USA TODAY International Edition
Fixed-income investments cut risks
Bonds, CDs offer revenue stream
Dennis Shirshikov, a financial analyst with entrepreneurship website FitSmallBusiness.com in New York, manages a portfolio for himself, one for his parents and one for his two small children.
In each portfolio, Shirshikov, 29, has some fixed-income investments for different reasons.
Nearly 80% of his parents’ retirement portfolio is invested in fixed income so they will have a relatively stable income stream when they stop working. Roughly 40% of Shirshikov’s investments are in fixed income securities because they make his portfolio more resistant to fluctuations in the stock market. Only about 10% of his children’s portfolio is invested in fixed income assets while the rest is invested in stocks.
“My kids are very young, so it makes sense to hold more risky assets today to potentially grow the portfolio more quickly,” he says.
Like Shirshikov, many investors depend on fixed income as an essential part of their investment strategy. Fixedincome investments are those that generate a payout of interest on a set schedule and the return of the principal investment when the bond matures. Types of fixed-income investments include bonds, certificates of deposit (CDs), money market funds and fixed annuities.
The key purpose of including fixed income in a portfolio is to reduce risk, says John Hagensen, founder and managing director of Keystone Wealth Partners, an investment advisory firm with offices in Arizona and North Dakota. They provide some stability to offset the potential highs and lows of stocks. Since they pay out at predetermined dates, they also can provide a predictable stream of income. Some fixed income products, such as municipal bonds, have tax advantages.
While fixed-income investments aren’t as risky as stocks, no investment product is 100% safe. For example, a bond issuer can default on owed payments. Also, some fixed-income investments are riskier than others. However, there is an upside to taking on more risk: Generally speaking, the higher the risk, the higher the yield or rate of return.
Riley Adams, 30, of Pleasanton, California, chose fixed-income assets that carried more risk when he purchased small fractions of ownership in borrowers’ consumer loans through the investment platform LendingClub. The return he received on his investment came as borrowers repaid their loans with interest.
“I chose to invest in these instruments because they provide lower risk than investing purely in stocks, but they still provide a good return above what you might receive in government bonds,” says Adams, who shares some of what he’s learned through investing on his blog Youngandtheinvested.com.
As investors consider the right portfolio mix, one thing to pay attention to is the interest rate environment. When interest rates rise, any bonds you own lose value. Say you own a bond with a 4% yield and interest rates rise. When you’re ready to sell your bond, it won’t be worth as much because investors may now be able to invest their money in newly-issued bonds with a higher yield, thanks to the higher interest rate environment.
Rates have been rising in general, with the Fed hiking interest rates nine times since 2015. However, the central bank has become more cautious about lifting rates, of late, and inflation remains low. But Hagensen recommends taking a more long-term approach. “We’re in an interest rate environment that is historically low. There’s much more room for them to go up than down,” he says.
Buying short-term bonds can be prudent in a rising interest rate environment, Hagensen says. “If rates rise and six months later your bond matures, you get your money back and can get a new bond at the better interest rate.”
While you can’t predict whether interest rates will ultimately rise or fall, experts offer some general guidelines for making fixed-income assets work.
Don’t chase returns. Be careful about taking on too much risk just to get a higher return. “As an investor, you have to be willing to accept lower rates of return in exchange for the trade-off for stability,” Hagensen says. “That’s why you’re buying fixed income to begin with.” Stay true to your personal goals. “Ask yourself, ‘Where am I in life? How risk-tolerant am I?’” says Richard Carter, vice president of Fixed Income Products for Fidelity. Those answers can help you come up with a suitable mix of cash, fixed-income investments and stocks. Diversify your fixed assets. Just as you’re advised to diversify your entire portfolio, create balance within your fixed-income assets, Carter says. That may mean investing in fixed-income products with varying levels of risk. It also may mean buying fixed-income products that mature at different times since generally speaking, those that take longer to mature tend to have a higher yield and a higher risk.
Keep things in perspective by remembering that fixed income is just one part of your overall plan.