Early McClintic & McMillan
Early McClintic & McMillan

Bond Market Commentary

Separating What Matters For Individual Bonds

By Doug Drabik
August 20, 2018

When you buy and hold individual bonds to maturity, price fluctuations don’t matter.

Many stock pickers can’t check the newspaper, cell phone or computer enough times during the course of the day. Why? Because for the stock picker, price matters! Price appreciation is their best friend. The growth goal, the stock holding objective, the rationale for the stock’s tenure is all about capturing the most growth (price increase) as possible. Therefore, it makes sense to monitor the price, show concern for price declines and celebrate price increases.

Bonds are different. The buy and hold individual bond investor should have no angst. Prices can escalate through the roof or fall considerably… and baring default or early redemption, the cash flow, income and maturity value will not change. So why do some investors panic when their investment statements show changes in bond prices?

A frequent response is, “bonds are supposed to be the stable part of my portfolio….” Answer: they are! Remember the income and cash flow haven’t changed. Most investors buy bonds for wealth preservation, steady income and cash flow. Mission accomplished.

Another response is, “interest rates are about to rise and I shouldn’t even be in bonds.” Answer: individual bonds are fixed income. This is a math answer. As rates go up bond prices go down and conversely as rates fall, bond prices rise. This is because the coupon is fixed. It is the reason that when you buy a bond, you know how it will perform, pay and be redeemed from day one. This is why you should be in bonds!

Another response is, “shouldn’t I buy higher coupon bonds to mitigate the price fluctuations?” Answer: Yes and no. Yes, higher coupon bonds will likely show less price movement versus lower coupon bonds. So all things equal, why not utilize the higher coupons? No, or at least not necessarily, because other than the psychological factor of seeing a bond price move, practically speaking, the price fluctuations during the holding period won’t matter for the buy and hold individual bond investor. Since income is a desired attribute, it is the bond’s yield, not coupon that should take precedence.

Getting over the psychological hurdle of statement valuation changes may be difficult because many investors are programmed to seek higher prices. After all, higher prices benefit so many growth assets such as stocks, real estate and MLPs. But again, the goal of many buy and hold individual bond buyers is to preserve wealth and benefit from predictable income. They typically are not seeking price appreciation.

The detractor will point to the opportunity loss when holding a bond to maturity. When buying and holding to maturity, you know exactly what to expect but forgo utilizing the invested funds in any other way during the holding period. This tradeoff is deliberate as it protects investors from the downside as well.

Keep portfolio allocations honest through balanced growth and capital preservation assets. Be mindful of the difference between the two: growth assets participate in total return while capital preservation assets (held to maturity individual bonds) calculatingly do not. Coming to terms with this distinction will bring clarity to both portfolio construction and ongoing monitoring as it embodies why when you buy and hold individual bonds to maturity, price fluctuations don’t matter.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.