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Iowa State Bank Investment Expert, Philip Horn

Re-confirming the Role of Fixed Income in Your Investment Portfolio and Re-balancing

July 6, 2022

As the second quarter of 2022 concludes, the S&P 500 Index is down approx. 20.5% with the Bloomberg Barclays Aggregate Bond Index down approx. 10.1% thru June 30th. The equity market’s year-to-date closing low occurred on June 16th (S&P 500 at 3,666.37) and the fixed income market’s year-to-date closing low price (highest yield) occurred on June 14th (10 year US T-Note at 3.48%). Given “bear market” returns like these to date, many investors are asking what is the role of fixed income in their portfolio(s)?

Fixed income provides two benefits in portfolios: income and diversification. Income is the primary benefit and constitutes a significant percent of the total return received over time. Often income is for distribution from a portfolio but it also serves to “compound returns” over time (income earned from fixed income that is re-invested in more fixed income that provides more income). In periods of broadly declining interest rates (e.g., 11/2/18 thru 8/5/21), fixed income securities usually appreciate in value as the discount rate declines and security market values increase. Declining interest rates typically result in declining income along with lagging re-investment rates over the future time period.  In periods of broadly rising interest rates (e.g., 8/6/21 thru 6/14/22), the opposite occurs, where fixed income securities usually depreciate in value as the discount rate increases and security market values decrease. Similarly, increasing interest rates typically result in increasing income along with lagging re-investment rates over the future time period. 

The second benefit is diversification within a portfolio’s asset allocation and price risk (volatility) reduction. Diversification benefits are provided across asset classes (equity vs. fixed income) as well as within an asset sub-class (types of fixed income securities  ̶  investment grade vs. high yield). Fixed income serves to buffer investment returns over the long term, as evidenced by the contrast in the equity and fixed income returns noted above.

As investors review their second quarter agency / IRA / Roth IRA / 401(k) Plan account statements, they may be well served to consider their overall asset allocation, recall their long term account objectives and re-balance where appropriate. Keep in mind re-balancing does not have to consist of solely one adjustment (selling 5% to 10% from fixed income and re-investing 5% to 10% in equities). Rather re-balancing can consist of incremental adjustments (e.g., half of one move). The important point is to avoid investor paralysis and take action to adjust your portfolio(s) for future markets vs. doing nothing and looking back after time passes and markets have moved onward.

Written by Philip Horn - Iowa State Bank VP, Investment Officer