Even with interest rates dropping to record lows in the past year, bonds and other fixed-income investments could be worth a closer look.
Fixed-income investments such as bonds, securities, notes, and CDs are staples in many diversified portfolios. However, while the last time interest rates stayed around 7% was roughly two decades ago, over the past year they have dropped to under 1%. And that begs the question: Are fixed-income investments still a good option?
George Rusnak, managing director of Investment Strategy at Wells Fargo Private Bank, offers this perspective: “Fixed-income investments can help offset volatility in the equities market. They can provide a buffer, even when the interest rate is at a historic low,” he says.
Rusnak believes today’s low-interest rates aren’t likely to increase any time soon, which means investors may need to rethink their fixed-income investment plans if they want to achieve the same results they’ve enjoyed in the past. “While previously you may have gotten a really great total return in fixed income, going forward when you have lower income due to low rates, you need more money to achieve the same return,” he says. There’s also uncertainty ahead due to the election, the results of which could affect tax policies in 2021 and beyond, as well as the coronavirus pandemic, which is disrupting industries and impacting portfolios.
With all that in mind, Rusnak shares five actions investors should consider as they evaluate the role fixed-income investments could play in a portfolio.
1. Don’t expect interest rates to climb soon.
During the 2008 recession, the Federal Reserve lowered interest rates to spur economic recovery, and it didn’t raise rates until the end of 2015. This year, the Fed once again slashed rates, and Rusnak believes they’ll stay low for a long time. “It’s tempting to think rates will recover over the 12 months, but we don’t think that will happen. Investors are better off adjusting course now rather than trying to wait it out.”
2. Explore the impact of adjusting your fixed-income allocations.
Given today’s major economic challenges, Rusnak says investors may need to adjust their fixed-income investing approach. “Dependent upon client goals and risk tolerance, one might be familiar with the concept of a 60/40 asset allocation, with 40% in fixed income,” he says. “But depending on the investor’s unique risk tolerance and time horizon, and what their cash tolerance is, today we might suggest adjusting that ratio or modifying the types of investments within the fixed-income asset class.”
3. Look at the income potential of all assets in your portfolio.
“Fixed-income investments serve a clear purpose in a portfolio, but they aren’t the only way to generate income, now or in retirement,” Rusnak says. “Equities, real estate assets, preferred stocks, and other alternatives1 can also potentially produce income, albeit with higher risk.” He explains that you may want to consider a wider range of income-oriented asset choices when interest rates are low. Talk to your wealth and investment professionals about evaluating all of your assets to gauge their full income potential.
4. Reevaluate your risk tolerance.
Has your risk tolerance changed over time? Has it gone up or gone down? Adjust each asset class in your portfolio accordingly. “Specifically within fixed income, you can potentially get more return by choosing, for example, corporate or municipal bonds over U.S. Treasury bonds or CDs,” Rusnak says. “Look at the various types of fixed-income investments to see where you might be able to increase yield in exchange for a bit more risk.”
5. Remember the adage about some things being too good to be true.
“If you find a fixed-income product that promises to yield 5% to 7% when everything else is yielding less than 1%, alarm bells should be going off,” Rusnak says. “There is no free lunch. You have to take a risk somewhere to get more yield. Be sure you know exactly what that risk is, and be very careful that you don’t put too many eggs into that basket.”
1 Alternative investments carry specific investor qualifications which can include high income and net-worth requirements as well as relatively high investment minimums. Available to pre-qualified investors only.
All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. There is no assurance any investment strategy will be successful. Asset allocation does not guarantee a profit nor does diversification protect against loss.Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and/or principal. This risk is heightened in lower rated bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Income from municipal securities is generally free from federal taxes and state taxes for residents of the issuing state. While the interest income is tax-free, capital gains, if any, will be subject to taxes. Income for some investors may be subject to the federal Alternative Minimum Tax (AMT).
Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Investments in equity securities are generally more volatile than other types of securities. There is no guarantee that dividend-paying stocks will return more than the overall stock market. Dividends are not guaranteed and are subject to change or elimination.
Investments in real estate securities include risks, such as the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions.