As investors begin looking at their monthly account statements they are seeing both taxable and tax-free bond portfolios going down in value. I would like to take some time to discuss the cause, and even talk about some proactive opportunities that investors have regarding these portfolios.
The Federal Reserve announced in November 2021 that they would start raising short term interest rates in March 2022. At year-end of 2021, taxable and tax-free bonds showed weakness in price as investors took profits and began trimming down their exposure to bonds. The Federal Reserve raised short term rates .25% in March, and again .50% in May all the while shifting to a tight money supply to instigate a slow down of economical growth and inflation. The Federal Reserve recently announced another .50% increase in June.
Bonds play an important role in an investor’s portfolio by offering capital preservation; income for cash flow and diversification for your investment portfolio.
When this report was being prepared, global equity funds saw the fifth straight week of money outflows. The outflow from the tech sector was the largest year to date; while outflow from investment grade and high yield debt was the largest since 2020. The DJIA is down 12%, the S&P 500 is down 16% and the NASDAQ is down 25%. Where is all the money going you ask? The answer is treasury bonds and cash (which is at the highest levels since 2011). (Private Wealth Management Research May 17, 2022)
Treasury Yield Curve 05/13/2022 (home.treasury.gov)
1 month 1 year 5 year 10 year 20 year 30 year
.61% 2.16% 2.96% 2.98% 3.36% 3.17%
The bond markets have experienced times when the Fed raised interest rates to slow down inflation (most recently 1994 and 2013). I think investors are concerned about the Fed’s language about raising the short term rate up to the inflation rate (if it is needed) to lower inflation. Does that mean if inflation in 2022 is 6% then the Fed will raise the short term rate to 6%? Remember the Fed is raising short term rates, and if the Fed raises rates too high they will push the strong economy into a recession. When was last time investors got 6% on their money markets? Investors are confused by what the Federal Reserve is doing, and as a result they are selling their taxable and tax-free bonds while running to the safety of cash.
The investors that are selling their bonds yielding 3-5% because they have declined in value are taking the proceeds and investing them where? Cash is yielding to 0%; money markets are yielding .75% and C.D.s are anywhere from 2% to 3.25% over 1 to 5 years. If they are investing in the stock market they are even more disappointed as year to date the DJIA, the S&P 500, and the NASDAQ are all down.
Investors hate uncertainty.
Opportunities exist for investors taking a proactive approach to their bond portfolios.
How should investors be proactive with their bond portfolios: buy, sell or hold?
Buy
- If you have been in cash for a period of time waiting for an opportunity, the time is right. Stair step your maturites over time. This approach gives you the possibility of renewing at higher rates as your bonds mature. Using a 5 year C.D. ladder as an example, when the 1 year C.D. matures you would roll the principal to a new 5 year C.D.. Usually, a 5 year C.D. has a higher yield than a 1 year C.D.
- If you have been waiting to get into bond mutual funds you will find most of them are down 10-15%. Strategies used by active bond managers include: duration management, yield curve management, bond selection, sector allocation.
- If you are not using the income as a cash flow, the cash is either building up your liquidity or reinvesting. Consider reinvesting and receiving lower priced shares (dollar cost averaging) which has the potential of increasing your compounding efforts.
Sell
- Harvest tax losses in taxable accounts. You have losses in your bond portfolio, sell the bonds for a realized tax loss. You can use the realized bond tax loss to offset other realized capital gains or use $3,000 a year against taxable income. Realized tax losses do not expire they are carried forward. Realized losses in retirement accounts do not provide you a tax loss. Consult your tax advisor.
- Do you have a good balance between stocks and bonds? Too many bonds or even cash? Consider equity income in addition to bond income or update your bond funds to meet your investment objectives (short duration vs long duration; investment grade vs high yield; income vs total return; U.S. vs global; inflation indexed vs floating rate).
Hold
- If you hold over time the individual bond portfolio gets closer to maturity or the bond managers do their job by managing the bond portfolio and valuations have the ability to improve.
- In most cases income from bond portfolios has stayed close to the same. As bonds in a portfolio mature the proceeds are reinvested in higher yielding bonds, and the income can increase over time with higher rates.
Bonds play an important role in an investor’s portfolio, the question an investor has to ask is how much do I allocate to bonds and how do I position that allocation.
Gary Foose is a Financial Advisor with Baird Retirement Management in Lake Jackson. Baird is located at 208 Parking Way, Lake Jackson. Gary’s personal website is GaryFooseBaird.com. Gary’s email is gfoose@rwbaird.com and his phone number is 800-711-6137. Gary has a Retirement Management Advisor RMA® designation and a Certified Private Wealth Advisor CPWA® designation.
Certified Private Wealth Advisor® is an advanced education and certification program for financial advisors who work with high-net-worth clients on the life cycle of wealth: accumulation, preservation, and distribution. Retirement Management Advisor® is an advanced certification for financial professionals that provides them with knowledge to build custom retirement income plans for their clients to better mitigate risk and strive to achieve better outcomes.
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