wright says. “If rates rise, every year we have a portion of the bond portfolio maturing which we can reinvest at higher rates,” he says. “If rates go lower, we have a portion of our bond portfolio at the longer end of the ladder that has locked in the higher rates.”
This allows for cash to become available to meet client spending needs and ride out any market volatility.
[See: 7 of the Best Dividend Stocks to Buy for 2018.]
Are you in it for the long term? If you are a buy-and-hold investor, then interest rate fluctuations might not be a big deal, Myerow says.
“This investor outlook is based on the premise that the bond investor will get their monthly or semi-annual interest payments on their investment and get their principal returned to them upon maturity of the bond,” he says.
Bonds that can be sold prior to their maturity are more subject to market conditions, making them best for long-term investors. Because bonds are not big on growth, investors should ask whether their cash could be better used elsewhere and how long they are willing to tie up their money in bonds, Myerow says.
Examine the quality of each bond. Bond maturity is important, Myerow says. Bond funds without maturity dates, such as bond mutual funds and bond exchange-traded funds, decline in value when rates rise, Demmert says.
Other market factors, such as pressure on credit-related and high-yield bonds, has resulted in more risk than usual, Caplan says. Because of this, Caplan prefers different types of fixed-income investments, including mortgages, municipal and emerging market bonds.
Wright says other choices include corporate, municipal and other government bonds, as well as incorporating some international bonds. “We find that they have a very low correlation with many other investments, so they are a nice diversification vehicle for our client portfolios,” he says.
However, investors should avoid extreme ends of the credit rating spectrum says Michael Temple, director of credit research at Amundi Pioneer in Boston. He suggests investing in A, BBB, BB and B securities as a balance.
[See: 7 of the Best Energy Stocks to Buy for 2018.]
“If you buy bonds, you are willing to hold to maturity without the need for liquidity [and] secondary market fluctuations don’t mean much,” Ware says. “Why? Because, as the bonds mature, your principal will be returned as long as you are invested in quality credits.”
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4 Things to Consider Before Investing in Bonds originally appeared on usnews.com
