- A common mistake investors make is chasing yields to try to get as much income as they can, and they end up with investments that are much riskier than they realize.
One of the most important things for investors to remember is that bonds are typically used to preserve capital and generate income.
It's important to find the right balance between the two to meet your needs.
Typically, investments that offer higher yields usually increase the risk that you might lose money,
and your capital may not be preserved.
We believe investors shouldn't try to pick which asset class is going to do best.
Investors, including many professionals, try to predict these things, but few have a consistent
Unfortunately, there isn't a crystal ball.
What we've found is that having an appropriate allocation of both stocks and bonds and diversifying within
each of those categories provides the best risk-adjusted returns over time.
Diversification within and across asset classes helps reduce the impact of the volatility swings
we often see in the market.
It is also extremely important to rebalance your portfolio at least annually to maintain your appropriate risk profile.
That brings us back to the need to generate income from your portfolio in a low interest rate environment.
Many investors come to us with an income target that they want when they look for bond investments.
The one I hear the most is 5%--Everyone wants 5%.
And that sounds great, especially when you compare it to the current rate on a 10-year Treasury bond--
but what if you lose 10% of your principal because what you've invested in to get that 5% is riskier than you thought?
Losses can quickly off-set the extra income you get.
The high-yield bond market is an example of this with many yields above 5%.
However, high-yield bonds are highly correlated with stocks.
Historically, the correlation between stocks and U.S. Treasury bonds is near zero and can even be negative.
A negative correlation means that, on average, when stock zig, bonds zag.
However, high-yield bonds tend to move in tandem with stocks.
This removes the benefit of asset allocation because when your stocks zig, so do your high-yield bonds.
High-yield bonds also have far more credit risks than investment-grade bonds that are rated BBB or higher.
There's a dramatic difference in the number of high-yield bonds that default, which is when the issuer is no longer able to make interest payments or return your principal.
This is not to say investors shouldn't own high-yield bonds, but it's important to illustrate that they are not a replacement for an investment-grade or core bond allocation.
Returning to the need versus the want of income, we think investors should start with a good plan to know exactly how much income they need in retirement.
While 5% may sound good, it may be more than you really need, or it may not be enough in your first years of retirement.
An investment professional can help you develop a personalized financial plan for generating income.
From there, you can select the best investment strategy to meet your needs and ensure you're balancing the risk you take with meeting your personal goals.
Finally, you may want to consider using a professional asset manager for a portion of your portfolio,
especially if you're looking to invest in a specialized or riskier strategy for higher income.