Key points:
- Questions abound about the US dollar, as well as interest rates and inflation—and all three could impact your fixed income investments.
- We don't think the importance of the dollar as a world currency is in question, or that interest rates or inflation will rise quickly soon.
- But if you're concerned, whether today or over the longer term, we discuss investment alternatives to consider as part of your fixed income portfolio.
Media attention on the "collapsing" US dollar has intensified as the dollar recently hit a 14-month low against a basket of six other international currencies. Whether or not you believe that this trend may be a sign that world markets are recovering, as we do, the long-term trends do point the benefits of international portfolio diversification.
The "dollar question" also wraps together three big macro concerns we've been hearing from many investors lately. All three are issues that could impact your bond investments:
- The currency decline itself and the impact on dollar-denominated investments
- The risk of rising rates to support the dollar (or the rising federal deficit)
- Concerns about inflation due to decreased purchasing power (or expansion in the money supply)
We don't recommend shifting your entire fixed income portfolio to international bonds, or other, even-more-extreme measures (like no investment in bonds at all). But, if you are concerned, there are a few strategies that might make sense for a portion of your fixed income portfolio.
If you're most concerned about diversification against a falling dollar, consider:
- Allocating a portion (up to 15%) of your total allocation to fixed income to developed-market international bonds. You can use an international bond mutual fund or exchange-traded fund, to help provide targeted, diversified exposure. For more information, see Take action at top right.
- Adding international bonds does add the extra variable of currency risk, particularly if they’re unhedged against changes in currency values. Of course, if you believe the dollar may continue to fall, however, this may be exactly the diversification you're looking for in a portion of your portfolio.
- Remember that many international bond funds have risen dramatically in value recently, due to the falling dollar and other factors. It doesn't make sense to chase performance, though. Prices could fall again if exchanges rates shift. If you do choose international funds, do so as part of a long-term allocation plan.
If you can stomach more volatility in a portion of your bond portfolio, consider:
- Adding an emerging market bond fund or exchange-traded fund, which can add currency diversification as well as higher yields. But beware: the risk of ratings downgrades (or even defaults) can lead to higher volatility in fund prices. Emerging market funds include higher-risk bonds issued by emerging market countries, such Russia, Brazil, and other countries with greater credit risks.
- We suggest limiting higher-risk emerging market bonds to no more than 10% of your total allocation to fixed income. Prices for many emerging market bond funds have risen dramatically recently, but such investments may not provide the stability you may be looking for from most of your fixed income investments. Think about them as a small part of an effort to provide diversification, if your tolerance for risk is consistent with the volatility involved.
If you're concerned that interest rates will rise, consider:
- Shortening the maturities in your bond portfolio, by choosing short- or intermediate-term bond funds. Limit your exposure to longer-term bonds or funds, which will fall more in value if interest rates rise.
- With shorter maturities (less than five years) or a short-term bond fund, you'll be better positioned to reinvest at higher rates if interest rates rise. Short-term bond fund managers can also reinvest quickly for higher returns if interest rates start to climb.
- With intermediate-term maturities (five to 10 years, on average) or an intermediate-term bond fund, you'll balance the risk of falling prices if rates rise with slightly higher yields today.
One of the fundamental rules of bond investing is that if interest rates rise, longer maturities fall in value faster than shorter-term bonds. The reason: you'll receive a lower coupon payment relative to what the market would give you today—and for a longer period—making it worth less to you for longer... and thus less valuable to other investors as well, should you need to sell.
The incremental benefit of yields on longer-term bonds in most markets—including today's—tends to fall quickly after maturities of about 10 years. For example, a 30-year US Treasury purchased when rates were at their low point in December 2008 fell nearly 30% in value by the end of July 2009, as the market yield on a 30-year bond rose from 2.6% to 4.6%. A 10-year Treasury fell only 10% during the same period, as 10-year yields rose from 2.1% to 3.7%.
If you're most concerned about inflation, consider:
- Adding up to a third of your bond portfolio to inflation-protected bonds, such as Treasury Inflation-Protected Securities (TIPS) or an inflation-adjusted bond fund.
- Income from inflation-protected bonds is typically lower than regular non-inflation protected bonds if inflation remains under control. But TIPS are designed to help your principal investment keep up if inflation rises faster than markets expect. Based on market prices today, TIPS should perform better than regular Treasuries if inflation averages more than 2% annually over the next 10 years.
- Look to stocks for the best protection against rising inflation—over the long-term, stocks and inflation tend to move together as prices charged for goods rise. Bonds are important for stability and income, but they're not typically the best place for an upside if inflation rises.
You're most
concerned about: | Consider | Pros | Cons | | Falling dollar |
- Add an international bond fund or exchange-traded fund (ETF)
- Add an emerging markets bond fund or exchange-traded fund (ETF)
|
- Diversification against weak dollar
|
- Currency exposure can increase volatility in price/NAV
- Increased credit risk in emerging market bonds
| | Rising interest rates |
- Limit investments to short- and intermediate-term bonds or bond funds (less than 10-year maturities)
|
- Limit exposure to falling prices if interest rates rise
|
- Yields are near zero for shorter-term bonds
| | Inflation |
- Consider inflation-protected bonds (TIPS) or funds for a portion of the fixed income allocation
- Maintain exposure to stocks for growth, if an allocation to equities fits with your investment objectives
|
- Provide some protection if inflation rises faster than expected
|
- Income is typically lower if inflation remains under control
|
For any of these options, too much of anything is never a good thing. To protect yourself from too much exposure to any single sector, or to the possibility that markets will change in unexpected ways, it makes sense to stick to a well-diversified investment plan. This can include a core of traditional domestic fixed income investments, diversified by some exposure to international and inflation-protected bonds.
For more help, or specific investment choices, refer to the Schwab OneSource™ Mutual Fund Select List and the multisector bond, emerging market bond, and inflation-protected bond fund categories.
Important Disclosures
Exchange-traded funds are subject to risks similar to those of stocks. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost.
Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. |
发表于 2009-11-21 20:35:55
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