Is it Time To Sell Bonds?
If you follow the markets closely on a day-to-day basis, you've probably been a little unsettled lately.
Back in May, Federal Reserve chairman Ben Bernanke signaled that the bank may soon start to scale back its aggressive program of buying bonds. Because the Fed's so-called "quantitative easing" has been credited with keeping borrowing costs down and aiding the economic recovery, the markets reacted with fear. Investors retreated from stocks, and they sold off bonds, causing an increase in bond yields. Certain commodities and currencies declined as well, in additional evidence of investor fears.
This week, markets are down reflecting investor fears that Bernanke will snatch away the "punch bowl" come the Fed's policy meeting this mid-September. Many fear this could lead to rising interest rates and are questioning allocations to fixed income.
In the short term, making decisions based on what you think lies ahead makes little sense. After all, the typical individual investor doesn't have the savvy to predict the course of bond yields, commodity prices or global monetary policy.
Even professional prognosticators get it wrong. Consider that when the Federal Reserve began its second round of quantitative easing three years ago, many economists and others warned of runaway inflation and the weakening of the dollar. Fast forward: Inflation has barely budged, and the dollar has actually risen in value.
When considering these events, it's important for investors to remember the role of bonds in a portfolio. Market conditions do not diminish the importance of having a globally diversified bond portfolio to reduce risk, even in a rising interest rate environment. Shorter term, higher quality bonds react less to increasing interest rates than longer term, lower quality bonds. Please see our last month blog on Are Your Bonds Safe?
At Northstar Financial Planning, we have been managing the risk in bond allocations over the past several years. We have shifted the duration of our bond holdings to be shorter term with a maturity of less than five years. We have reduced credit risk with virtually all of our bonds to investment grade (rated BBB or higher). The allocation to international bonds has increased to provide important diversification from US markets. We believe this approach helps provide investors with the benefits of fixed-income while limiting the risk from rising interest rates.
So how should investors react to market volatility? The short answer is that they shouldn't—not if they're in it for the long haul. The soundest course toward reaching your goals is to seek out professional advice, identify your goals, develop a plan and stick to it.
Sticking with the plan doesn't mean doing nothing; it means making educated decisions, not reacting. Once an asset allocation has been developed, it's necessary to rebalance and re-evaluate the components on a regular basis. Though we use passively managed investments, we take an active role in managing and positioning your portfolio's allocation. Due to the recent stock market rally and weakness in the bond markets, we have been proactively rebalancing client's portfolios that have grown out of alignment.
The bottom line: Reacting in the short term to what we think may happen in the market is a game that almost no one can win. The good news is that by building an investment portfolio for the long run, you won't have to play it.
If you have any questions, or would simply like to discuss this topic further, feel free to reach me at 603.458.2776 or email me here.
