Fortify your bond holdings in 3 steps
Bond market volatility is back.
No, that’s not an oxymoron. But it is an understandable source of apprehension, and one that could tempt you to respond to short-term movements. Instead, focus on ways to prepare the fixed-income portion of your portfolio to withstand more ups and downs while supporting your long-term strategy.
First, get perspective on the market action. The summer bond session got off to a heated start in late June when Federal Reserve Chairman Ben Bernanke hinted that the U.S. central bank could pull back its stimulus efforts, depending on the country’s economic recovery. The remarks helped push the yield on 10-year U.S. Treasuries to two-year highs of 2.57 percent by mid-July. Because rising yields mean falling bond prices – and lost face value on maturing investments – many investors looked for the exits. They pulled more than $23 billion out of bond funds in the week after Bernanke’s comments.
‘Bonds have generally gone up in value and exhibited a fairly low level of volatility lately,” said Brian Rehling, chief fixed income strategist at Wells Fargo Advisors. “Perhaps that’s why investors had been lulled into a sense of security.”
Bonds tend to provide investors with smaller capital growth but lower volatility than equities or other types of investments, but as the action in that market this summer has reminded us, that doesn’t mean they never experience movement. Consider taking these steps to manage how much that affects your portfolio – and your mindset:
1. Schedule your rebalancing. Market swings are inevitable, but you can stabilize your investment experience by scheduling a regular check-in with your financial adviser. Together, you can spot areas where your allocation is drifting away from your preferred target and leaving you with more (or less) exposure than you originally had planned. Regular rebalancing helps make sure your investment portfolio continues to reflect your tolerance for risk and your time horizon. Take a look every quarter or six months before making changes. It’s also a good idea to rebalance after a major market move.
Beware of rebalancing too often, though. You might incur excess transaction costs that eat away at your investment returns. If those fees are a major cost in your portfolio, consider limiting your rebalancing to an annual basis. But even with higher costs, regular rebalancing remains an important component of your long-term investment strategy.
2. Return to your core values. You are investing and saving with the idea of covering big costs down the line, such as a comfortable retirement or a child’s college education. When interest rates – and fixed income yields – remained low, many investors sought to generate income by investing in higher-yielding issues, such as corporate bonds. The trade-off, however, is that these investors probably now carry far more credit risk than they realize. Investors should stay focused on their long-term goals and steadily return their portfolios to an allocation more in line with their risk tolerance.
Further, another investor exodus from the bond markets could trigger a precipitous decline in prices for these riskier fixed income assets. That could expose portfolios that hold such assets to a steep drop in value. That’s a bigger risk than inflation or tapering of the Fed stimulus.
3. Watch your bottom line. While making changes to your bond holdings, ask your financial adviser about options that carry relatively low fees and expenses. If you normally buy and sell individual bonds before they mature, you may be paying more than you need to for every trade you execute. You may want to consider more cost-effective options, including exchange-traded funds and bond funds, which can provide access to several individual securities while helping keep expenses in check.
Understandably, you want to respond to market ups and downs. While doing that, try to avoid making short-term decisions that could undermine your long-term strategy. Think of investing as a marathon, not a sprint. Over time, and as part of a balanced asset allocation model, your bond portfolio can help you generate potential better returns with less volatility. That hasn’t changed.
• Patrick S. O’Connor is the managing principal, senior financial adviser, PIM portfolio manager and a chartered retirement planning counselor at Wells Fargo Advisors Financial Network in Algonquin. He can be reached at 847-458-0142, firstname.lastname@example.org or www.algonquin.wfadv.com.