Don't Gamble With Interest Rates

The decisions you make today for your fixed-income portfolio should reflect a long-term perspective. If you simply react to short-term market changes, you could compromise the success of your financial goals.

Avoid Defensive Measures During Volatility
During volatile markets when the future direction of interest rates may be uncertain, you may be tempted to take a more defensive investment posture. For many investors this means putting a greater proportion of their investments into cash, cash equivalents and short-term fixed-income investments, including GICs. Unfortunately, increased dependence on these types of investments generally reduces the effectiveness of your portfolio to maintain a more stable income stream. We call them variable-income investments because the rates they offer can change suddenly, and quite frequently, which can cause your income to decline substantially.

In fact, while you may think this strategy is interest rate neutral, it’s actually an implicit bet that interest rates are going to rise. That’s because should interest rates fall, your income would decline as those rates are adjusted lower.

It may be tempting at times to base your investment decisions on what direction you think interest rates are headed. However, with so many diverse factors impacting interest rate movements, even seasoned professionals are wrong more often than not.

A Better Strategy
Laddering the maturities of your fixed-income investments may be a better strategy. This is actually a more interest rate neutral strategy that does not depend on rates rising or falling for success. If interest rates fall, rates of the majority of investments in a laddered portfolio are still locked in, helping to keep portfolio income more stable. On the other hand, should rates rise, funds are regularly available to take advantage of the higher rates, since investments in the ladder will mature periodically.

Of course, when laddering your fixed-income portfolio, it is important to consider the call protection of your bonds. If all of your investments are callable at about the same time, there is a risk that they could all be called or redeemed during a period of declining interest rates. In that case, the ladder would not do a very good job of maintaining a steady stream of income for the portfolio. Therefore, you need to strive for some variety in the call protection of the callable bonds that are included in any fixed-income ladder.

It’s easy to get caught up with the current headlines and get distracted from your long-term investment strategy. But like other investments, bonds require a long-term perspective to maximize the benefits you hope to receive in the long run.

Mario D. De Rose, CFA
Fixed Income Strategist

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News For Investors Ideas to Invest in Calculators Special Events Knowledge Centre	Don't Gamble With Interest Rates The decisions you make today for your fixed-income portfolio should reflect a long-term perspective. If you simply react to short-term market changes, you could compromise the success of your financial goals. Avoid Defensive Measures During Volatility During volatile markets when the future direction of interest rates may be uncertain, you may be tempted to take a more defensive investment posture. For many investors this means putting a greater proportion of their investments into cash, cash equivalents and short-term fixed-income investments, including GICs. Unfortunately, increased dependence on these types of investments generally reduces the effectiveness of your portfolio to maintain a more stable income stream. We call them variable-income investments because the rates they offer can change suddenly, and quite frequently, which can cause your income to decline substantially. In fact, while you may think this strategy is interest rate neutral, it’s actually an implicit bet that interest rates are going to rise. That’s because should interest rates fall, your income would decline as those rates are adjusted lower. It may be tempting at times to base your investment decisions on what direction you think interest rates are headed. However, with so many diverse factors impacting interest rate movements, even seasoned professionals are wrong more often than not. A Better Strategy Laddering the maturities of your fixed-income investments may be a better strategy. This is actually a more interest rate neutral strategy that does not depend on rates rising or falling for success. If interest rates fall, rates of the majority of investments in a laddered portfolio are still locked in, helping to keep portfolio income more stable. On the other hand, should rates rise, funds are regularly available to take advantage of the higher rates, since investments in the ladder will mature periodically. Of course, when laddering your fixed-income portfolio, it is important to consider the call protection of your bonds. If all of your investments are callable at about the same time, there is a risk that they could all be called or redeemed during a period of declining interest rates. In that case, the ladder would not do a very good job of maintaining a steady stream of income for the portfolio. Therefore, you need to strive for some variety in the call protection of the callable bonds that are included in any fixed-income ladder. It’s easy to get caught up with the current headlines and get distracted from your long-term investment strategy. But like other investments, bonds require a long-term perspective to maximize the benefits you hope to receive in the long run. Mario D. De Rose, CFA Fixed Income Strategist	Find an Edward Jones financial advisor*. Find now »