Understanding Fixed Income Securities: Expectations
by: Steve Selengut
I?ve come to the conclusion that the Stock Market is an easier medium for investors to understand (i.e., to form behavioral expectations about) than the Fixed Income Market. As unlikely as this sounds, experience proves it, irrefutably. Few investors grow to love volatility as I do, but most expect it in the Market Value of their equity positions. When dealing with Fixed Income Securities however, neither they nor their advisors are comfortable with any downward movement at all. Most won?t consider taking profits when prices increase, but will rush in to accept losses when prices fall.
Theoretically, Fixed Income Securities should be the ultimate Buy and Hold; their primary purpose is income generation, and return of principal is typically a contractual obligation. I like to add some seasoning to this bland diet, through profit taking whenever possible, but losses are almost never an acceptable, or necessary, menu item. Still, Wall Street pumps out products and Investment Experts rationalize strategies that cloud the simple rules governing the behavior of what should be an investor?s retirement blankie. I shake my head in disbelief, constantly. The investment gods have spoken: ?The market price of Fixed Income Securities shall vary inversely with Interest Rates, both actual and anticipated? and it is good.?
It?s OK, it?s natural, it just doesn?t matter, I say to disbelieving audiences everywhere. You have to understand how these securities react to interest rate expectations and take advantage of it. There?s no need to hedge against it, or to cry about it. It?s simply the nature of things. This is the first of three successive articles I?ll be writing about Fixed Income Investing. If I don?t improve your comfort level with this effort, perhaps the next one will strike the proper chord.
There are several reasons why investors have invalid expectations about their Fixed Income investments: (1) They don?t experience this type of investing until retirement planning time and they view all securities with an eye on Market Value, as they have been programmed to do by Wall Street. (2) The combination of increasing age and inexperience creates an inordinate fear of loss that is prayed upon by commissioned sales persons of all shapes and sizes. (3) They have trouble distinguishing between the income generating purpose of Fixed Income Securities and the fact that they are negotiable instruments with a Market Value that is a function of current, as opposed to contractual, interest rates. (4) They have been brainwashed into believing that the Market Value of their portfolio, and not the income that it generates, is their primary weapon against inflation. [Really, Alice, if you held these securities in a safe deposit box instead of a brokerage account, and just received the income, the perception of loss, the fear, and the rush to make a change would simply disappear. Think about it.]
Every properly constructed portfolio will contain securities whose primary purpose is to generate income (fixed and/or variable), and every investor must understand some basic and ?absolute? characteristics of Interest Rate Sensitive Securities. These securities include Corporate, Government, and Municipal Bonds, Preferred Stocks, many Closed End Funds, Unit Trusts, REITs, Royalty Trusts, Treasury Securities, etc. Most are legally binding contracts between the owner of the securities (you, or an Investment Company that you own a piece of) and an entity that promises to pay a Fixed Rate of Interest for the use of the money. They are primary debts of the issuer, and must be paid before all other obligations. They are negotiable, meaning that they can be bought and sold, at a price that varies with current interest rates. The longer the duration of the obligation, the more price fluctuation cycles will occur during the holding period. Typically, longer obligations also have higher interest rates. Two things are accomplished by buying shorter duration securities: you earn less interest and you pay your broker a commission more frequently.
Defaults in interest payments are extremely rare, particularly in Investment Grade Securities, and it is very likely that you will receive a predictable, constant, and gradually increasing flow of Income. (The income will increase gradually only if you manage your asset allocation properly by adding proportionately to your Fixed Income holdings.) So, if everything is going according to plan, all that you ever need to look at is the amount of income that your Fixed Income portfolio is generating? period. Dealing with variable income securities is slightly different, as Market Value will also vary with the nature of the income, and the economics of a particular industry. REITs, Royalty Trusts, Unit Trusts, and even CEFs (Closed End Funds) may have variable income levels and portfolio management requires an understanding of the risks involved. A Municipal Bond CEF, for example will have a much more dependable cash flow and considerably more price stability than an oil and gas Royalty Trust. Thus, diversification in the income-generating portion of the portfolio is even more important than in the growth portion? income pays the bills. Never lose sight of that fact and you will be able to go fishing more frequently in retirement.
