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Why 2023 is the year to reconsider your bond portfolio

Bonds are investment vehicles issued by governments and corporations as debt repayment guarantees and serve as the foundation of a classic retirement portfolio. These investments have traditionally been considered safer than equities and other more volatile instruments. However, 2022 was a record year for bonds, and not in a good way.

The rise of the I's

2021 was the year that the world began to reopen after COVID restrictions eased.

The financial markets seemed to be recuperating after massive government stimulus programs and intervention by the Federal Reserve, with average inflation and depressed interest rates. However, by mid-year, inflation crested 4% and only continued to rise.

By 2022, inflation surged to over 9%, with a strong labor market and business and consumer spending and borrowing propping it up. The housing market reached feverous heights due to the ease of borrowing money, and corporate debt was at unprecedented levels.

Finally, the Federal Reserve began raising interest rates in March 2022. By year-end, the Federal Reserve raised rates by over 3% to try and cool down the economy, which many feared was overheating.

By early 2023, inflation began trending downward, and many predict that only a few Federal Reserve rate increases remain on the horizon. But, during this chaotic time, something happened to the bond markets.

Interest rate risk

Most individual investors hold bonds in their portfolios by the time they retire via mutual funds or ETFs. These investment vehicles provide diversified, low-cost exposure to various types of bonds and are a great way to manage one's fixed-income portfolio passively.

However, bond fund prices are susceptible to interest rate fluctuations, and 2022 spelled trouble for this otherwise stable investment class. The US bond market was down by over 15% at an October low in just ten months.

Interest rate risk for bonds and fixed-income investments warns that a rise in interest rates can cause prices for these vehicles to drop as they attempt to re-price their yields to match the prevailing rates. After all, when you buy a bond or fixed-income investment, you buy its current yield, a combination of the interest rate when it was issued and the bond's price.

For bonds issued at a lower interest rate than the prevailing rate, sellers must lower their bond pricing so that when the bond matures, the buyer is made whole and receives the total current yield as of today. Thus, this discounted bond face value acts as a quasi-interest payment through appreciation when a bond matures.

While bond funds are easier to invest in due to lower minimums, increased liquidity, ease of use, and diversification, they also potentially require retirees needing income to sell depreciated assets when rates rise.

That is why Lundeen Abrams Advisors has begun weighing strategic repositioning in our client portfolios through bond ladders.

Locking in losses and great rates

Most investors and clients of ours are familiar with capturing capital gains and losses for tax benefits. However, they are not as familiar with locking in losses on their defensive fixed-income positions.

2022, while a rough year, has provided us with the opportunity to capture losses in client brokerage accounts on bond funds while strategically repositioning clients into bond ladders that pay higher rates.

The result for clients is a loss they can carry forward to offset equity gains in the future while also moving into a portfolio with excellent current yields and potential for future bond price appreciation.

Detaching income needs from portfolio value

One benefit of a bond ladder portfolio during periods of higher interest rates is that clients with more substantial holdings can generate income payments that do not require selling their principal to cover their everyday needs.

Further, these clients can lock in desirable rates for the next 5-7 years that might otherwise disappear during the next economic downturn or structure maturities around their financial needs, neither of which is available through fund investing.

Excluding certain issuers

Similar to custom-built equity portfolios, holders of bond ladders have direct input on which securities they hold so that their personal beliefs and ESG goals are met by including or excluding particular corporate and governmental bonds.

Next steps

While 2022 was a dismal year for fixed-income and bond securities, these investments remain just as crucial for a well-balanced portfolio.

We recognize that each person is different at Lundeen Abrams Advisors, so we strive to build solutions tailored to your specific goals and concerns. For those with at least $100,000 invested in bond funds, considering a bond ladder could make sense for your cents, depending on your investment and liquidity needs.

So, please get in touch with us and schedule an appointment today. We are here to help and look forward to speaking with you soon.

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