Plan for Changing Bond Markets

August 23, 2016

fb-boatimageMany retirees want to preserve their capital, so bonds have often been a key component of their portfolios.

But some retirees wonder if bonds can continue to provide the stability they’re looking for. They’ve spent decades putting aside money for their retirement, and they don’t want to risk losing it now.

One thing we’ve learned in our nearly 50 years of managing retirement accounts is that avoiding bonds isn’t going to help you fund a comfortable, secure life in retirement.

If you abandon bonds in favor of cash, your portfolio will lose value over time due to inflation, and if you turn entirely to stocks, you could put your retirement at risk.

A better option is to recognize that bond markets will change over time, just as stock markets do, and come up with a plan that helps you adapt to these changes. Most investors have never had any training on how to effectively adapt to changing markets, but it’s what we’ve been doing for decades.

Here are four key steps to navigating changing markets:

1. Focus on funds

Focus on bond funds rather than individual bonds. Funds can be a tremendous advantage in changing markets. They offer greater diversification, which can help manage risk. They give you access to many different areas of the bond market so you can capitalize on new opportunities. Perhaps most importantly, funds allow you to easily and efficiently respond to changing markets.

If interest rates rise, for example, you could lower the duration of your bond fund portfolio by simply selling your longer-duration funds and buying lower-duration funds. You’d get that day’s price (or NAV, net asset value) for your shares, and you may be able to trade your funds without paying transaction fees. Re-shuffling a portfolio of individual bonds, however, could be costly and time-consuming.

2. Stay open to many opportunities

Don’t limit yourself to just one kind of bond fund. Consider a wide range of different bond funds, including corporate and government funds, higher and lower quality funds and global and domestic funds.

In challenging market environments, some funds typically hold up better than others, and investors who are open to many different funds are more apt to find a safe haven. In the 2008 financial crisis, for instance, some high-yield and strategic bond funds lost 30% or more, while higher-quality bonds, like short-term U.S. Treasury bonds, ended the year with gains.

Our fixed income strategy even looks beyond traditional bond funds: we can also own total-return funds, like balanced funds and preferred stock funds. These funds typically aren’t fully invested in bonds so they tend to have less interest-rate risk or credit risk.

3. Keep an eye on risk

Bonds have historically been less volatile than stocks, but not all bonds are low risk, so if you’re worried about preserving your capital in retirement, you’ll want to keep risk in mind. One simple way to manage risk is to limit your exposure to less stable areas of the bond market like world bonds, strategic (go anywhere bonds) or high yields.

This is what we do in the bond portfolios we manage: we invest in world bond, strategic and high yield funds, but we only invest a small portion of our portfolios in these funds. That way, if these funds sell off suddenly, only a portion of our portfolio will be affected, and if these funds continue to do well, then we’ll participate in the gains.

4. Rely on a disciplined strategy

Perhaps the very best way to adapt to changing markets is to have on an investment strategy that helps you invest in a way that supports your long-term goals. We’re all emotional about money, but a solid strategy can help us avoid making emotional mistakes and guide us through many different market environments.

This post by FundX President Janet Brown originally appeared on Forbes.

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