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Inflation and Your Fixed-Income Investments Thumbnail

Inflation and Your Fixed-Income Investments

Investments

Key Takeaways:

  • When inflation fears push interest rates higher, new bonds pay more, but the value of bonds you already own can drop.
  • Duration measures interest rate risk: a bond with a 7-year duration can be expected to lose about 7% of its value if rates rise 1%.
  • Municipal bonds may be worth a look as tax rates rise, since their tax-exempt income has historically made them less vulnerable to rising rates.

Concerns about persistent inflation have pushed interest rates higher, creating an opportunity for fixed-income investors. This is good for investors with cash to invest but can be devastating to the value of the bonds you already own.

This spells trouble for investors who “reached for yield” by purchasing long-dated, long-duration bonds. “Duration” is a measure of interest rate risk. For instance, a 7-year duration implies that if rates rise by one percent, bonds with a 7-year duration can be expected to lose seven percent of their value.

Imagine owning a portfolio of 20-year duration bonds, or a bond fund that exposes your capital to that much interest rate risk, and you can see how the losses can mount.

This is exactly what is happening now as the yield on the benchmark 10-year Treasury has risen abruptly from 4.2% to 5.3% in a number of months. Unpleasant surprises abound as investors review their monthly statements.

A financial advisor who fails to truly understand interest rate risk, and how quickly it can deliver devastating losses to a bond portfolio, can cost you far more than their annual fees. An advisor with extensive fixed-income experience can tailor the right balance between return and interest rate risk to meet your needs without unpleasant surprises.

Rising rates aren't the only thing investors need to plan for, because tax rates can change, too. Tax-free municipal bonds can be a haven for those who value tax-free income. As yields rise, attractive opportunities may be appearing. Municipals can become more attractive when tax rates rise. Moreover, tax-free bond valuations have historically been less susceptible to the ravages of rising interest rates because the coupon cash flow is tax exempt.

The bottom line in fixed-income investments, as with all investments, is to understand what you own and how it can be expected to perform in various scenarios.


About Edward P. Mahaffy, MBA, CFP®, ChFC®

Ed founded ClientFirst Wealth Management in 2007, after more than 23 years in the wealth management industry. Prior to launching ClientFirst, he spent 6 years as a portfolio manager and branch manager with Raymond James, 6 years as a vice president and portfolio manager with Merrill Lynch, and over 11 years as a financial advisor and fixed-income portfolio manager with Stephens, Inc. 

Designated as a Certified Financial Planner and Chartered Financial Consultant, Ed holds a Bachelor of Science in Business Administration from The Citadel and earned his MBA from the University of Arkansas. He is also a member of the Financial Planning Association (FPA). Ed has had articles published in The Arkansas Banker as well as Barron’s magazine and is a member of the National Association of Personal Financial Advisors (NAPFA). He is also the author of How to Select a Financial Advisor: The Least You Should Know. ClientFirst Wealth Management was recently named one of the 2020 Top Financial Advisor Firms in Arkansas list by investor.com. At ClientFirst, Ed is president and senior portfolio manager. 

Disclosures

The views expressed represent the opinions of ClientFirst Wealth Management, LLC (“ClientFirst”) and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. 

Additional information, including management fees and expenses, is provided on ClientFirst’s Form ADV Part 2, which is available at https://adviserinfo.sec.gov/firm/summary/120286


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