The critical relationship between the two classes of securities in your portfolio, is this: The Market Value of your Equity Investments and that of your Fixed Income investments are totally, and completely unrelated. Each Market dances to it?s own beat. Stocks are like heavy metal or Rap?impossible to predict. Bonds are more like the classics and old time rock-and-roll?much more predictable. Thus, for the sake of portfolio smile maintenance, you must develop the ability to separate the two classes of securities, mentally, if not physically. For example, if your July 2005 Market Value fell, it was because of higher interest rates not lower stock prices. More recently, the combination of higher rates and a weaker Stock Market has been a Double Whammy for portfolio Market Values, and a double bonanza for investment opportunities. Just like at the Mall, lower securities prices are a good thing for buyers? and higher prices are a good thing for sellers. You need to act on these things with each cyclical change.
Here?s a simple way to deal with Fixed Income Market Values to avoid shocks and surprises. Just visualize the Scales of Justice, with or without the blindfold. On one side we have a number that represents the Current Market Value of your Fixed Income portfolio. On the other side, we have a small ?i? for interest rates, and ?up? or ?down? arrows that represent interest rate directional expectations. If the world expects interest rates to rise, or even to stop going down, ?up? arrows are added to ?i? and the Market Value side moves lower? the current scenario. Absolutely nothing can (or should) be done about it. It has no impact at all on the contracts you hold or the interest that you will receive; neither the maturity value nor the cash flow is affected? but your broker just called with an idea.
The mechanics are also simple. These are negotiable securities that carry a fixed interest rate. Buyers are entitled to current rates, and the only way to provide them on an existing security is to sell it at a discount. Fortunately, one rarely has to sell. Over the past few years of falling interest rates, Fixed Income securities have risen in price and investors (should) have realized capital gains as a result?adding to portfolio income and Working Capital. Now, that trend has reversed itself and you have the opportunity to add to existing holdings, or to buy new securities, at lower prices and higher interest rates. This cycle will be repeated forever.
So, from a ?let?s try to be happy with our investment portfolio because it?s financially healthier? standpoint, it is critical that you understand changes in Market Value, anticipate them, and appreciate the opportunities that they provide. Comparing your portfolio Market Value with some external and unrelated number accomplishes nothing. Actually, owning your fixed income securities in the most freely negotiable manner possible can put you in a unique position. You have no increased risk from a reduction in security prices, while you gain the ability to add to holdings at higher yields. It?s like magic, or is it justice. Both sides of the scales contain good news for the investor? as the investment gods intended.
About The Author
Steve Selengut
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Happy Healthy Hollidays with this Eggnog Recipe
Happy Healthy Hollidays with this Eggnog Recipe
by: Hans Dekker
When it is holiday time, only one drink comes to mind: eggnog.
This healthy drink recipe is delicious and it uses soymilk instead of whole milk. It gets a completely new flavor and color with the addition of peppermint oil.
A drink fills up your tummy just before you hit the sack. Serve it warm and you will be on your way to sleepy town.
Now you can dream away while Santa does his magic.
Ingredients:
4 eggs, separated
2 cups soymilk
1 cup granulated white sugar
2 tbsp. vanilla extract
2 cups heavy cream
1 tbsp. peppermint oil
1 tsp. ground nutmeg
1 tsp. ground cinnamon
1 tsp. pumpkin spice
To Make:
First, take your 4 eggs and put the egg whites into a bowl and the egg yolks into a bowl.
Put a half a cup of white sugar into each egg bowl. Beat each egg bowl slightly.
Add...
Happy Healthy Hollidays with this Eggnog Recipe
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Adult Acne Solved!
