Financial Advisor (FA) has tapped Laura for her insights on the dynamics of buying and selling bonds. The article featured comments from Laura explaining bond yields and the correlation between yields and prices.
Laura Mattia, chief executive of Atlas Fiduciary in Sarasota, Florida, said the biggest mistake she sees clients make with bonds is chasing yield, especially with corporate bonds. Recently elevated yields and low prices have made some investors think they can use bonds to generate the same returns that they might get from stocks, but with lower risks. There are a few problems with that assumption, however.
First: Higher yields can be a sign a bond investment or fund is too risky for the average investor. This is especially the case with companies that are in distress. In order to attract investors, they need to offer higher yields. But this reward comes with the risk that a company may go under and end up unable to pay back investors anything at all.
Second: Some bond yields change over time, particularly if they are linked to inflation.
“I bonds were really popular for a while when their interest rates were almost 10%,” said Dennis Nolte, a financial consultant with Seacoast Investment Services in Winter Park, Florida. “A bunch of people read the articles and put their $10,000 into I Bonds online and didn’t realize that the interest rate moves every six months.”
Now I bond interest rates are sitting at 5.27% and investors, and investors not only must hold I bonds for at least a year, but will lose interest from the prior three months if they cash them in before five years.
Third: Yields mask tax implications. Corporate, government and municipal bonds all face different liabilities. Income from corporate bonds is usually taxed at all levels; government bonds only at the federal level; and municipal-bond income is generally untaxed at the federal and state levels, depending on where you live. This means that a corporate bond with a high yield may actually bring an investor lower real returns versus a (possibly less risky) municipal bond once taxes are taken into account.
So, for the average individual investor — it’s best not to exit an asset class just because it has not been performing well recently, says Mattia.
“Investors need to have the discipline to stay with a well diversified portfolio that has been developed strategically,” she says. “In the long run, they will be rewarded. Remember correlation is dynamic and bonds will perform.”