We believe that every portfolio benefits from a fixed income allocation, no matter what the investor’s age. Fixed income has a moderating effect in a down market. For those who need it, it can provide income. For clients with short-term goals, fixed income can be used to protect the principal earmarked for more immediate goals.
In the fixed-income portion of a portfolio allocation, we use short- and intermediate-term bonds. We do not use long-term bonds because of the higher interest rate risk for a nominal increase in yield. We typically do not use bond funds because unnecessary expenses can sometimes diminish overall yield. Instead, we may propose building a bond ladder, which averages out the return on interest over time while reducing interest rate risk without incurring additional fees charged by mutual fund providers. This approach involves purchasing individual bonds in two- to six-year maturities and holding each to maturity. Then we roll them into new bonds at the prevailing rate of interest for an additional five years.
For example, we may construct a bond ladder that invests $100,000 in a two-year bond, $100,000 in a three-year bond, and $100,000 each in bonds that will mature in four, five, and six years. At the end of year two, when the first bond matures, we use the proceeds to purchase a new bond with a five-year maturity. At the end of year three, the next bond matures and proceeds are again invested in a five-year bond. Each year, the maturing bond proceeds are used to purchase a new five-year bond. This strategy can be effectively applied to many investors’ time horizons to meet numerous goals.