Utilizing a portfolio of individual bonds can provide benefits that are difficult to reproduce via other fixed income investment vehicles. The portfolio can be completely customized to the specifications of an investor, providing a solution that aligns long-term financial goals with personal preferences. Product choice, issuer selection, cash flow, maturity, tax considerations, and credit quality, can all be customized. This level of specification is a powerful tool, but to reap the benefits, upfront thoughtful planning is required to ensure that an optimal portfolio is constructed. This commentary outlines the key considerations and decision points involved in building a portfolio of individual bonds.
WHAT’S THE “WHY”?
The first question that should be answered is: Why? Why is this investment being made and what do you need this investment to do? Are you nearing retirement and need to replace your employment income with cash flow from the portfolio? Do you have a large liquidity need in the future, such as a downpayment for a house or a tuition payment for college? Maybe the investment is simply intended to provide consistent and known cash flow as part of a long-term financial plan. Whatever the reason, identifying “why” upfront ensures that the end-result works towards the ultimate goal.
WHAT ARE THE INVESTOR-SPECIFIC DETAILS?
Equally important is considering the details that are specific to you. Identify account type: qualified, non-qualified, trust, etc. What is your current Federal and state tax bracket? Just as, if not more, important: what is your expected future tax bracket at both the federal and state level? If purchasing a 20-year bond portfolio, expectations for the future should be considered just as much as your current situation. When it comes to taking risks, how comfortable are you with the various types of risks? Any investment is going to involve risk, so determining what types (credit risk, duration risk, reinvestment risk, etc.) and how much you are willing to take is important. Personal preferences can also be considered. You may have state or geographical preferences or sectors to prioritize and/or avoid. Building a portfolio of individual bonds allows you to tailor the portfolio to your exact preferences, so identifying them upfront can lead to a more optimal solution.
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WHAT ARE THE CURRENT DYNAMICS OF THE MARKET?
After determining the above details of your specific situation, it is time to overlay the current state of the fixed income market to identify an optimal portfolio in whatever the current environment is. This is where your financial advisor and the Fixed Income Solutions team can help by providing timely market data and fixed income expertise to you for your financial plan. Information regarding current interest rates, relative value between asset classes, macroeconomic themes, product-specific dynamics, and market outlook are among the countless considerations that should be considered. Also, keep in mind that these dynamics are constantly changing, so just as the optimal portfolio for two investors today might be very different, the optimal portfolio for your specific situation might be different today than it was a year ago.
There is no one-size-fits-all portfolio. What may be an effective strategy for one investor, may not work towards the goals for another investor. An optimal portfolio is one that is best aligned with your specific needs. However, when investing your fixed income allocation via a managed solution, investors oftentimes start with the answer - meaning that they just select a “bucket” that seems like it fits (i.e., an intermediate, high-quality, taxable strategy). While this “bucket” might be where an asset manager thinks there is currently a great opportunity, that strategy might not necessarily line up with your long-term goals. When investing with individual bonds, start by asking questions and the answers can guide you to a more custom-tailored solution that better aligns with your long-term goals. This will provide an optimal solution for you, not just a general solution. Speak with your financial advisor today and ask how a customized fixed income portfolio might fit into your financial plan.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.
To learn more about the risks and rewards of investing in fixed income, access the Financial Industry Regulatory Authority’s website at finra.org/investors/learn-to-invest/types-investments/bonds and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) at emma.msrb.org.
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