While you consider your retirement portfolio of investments, ask yourself a simple question. How steady is my fixed income portion of the portfolio?
First, let’s review: there are 3 major classes to consider when allocating our assets (what investments to buy with our savings for retirement):
- #1 Cash/near cash liquidities (Found in money market accounts or high yield savings account)
- #2 Fixed income (Bonds, certificate of deposits or preferred shares)
- #3 Equities (Companies listed on the stock market)
Further detail on the other two classes can be found in our series on asset allocation, today’s focus is on fixed income. The major types of investment vehicles in this class are: bonds, debentures, preferred shares. The goal behind these investments is to deliver an income that is certain or “fixed”.
Fixed Income Definition:
Fixed income products are sought after by investors to bring stability to your portfolio. To provide a steady stream of revenue into the future, especially important once you expect your investments to replace your regular income stream. And in a traditional investing environment provide somewhat of a hedge against falling equity markets (this has been debatable in recent years).
Fixed Income Possibilities:
So what about right now? In Canada short-term interest rates are officially on the rise. In the US, two Fed officials are now advocating a look to increase the short-term interest rates. Many believe that the US Fed fund rate will increase in the middle of 2011. Now although short term rates have or soon will increase, long-term rates have steadily fallen since the beginning of 2010. Last week, I read how Corporations are rushing to replace their long-term debt as the 10 and 20 year rates are at a 6 year low. The yield curve for fixed income products is flattening. `
So what does this mean for your retirement portfolio?
It could mean that your bond and other fixed income investments are valuable now! If you have seen an important increase in the value of your fixed income portfolio, this could be the time to sell part of it. First, you may want to consider first the income that you are giving up by selling these investments and what it will take to replace that income.
The goal of monetary policy in North America is to encourage sustainable economic growth while limiting inflation to reasonable levels (around 2%). To do this, central banks set the overnight lending rate and buy or sell bonds in primary market auctions. Often the amounts placed up for auction help determine the long-term yields. As the government would like to see a normal yield curve where interest rates increase with the duration (time to maturity) of the bonds, we will return to higher long-term rates in the future. Enough of Economics 101…
What To Do With Your Bonds
If your fixed income investments are valuable now (seen an increase in principal), you might want to consider to sell them while they are high. When all interest rates rise along a normal yield curve, the value of existing products will decrease with each passing day. You may want to reconsider replacing your existing fixed income positions with dividend producing preferred shares which might not be so affected by increasing interest rates and may also benefit from rising equity markets.
So what about your retirement portfolio? How steady is your fixed income portion?
This post has been written by Mike from Green Panda Treehouse. He is a financial planner and runs several blogs within his online company such as The Financial Blogger and The Dividend Guy. Mike is not endorsed or affiliated with LPL Financial.