Inflation and Your Fixed-Income Investments
The recent threat of rising inflation has caused interest rates to rise, providing 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”, 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 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 owning a bond fund exposing your capital to such interest rate risk, and you can see how the losses can mount.
This is exactly what is happening now as the interest rate on the benchmark 10-year maturity treasury bond has risen abruptly from 0.5% to 1.75% 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 way more than their annual fees. Conversely, an advisor with extensive experience in fixed-income markets who can tailor the right balance between return and interest rate risk to meet your needs without unpleasant surprises.
In addition to rising interest rates, it would appear that investors will soon face income tax increases. Tax- free municipal bonds provide a haven for those with a tax-free appetite. Yields are rising and attractive opportunities are again cropping up. Municipals will only become more attractive as tax rates rise. Moreover, tax-free bond valuations are historically not as 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
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