Adult Acne Solved!
by: Kirsten Hawkins
Acne has always been a dreaded occurrence in our life. Most of us have carried this burden in our teenage years and after almost seven teenage years we think we are finally home free. Then one morning in your twenty sixth, twenty seventh or even twenty eighth year of your existence you wake up with a huge zit on you face. And even worst, sometimes it is not just one but two or even three or even four! And they just keep on sprouting like weeds in an inhibited garden! So you wonder, I?m already an adult so why, why, WHY?
Adult acne is more common than we thought. Almost five percent of adults have adult acne mostly in their twenties, thirties and even forties and beyond. Adult acne can be found in the face and sometimes even on the neck and on the chest and back area. There are many reasons for the occurrence of these devils incarnates and we will enumerate them here plus ways on how to outsmart them.
Adult...
Adult Acne Solved!
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The Significance of Brochures
The Significance of Brochures
by: Viojieley Gurrobat
Brochures are a great form of advertisement and a great way of selling products and services. They have been proven effective for promoting products and steering customers toward purchasing a particular product or availing of a particular service. Let?s say you own a hotel in a highly urban area with competitors in just about every corner of the city. Since competition is stiff you have to think of ways to advertise your hotel in a way that will make it stand out among your competitors. Of course, you can do it by giving discounts, special offers or offering free breakfast to visitors.
But some hotel owners especially small hotels think that they do not need to advertise as it will cost them thousands of dollars just to print a few copies of brochures. This should not be the case. Hotels should be advertised as hotels sell something to the public. They are public necessities and every day...
The Significance of Brochures
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Buying Tips When You're Camping
Buying Tips When You're Camping
by: Gray Rollins
Whether you are an experienced camping enthusiast or you are starting off on your first camping experience, it is important to have the proper gear and equipment. Many of the supplies can be expensive and some items may be hard to find. To get the most for your money, though, there are several tricks you can employ.
Plan
Unless you have an unlimited budget, a camping trip is not something where you can get everything at once without a bit of planning. Research where you will be going, the conditions that will be present and the climate. Make a list of all the supplies you will need and determine what items you have available and what items you will need to purchase. If you start early enough, you?ll be able to spread purchases over a longer period of time so it does not take as big a hit to your budget all at once.
Budget
Research on the Internet or at local sporting goods stores...
Buying Tips When You're Camping
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Not All Paintball Markers Are Made The Same!
Not All Paintball Markers Are Made The Same!
by: Caroline Smith
There?s a wide selection of paintball markers on sale, so it pays to do your research to make sure you buy one that suits your abilities.
Paintball guns range in price from under $200 for a decent entry level gun,
such as a Spyder or Tippmann, to over $1000 for a tournament style marker such as an Angel paintgun.
If you?ve just discovered the sport of paintballing and want to play regularly, it makes sense to buy your own gun and gear rather than rent it each time you go to games.
As well as a marker, all paintballers must wear masks out on the field, and you?ll need to check out equipment like hoppers and air tanks too.
Paintball gun packages can be a cheap way to buy all the supplies you need in one go, but make sure you?re getting value for money.
There are some top quality markers available at discount prices, but there are a few...
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Use Carpet Cleaning Equipment To Care For Your Rugs
Use Carpet Cleaning Equipment To Care For Your Rugs
by: John Murray
You've spent a fortune on beautiful rugs that compliment your home decor. And they are ever so comfy on the feet! You don't want to see your investment get ruined by dirt, oily soil, and stains that can wear your carpet down and make it look and smell much older than it really is. So be sure to use carpet cleaning equipment to care for your rugs.
I'm sure you'd rather have your carpet looking and smelling clean and fresh than looking old and smelling bad. A bad smelling carpet can be the result of cooking odors, pet odors but it can also come from normal every day dirt and grime. Carpet cleaning equipment can keep your carpets looking like new.
When one hears the word carpet cleaning equipment we automatically think of the big steam cleaners that are used to shampoo the rugs, but your regular old vacuum is part of your carpet cleaning equipment armor.
So you can...
Use Carpet Cleaning Equipment To Care For Your Rugs
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