Tips for a recovering market

By Lou Bartenstein Vice President of Fixed Income, St. Germain Investments Just as we noted in previous articles, the market is recovering. It may not be at a clip favorable to some, but the recovery is in motion. What hasn't changed is the volatility that's inherent with stocks. It's always been a part of investing since day one. Because bonds typically earn more than cash and fluctuate less than stocks, it's important to consider bonds in your portfolio. What follows are the most asked questions about bonds, and why they matter in your portfolio. Q: Aren't bonds really for older more conservative investors? A: Not necessarily. A lot depends on your life stage and other factors that influence your investment goals. Regardless of age, if a good part of your investment strategy is to generate income, then having bonds in your portfolio could make sense. In several instances, bonds can provide more favorable interest rates when compared to CDs or money market funds. Q: But I'm not overly conservative. I'm comfortable with some risk and if bonds are safer compared to stocks, then shouldn't I forego bonds altogether? A: We hear this question on occasion and it's important to remember that while bonds may not offer the same return potential as some stocks, bonds do have the potential to balance or offset some of the uncertainty stocks present. Having said that, we firmly believe that bonds are an essential element in a diversified portfolio. For example, bonds can help deflect some of the volatility and curb stock losses during market downturns. As is often the case, bonds typically rise in value when stocks decline. You do have a number of options or choices when it comes to investing in bonds. U.S. Government bonds: issued by the U.S. Treasury and various government sponsored entities, these bonds are backed by the Federal Government. While it's true that interest is taxable, having U.S. Treasuries exempts investors from both state and local taxes and represent the most credit worthy fixed income investment. Municipal bonds: issued by local and state governments, these are issued to help fund public projects. Since bonds are loans you make, be advised that credit quality can vary from one municipality to another. Income from municipal bonds is generally exempt from Federal taxation and may be exempt from state and local taxes. Corporate bonds: issued by companies of various sizes across a number of industries to help fund their business activities. International bonds: issued by foreign countries and non-domestic companies. These bonds must meet the same quality and return standards as the other bond categories. Q: So for the long term, diversifying my portfolio with bonds practically eliminates the possibility of losing money. Is that an accurate assumption? A: In word, no, but we understand where you want to go with that feeling. It's important to remember that while diversification will not guarantee a profit or eliminate the possibility of loss, investors have historically been well served by constructing diversified portfolios based on long term goals and objectives. Q: I've been told that interests rates are rising and we're entering an inflationary period. What happens to my bonds? A: The bond portfolios are intended to provide a stable stream of income based upon the coupon rate and the par amount of the asset (these elements are fixed and do not vary over time). Bonds are not intended to provide a counter to rising inflation rates (inflation indexed bonds are exceptions but owing to their lower yields and tax status are at best an adjunct asset class). Employing a portfolio construction which contains short maturities, you have the ability to reinvest in a current rate environment as bonds mature and principal is made available for reinvestment. This structure along the yield curve serves as a counter to an inflationary environment. Q: What kind of returns should an investor expect with a bond portfolio? A: Bond portfolios are designed to provide a 4-6 percent return over a long-term horizon. That horizon will include periods of expansion, inflation and even periods of recession. The portfolio is NOT designed to maximize returns at every discrete point of the economic cycle. Given the quality of the holdings, the diversification among the sectors and maturities over the course of the economic cycle, a fixed income portfolio will optimize the risk / reward trade off and best serve the investment objectives of the client. Column provided to PRIME by: St. Germain Investment Management; 1500 Main Street, Springfield, MA; Phone is 413-733-5111 or 1-800443-7624; web site: www.stgermaininvestments.com