Retirees and others have been looking for income from a variety of sources in recent years, thanks historically low interest rates.
This has led investors to turn to higher-yielding fixed-income instruments like long-term government bonds or high-yield and junk bonds.
But what should they do when the current low-interest environment gives way to rising rates?
Advisor Nate Carlon (left) of Burnham Gibson Financial Group in Southern California—a group of nine advisors and about $750 million in assets that is affiliated with AXA Advisors—has a few tips to share.
The former vice president of investments with JPMorgan Chase’s wealth management operations says these five steps can help:
1. Understand Duration
Duration, Carlon explains, “is the price sensitivity of fixed-income instruments to changes in interest rates.” When interest rates move up, bond prices decline, and duration can serve as a guide in determining how fixed-income products will likely react to rising rates.
For instance, the expectation for a bond fund with a duration of 10 years is its price will drop by 10% if interest rates increase by 1%, he notes. (Bond prices and interest-rate shifts have an inverse relationship.)
2. Shorten Your Duration
To protect fixed-income instruments from rising rates, consider fixed-income funds that offer quality bonds with a range of less than five years, the advisor shares.
“While you may see a minor drop in expected yield by making this change, you have actually implemented a strategy to help protect the bond prices from significant price fluctuations,” Carlon said.
3. Bond Fund Mandates
Many investors don’t pay attention to the mandates and objectives of a bond fund.
Some funds have strict mandates and limit the investment products they invest in, while others have broader, more flexible mandates.
“Investing in a strategy that offers flexibility to the mandate can allow for portions of the portfolio to zig when other parts zag, therefore, helping reduce volatility and ultimately help in producing more stability in value and in income,” according to Carlon.
4. Consider Absolute
Absolute-return-oriented funds let investors focus on downside-risk management through broad-based and strategic investing strategies, and they aim to capitalize on market shifts that can help produce positive absolute returns, the investment expert points out.
“The ability to add risk or take risk off during market volatility can serve as a diversified, tactical element to most traditional strategies in an investment portfolio,” he said.
5. Be Emerging
The emerging markets in Brazil and India, for example, have a growing number of investing opportunities for fixed-income and other investors.
Along with yield and duration, be sure to check credit quality when compared emerging-market bonds to domestic fixed-income choices.
By adding emerging-market bonds to their mix, investors can begin to diversify their fixed-income risk across additional, and in some cases, nontraditional markets, Carlon adds.
"Interest rates probably won’t stay at their current low rates," the advisor concluded. "The goal is to make sure that the investor has had the chance to fully understand the challenges that lay ahead and have considered adding one or more of these strategic elements to their portfolio."
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