Most of the time when the term Fixed Income investments or bonds are mentioned, words like “boring,” “confusing,” and thoughts of “why bother?” come to mind. The Federal Reserve has control over the federal funds rate, which in turn sets the tone for interest rates across the entire bond market. On July 26th the Federal Reserve approved a hike that takes interest rates to the highest level in more than 22 years!
If you haven’t taken the time to learn about bond investments, now is the time. Some may say bonds are confusing; however, bonds are one of the most predictable asset classes and a more conservative means to help protect investors’ wealth and provide stable income.
Let’s look at the basic mechanics of a typical municipal bond,
Issuer/Borrower: Port of Seattle
Maturity Value/Principal: $100,000
Interest Rate: 4.50%
Callable Date: 8/1/2033
Maturity Date: 8/1/2038
S&P Rating: AA
*This is a hypothetical example for illustration purposes only and does not represent an actual investment.*
A bond represents a loan made by an investor to a borrower. Think of it as an IOU between you and a lender. There is a fixed rate of interest (4.50%) which creates cash flow paid to the lender, and a maturity date when the principal ($100,000) is due. The income that the lender would receive annually equals the principal amount lent multiplied by the interest rate ($100,000 * 4.50% = $4,500). There may also be a “callable date.” This allows the borrower to pay the loan off prior to the maturity date. A lender may do this if they have excess cash and want to pay down debt, or they could re-finance the bond at a lower rate. The credit rating, as determined by rating companies like S&P and Moody’s, provides an indication of the quality or likelihood that the lender will meet their obligations to make timely payments of interest and principal. Think of this as its credit score, the more A’s, the better.
Bonds can be issued by a corporation; in which case the income is treated as taxable income. However, some bonds are issued by States and local governments making the income free from Federal Taxes and potentially free of state income taxes if you live in the state the bond was issued. For investors in higher tax brackets, this can make these types of municipal bonds very appealing.
At Mainspring, engaging with your advisor about the function of municipal bonds and municipal bond mutual funds in your portfolio is a conversation worth having. As with any investment, it is worth discussing your timeframe, risk tolerance, and cash flow needs. It’s common to hear about the drawbacks of higher rates, such as inflation and increased interest rates on loans. However, with rate increases also comes the opportunity to generate better income on your investments. Ensuring your money is working for you and talking to your advisor about utilizing bonds in your portfolio is a worthwhile conversation.
There are always details to consider, including the risks and benefits that come with any investment. Understanding these aspects is essential to ensuring an investment aligns with your needs and suitability. This blog is intended to spark your interest in the bond market, and for a more in-depth understanding, please consult your Mainspring Financial Planner.
Any opinions are those of the authors and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Expressions of opinion are as of this date and are subject to change without notice.
There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Investing involves risk and you may incur a profit or loss regardless of the strategy selected.
Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices rise.
Investments in municipal securities may not be appropriate for all investors, particularly those who do not stand to benefit from the tax status of the investment. Municipal bond interest is not subject to federal income tax but may be subject to AMT, state or local taxes.
