Currently, we are in a low interest rate environment. Although the Fed has started raising interest rates, interest rates (and yields) are likely to remain low for a long time.
Faced with the prospect of continued low yields, it may be tempting to increase interest by issuing more exotic bonds. Before you decide to change your strategy, it’s best to take a step back. Ordinary vanilla bonds may be more appropriate.
Ordinary and liquid
“It’s easier to buy and sell when bored,” said Mary Talbutt, chief portfolio manager of SLG’s fixed income fund. “If you own a benchmark bond or a bond with a larger issuer, you can buy it at a narrower spread. If you plan to sell, you are more likely to find someone who wants to buy it.”
Ordinary bonds are easier to trade and have smaller spreads. “Look at the national debt,” Talbat continued. “These products are very tight and easy to trade. They provide you with a good variety and maintain market value.” She pointed out that more esoteric bonds will bring larger spreads, which may make it more difficult for you to lead or even break even. , Depending on when you buy or sell. And, of course, you may not even be able to find buyers for more exotic products.
Talbutt said that even if you decide to switch to corporate bonds instead of government bonds, you can still benefit from regular bonds from highly rated companies. “If you buy an ordinary company, people have a lot of opportunities for buying and selling,” she said. “Traders have been making markets, and liquidity is the key.”
Another factor to consider is stability. With the help of appreciation of bonds, investors and retirees may want to squeeze out more returns or take advantage of rising interest rates. “If the interest rate environment rises, these bonds are attractive because it may raise interest rates immediately after the Fed raises interest rates,” Talbat said.
However, it is important not to be deceived by appearances. Talbutt said that while it is a good thing to think that your bond yields will align with the Fed’s decision, the reality is that you don’t know whether you will actually get the benefits. “A lot of these boost bonds have the characteristics of call options,” she said. “So it may be cancelled before it strengthens.” If your bond is redeemed before you see the benefit of raising interest rates, you need to find a new income-generating tool for your portfolio.
Another issue related to stability is the bonds you choose to invest in. “As people pursue yield, they may decide to invest in something that is not exactly investment grade,” Talbat said. “Even if the rate of return is fixed, it is not very simple, because the company’s rating may be poor, and you may lose your principal and future earnings.”
By using ordinary bonds in your investment portfolio, you can have reasonable confidence that you will not lose your principal and that you know what your monthly income is. When living on a fixed income, stability is important. Talbutt said that if you want to include yields, diversifying your portfolio to include some index funds may help, and you rely on ordinary bonds to meet your current income needs. “It’s easier to target your income stream with ordinary vanilla.”
If you know that you need a certain amount of income during retirement or at other times, ordinary bonds may be a good way to support your investment portfolio. “In a falling environment, you can keep interest rates the same no matter what,” Talbat said. “In an environment of rising interest rates, it will mature at par, even if you don’t see the same interest rate rise—and your monthly income will be fairly safe.”