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Managing Your Money
Everybody wants income but are fixed income investments right for you? October 2005
Safety is always an issue with investors. How safe is my money? Will my investments provide a safe and steady income as I move into my retirement years? Can I sleep at night, secure in the knowledge my investments are generating returns safely above the rate of inflation, that is, the escalating cost of everyday living?
Good questions and for many conservative investors the easy answer is to plunk most of their investment dollars into fixed income investments. After all, these safe haven investments government bonds, strip bonds, mortgage-backed securities, treasury bills, and the like generally provide safety of principal, a regular and predictable income, and the potential to generate capital gains if interest rates decrease. And, while it is true that fixed income investments should form an important part of any well-balanced portfolio, you should approach them with a critical eye, just as you would any other investment. Let's look at bonds for example.
When you invest in bonds
- You purchase the bond for a specific amount of money and at a specific interest rate, and it will continue to pay interest until its maturity which can be a term of anything from 30 days to 30 years. Generally, if you sell your bond before maturity, you will incur either a capital gain or a capital loss.
- Your bond pays interest either on a regular basis or as an accrued amount on its maturity date at which time the face amount of the bond, referred to as the principal investment, is also returned. The amount of income paid by the bond is fixed when it is sold and the bond will generate exactly the same amount of interest over its entire term.
- Like all fixed income securities, bonds are interest sensitive as interest rates rise, the prices of outstanding bonds generally decline; if interest rates decline, the prices of outstanding bonds generally increase. For example, if you own a bond that pays 5% interest and interest rates decline to 4%, your bond will generally be worth more because it is yielding a higher interest rate than bonds currently being issued. But if you buy a bond paying 5% interest and interest rates rise to 6%, your bond will usually be worth somewhat less because new investors are getting a better yield.
- For your information, bond yields on many federal government issued bonds peaked above 19% in 1981 and are currently around 4%, a 40-year low.
- With yields for bonds and other fixed income securities at historic lows, it can be difficult to achieve your financial goals. When the return on an investment does not outpace the rate of inflation (the rate of price increases) you can't make money no matter how much you invest.
And that's why you should also consider other investment options
- By balancing your portfolio through the addition of equity investments (stocks) you increase the potential for better returns. Mutual funds that invest in equities can be a good choice providing needed diversification and more steady returns than an individual investor buying a few stocks is likely to achieve.
- Fixed income mutual funds can also be a good idea. For example, a bond mutual fund invests in many individual bonds helping to smooth out performance and providing greater diversification and liquidity. The bond fund manager can provide value in adjusting the holdings of the fund in anticipation of interest rate moves as well as in fundamental research on the credit quality of bond offerings in the marketplace.
Diversification and portfolio balance through the correct mix of asset classes for your particular situation are the keys to successfully reaching your short- and long-term financial goals. Talk to your financial advisor about how to keep your financial life safe and in perfect balance.
This column, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.
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