Is it time to revisit fixed income?

Choosing what to invest in can be as difficult as maintaining a good diet.

We all know we should eat healthily, yet how exciting would life be if we were always munching down on a quinoa and kale salad, leaving no room for an expensive steak, or a bag of your favourite lollies?

Likewise, reliable, lower-risk bonds generally won't keep you up at night with wild price swings, yet do they offer the necessary returns available in riskier and perhaps more exciting asset classes?

Sometimes you want that hot growth stock that may come at a steep premium, or even that speculative flavour of the month, that in the end, just might leave you feeling a little sick to the stomach.

With a virtually infinite range of options, how do you weigh up what is right?

When it comes to building a healthy, resilient investment portfolio, consensus tells us that a balanced diet approach is the way to go.

One size does not fit all

Unfortunately, what works for one investor may not work for another, as we all have our own risk aversions and intolerances.

Not to mention age being a major consideration. In your 20s, those late-night kebabs often seem like a good idea at the time, yet you come to regret them later, even if just for a short time, much like a poorly-timed small-cap. Try such nonsense in your 60s and you could be in for a world of hurt, without the time available to recover properly.

To top it all off, economic and environmental conditions heavily dictate why and when we should choose particular investments…just like food.

Why bother with bonds at all

Food analogies aside, in simple terms, stocks are generally seen as riskier than bonds. Largely because stocks don't guarantee any returns and depend on how well the company is doing. Unfortunately, there is even the potential that you could lose all of your money.

Bonds can act as a safety net for an investment portfolio. When you buy a bond, you are lending money to a government or a company which promises to pay you back with interest after a set period of time.

While returns may not be as attractive as equities, fixed income can not only become a crucial means for steady and attractive returns, but also a protection and mitigation against the potentially huge downside risks of equities. Particularly in a market environment where recessionary risk is a real possibility.

Assuming your chosen bonds are of good quality, they should provide a steady stream of income as well as return an initial investment after a certain period. Which can be particularly handy during rough times when the stock market is on a roller coaster ride.

In addition, if a company goes belly up, bondholders are higher up the queue to get their money back compared to shareholders. So including bonds in a portfolio can help balance out risks and bring a bit of stability to your investment returns.

But that doesn’t mean bonds are risk-free. If the rate of inflation is higher than current interest rates, the money you get back when a bond matures could be worth less than when you first invested. And to add insult to injury, you still have to pay tax on the interest earned, further reducing returns.

Time for a diet?

Most Aussie portfolios have a heavy weighting toward equities. Particularly those following the loud drum of keeping things simple with ETFs that essentially have portfolios allocated to the country’s top 200 or 300 companies.

While bond yields were close to all-time lows this approach has not been without merit. In fact, after years of extremely low returns, investors have been forced to seek out riskier asset classes just to beat high inflation, resulting in portfolios that are now potentially overweight in equities.

Now, rising interest rates are once again providing a compelling backdrop for investors to rethink whether their portfolios are offering the optimal mix of bonds and stocks given how materially prices have changed.

Thanks to the actions taken by the central banks in the past year, bonds are now offering better returns than they have in quite a few years. Major banks are beginning to offer term deposits higher than 5% for the first time in a decade, while risks on the horizon could also weigh on equity valuations.

Looking ahead, analyst expectations of recessions in developed markets, albeit modest, have the environment for equities appearing somewhat vulnerable. For those wanting to review asset allocations, the future now appears much brighter for fixed income. Investors with long time horizons can lock in high levels of yield and benefit from the diversification benefits of these more conservative investment options.

Final thoughts

The world of fixed income is vast, with a variety of assets ranging from those that have little to no relationship with stocks, to those that move closely with them. Hence, the importance of a diversified and thoughtfully built portfolio in achieving investor goals.

So, whether it's reassessing your diet as winter weight needs to be shed or recalibrating your portfolio as the economic climate fluctuates, there’s always an opportunity to consider a shift. It’s important to stay adaptable and be ready to make good choices when needed.

After all, it's your financial health we're talking about.

Disclaimer: This article is prepared by Mark Garro. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.