Mid-Year Bond Review

Scott Kahan |

Article written by Scott M. Kahan in Stroll Chappaqua - April 2024 Magazine

INVESTING IN FINANCIAL MARKETS requires a proactive approach, and one key aspect of maintaining a healthy investment portfolio is conducting periodic reviews. While many investors focus primarily on equities, it’s crucial not to overlook the fixed-income portion of one’s investments.

The financial landscape is dynamic, with economic conditions, interest rates, and market trends constantly evolving. A mid-year portfolio review provides an opportunity to assess whether your fixed-income investments align with the prevailing market conditions.

Bond Prices and Interest Rates
As you probably know, bond prices and interest rates have an inverse relationship. So, bond prices tend to fall when interest rates rise, and vice versa. There are a few key reasons for this phenomenon:

  • Opportunity Cost: When interest rates increase, new bonds issued will offer higher coupon rates, reflecting the higher prevailing rates. As a result, existing bonds with lower coupon rates become less attractive to investors because they generate lower income than newly issued bonds. To make existing bonds more appealing in the market, their prices need to adjust downward, which raises their effective yield.
  • Fixed Income Sensitivity: Bonds, especially those with longer maturities, are more sensitive to changes in interest rates. This sensitivity is known as duration risk. When interest rates rise, the present value of future cash flows from a bond decreases, primarily due to the higher discount rate applied to those cash flows. Consequently, bond prices decline to compensate for the reduced value of future payments.
  • Market Demand: As interest rates increase, investors may shift their preference toward higher-yielding investments, such as newly issued bonds or other fixed-income instruments. This shift in demand reduces the demand for existing bonds, putting downward pressure on their prices.
            It’s important to note that these relationships are general principles, and other factors can influence bond prices, such as credit risk, inflation expectations, and overall market conditions. However, the inverse relationship between bond prices and interest rates remains a fundamental concept in bond markets.

How to Conduct a Review
Here are some steps to follow when conducting a review of your fixed-income portfolio:

  • Gather information: Start by gathering all the necessary details on your fixed-income investments.
  • Assess investment objectives: Clarify your investment objectives and risk tolerance. Are you seeking income, capital preservation, growth, or a combination of all three?
  • Evaluate performance: Examine the performance of your fixed-income investments over a specific period and compare the returns of individual securities to relevant benchmarks or indices. Assess whether your portfolio is meeting your performance expectations.
  • Review credit quality: Assess the credit quality of the bonds in your portfolio. Credit ratings provided by rating agencies like Moody’s or Standard & Poor’s can give you an indication of the creditworthiness of the issuers.
  • Analyze interest rate sensitivity: Consider the interest rate sensitivity of your fixed-income investments. When interest rates rise, bond prices generally decline, and vice versa.
  • Diversification and risk management: As with equities, diversification of your bond portfolio is important. Ensure you are exposed to different sectors, industries, and issuers to manage risk effectively. It is not hard to diversify bonds by owning different mutual funds and Exchange Traded Funds (ETFs).
  • Rebalance if needed: Determine if your fixed-income portfolio needs rebalancing. Rebalancing involves adjusting the allocation of your investments to maintain your desired asset allocation.
  • Consider tax implications: Take into account the tax implications of your fixed-income investments. Interest income from bonds is typically subject to income tax. Evaluate whether any tax-efficient strategies, such as holding municipal bonds or having your bonds in a retirement account, can help minimize your tax liability.

Seek Professional Guidance
Bonds can play an important role in your overall portfolio. Remember that conducting a review of your fixed-income portfolio as part of an overall
portfolio review should be an ongoing process. Market conditions, interest rates, and financial goals will change over time, so it’s essential to regularly
monitor and adjust your fixed-income holdings. 

For more tailored guidance, work with a fee-only Certified Financial Planner™ professional. 

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