Kozak Financial Group
January 19, 2024Money Education Financial literacy Economy Women & wealth Monthly commentary
Prepare your investment portfolio for the present and the future
If you have been keeping up with Kozak Financial Group, you are probably well aware of how excited we are with the interest rates available on bonds, GICs and other fixed-income instruments. After a number of years of historically low interest rates, it’s good to see interest coupons above five per cent. With that being said, interest rates at this level can sometimes cause unintended things to happen within an investment portfolio.
Over the past year-and-a-half of rising interest rates, bond prices have fallen, resulting in negative performance or losses from most bond portfolios. This is normal in these circumstances, but it’s important to keep in mind that price fluctuations do not change the amount of interest earned from bonds or their final maturity value.
What this actually means is that now is an extremely attractive time to be purchasing bonds — or other fixed-income products — within a portfolio to take advantage of high interest rates, by either re-investing existing bonds as they mature or re-allocating cash toward more fixed income. This opportunity, however, can also be one of unseen risk, and care must be taken to not fall into an “interest rate trap.”
With short-term interest rates at a high, often surpassing the rate potential on longer-term bonds, it can be seen as an attractive prospect to pile as much capital as possible into those short-term instruments such as one-year GICs to lock in those rates now. The risk, and hence “trap” in doing so, is the uncertainty on what interest rates will be when those short-term bonds mature — this is known in the bond world as “re-investment risk.”
If, for example, interest rates fall over the next year, what was once an attractive rate potential on short-term fixed income could at that point in the future be less than desired, resulting in lower future earning potential compared to a longer-term bond purchased at the same time. It is for this reason that we employ a bond ladder strategy, aimed at a more even split between short-term and long-term fixed income.
By building a more balanced portfolio, with a mix of short-, medium- and long-term investments, each part can play their own significant role in the overall health of one’s portfolio. As markets fluctuate, different assets will perform differently, and each will serve a purpose in helping you achieve your long-term goals while also aiming to minimize risk along the way.
Just as we knew the exceptionally low interest rates seen through the pandemic would not last forever, we also know that the higher rates we are experiencing today won’t last either. We are fond of saying “if you think predicting what the stock market will do next is hard, predicting where interest rates go is even harder.”
For this reason, we strive not to speculate on interest rate changes and instead focus our efforts on generating a strong, stable income stream from our bond portfolios. In doing this, our bonds serve two main purposes: they provide stable ongoing income and they provide a less volatile counterweight to the stock market portfolio.
In the end, it is important to remain focused on one’s long-term goals. Your investment portfolio has a number of important jobs to do, including providing for your retirement, protecting you against inflation, acting as a back stop in the event of a financial emergency and leaving behind a legacy for the next generation. Rather than only focusing on what is around the corner, it’s important your investment portfolio is geared toward the best possible outcome now and in the far-reaching future.