Investing in financial markets requires a proactive approach, and one key aspect of maintaining a healthy investment portfolio is conducting periodic reviews. While many investors focus primarily on equities, it’s crucial not to overlook the fixed-income portion of one’s investments.

The financial landscape is dynamic, with economic conditions, interest rates, and market trends constantly evolving. A mid-year portfolio review provides an opportunity to assess whether your fixed-income investments align with the prevailing market conditions. Evaluating factors such as interest rate movements, credit spreads, and inflation expectations can help ensure that your fixed-income holdings are appropriately positioned for current and anticipated market environments.

Further, a mid-year review can also serve as an opportunity to identify potential investment opportunities within the fixed-income market. Market conditions have probably changed since your initial investment, presenting prospects for yield enhancement or capital appreciation. By reviewing your fixed-income holdings, you can identify any underperforming investments and consider reallocating capital to potentially more attractive opportunities, thus optimizing your portfolio’s yield potential.

Bond Prices and Interest Rates

As you probably know, bond prices and interest rates have an inverse relationship. So when interest rates rise, bond prices tend to fall, and vice versa. There are a few key reasons for this phenomenon:

Opportunity Cost: When interest rates increase, new bonds issued will offer higher coupon rates, reflecting the higher prevailing rates. As a result, existing bonds with lower coupon rates become less attractive to investors because they generate lower income compared to newly issued bonds. To make existing bonds more appealing in the market, their prices need to adjust downward, which raises their effective yield.

Fixed Income Sensitivity: Bonds, especially those with longer maturities, are more sensitive to changes in interest rates. This sensitivity is known as duration risk. When interest rates rise, the present value of future cash flows from a bond decreases, primarily due to the higher discount rate applied to those cash flows. Consequently, bond prices decline to compensate for the reduced value of future payments.

Market Demand: As interest rates increase, investors may shift their preference toward higher-yielding investments, such as newly issued bonds or other fixed-income instruments. This shift in demand reduces the demand for existing bonds, putting downward pressure on their prices.

It’s important to note that these relationships are general principles, and other factors can influence bond prices, such as credit risk, inflation expectations, and overall market conditions. However, the inverse relationship between bond prices and interest rates remains a fundamental concept in bond markets.

2023 Mid-Year Review for Bonds

It was a mixed first half of the year for bond investors as investors accepted that higher rates are not going away any time soon, especially since the Fed (and other central banks) is likely to continue raising rates to keep inflation in check.

How to Conduct a Review

Here are some steps to follow when conducting a review of your fixed-income portfolio:

Gather information: Start by gathering all the necessary information about your fixed-income investments. This includes details such as the types of bonds you own, their maturity dates, interest rates, credit ratings, and any associated fees or expenses.

Assess investment objectives: Clarify your investment objectives and risk tolerance. Are you seeking income, capital preservation, or a combination of both? Understanding your objectives will help you evaluate whether your fixed-income holdings align with your financial goals.

Evaluate performance: Examine the performance of your fixed-income investments over a specific time period, such as the past year or quarter. Compare the returns of individual securities to relevant benchmarks or indices. Assess whether your portfolio is meeting your performance expectations.

Review credit quality: Assess the credit quality of the bonds in your portfolio. Credit ratings provided by rating agencies like Moody’s or Standard & Poor’s can give you an indication of the creditworthiness of the issuers. Look for any significant changes in credit ratings or news that may impact the creditworthiness of the bond issuers.

Analyze interest rate sensitivity: Consider the interest rate sensitivity of your fixed-income investments. When interest rates rise, bond prices generally decline, and vice versa. Assess how changes in interest rates may impact the value of your bond holdings and evaluate whether adjustments are necessary.

Diversification and risk management: Evaluate the diversification of your fixed-income portfolio. Ensure that you have exposure to different sectors, industries, and issuers to manage risk effectively. Overconcentration in a particular sector or issuer can increase the vulnerability of your portfolio.

Rebalance if needed: Determine if your fixed-income portfolio needs rebalancing. Rebalancing involves adjusting the allocation of your investments to maintain your desired asset allocation. If certain positions have become overweight or underweight due to market movements, consider adjusting your holdings to align with your target allocation.

Consider tax implications: Take into account the tax implications of your fixed-income investments. Interest income from bonds is typically subject to income tax. Evaluate whether any tax-efficient strategies, such as holding municipal bonds, can help minimize your tax liability.

Seek Professional Guidance

If you are unsure about the review process or lack expertise in fixed-income investments, consider consulting a financial professional for help. They can provide guidance tailored to your specific needs and help you make informed decisions.

Remember that conducting a review of your fixed-income portfolio should be an ongoing process. Market conditions, interest rates, and your financial goals will change over time, so it’s essential to regularly monitor and adjust your fixed-income holdings accordingly.

Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by FMeX.

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