Interest rates have gone up over the course of the last several weeks on expectations that a new administration will implement stimulus programs that trigger inflation. As a result, many investors now wonder if they should sell their fixed-income assets in the face of rising inflation. Recently I spoke with a concerned investor who wondered if it was time to liquidate all bonds and head toward cash. "The media says I should not be in fixed income. Do you agree?" he said.
Here are some suggestions regarding allocating your fixed-income portfolio given current conditions.
— By Michael Yoshikami, founder and CEO of DestinationWealth Management
Posted 28 November 2016
In times like these, it's important to stand back and have perspective on recent events. Interest rates are essentially now at levels where they were 12 months ago. The recent short-term spike when viewed in this context isn't quite as alarming. Given the Federal Reserve's pledge to gradually increase rates, I believe panic is not warranted regarding fixed-income investments.
Reduce your duration below that of the average bond market aggregate. A duration of 3 or 3.5 is appropriate.
Make sure you have a mix of different types of fixed-income assets, including corporates, Treasury, government agencies and floating-rate assets.
Target a credit quality somewhere around AA, as this helps with yield while still giving you a quality pool of invested assets.
These simple guidelines can help shape your investment strategy regarding fixed income. This approach takes into account rising rates but also avoids the binary choice of simply moving all funds into cash, which continues to pay zero percent interest.
Don't assume because the headlines scream that inflation is a given that it is a guarantee to play out to the degree as outlined by the press. I can give you 100 examples where a headline turned out to be erroneous in terms of future projections. Remember that market timing is a dangerous proposition and that it is not just related to equities; it applies to fixed income, as well.
A long-term allocation strategy requires that you have fixed income in your portfolio. If you're a market timer or trader, perhaps you don't need fixed income and are willing to speculate on the direction of rates.
But the truth is, for most investors, constructing a long-term allocation strategy is the more prudent course of action. As is usually the case, time horizon matters, and for most long-term investors, having fixed-income makes perfect sense even in today's environment.