Ignore Your Portfolio’s Ups and Downs

05/08/2012 11:00 am EST

Focus: BONDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Income Securities Advisor’s Richard Lehmann suggests that those with fixed-income portfolios look at the total return and not be concerned with fluctuations in their portfolio’s value.

Today, my guest is Richard Lehmann, and we’re talking about income investing. Richard, last year was a pretty good year for income investors, wasn’t it?

Well, it was a good year for those in high-quality issues. But there was a lot of volatility in the lower levels, and overall, the returns were pretty low…as they have been ever since the new Fed policy came into effect.

What risks do you see this year for income investors?

Well, the traditional risks that income investors worry about are basically interest-rate risks’that rates will skyrocket’and default risk.

These two traditional concerns are pretty low in terms of what investors should be worrying about. In interest rates, because the Fed has effectively promised us that for the next two years, we’re going to have pretty much low, stable interest rates at the levels that they’re at today.

And on the default risk equation, that’s usually a factor of a poor economy. Banks call in loans. That’s what precipitates default waves…and we know that banks are flush with cash. They can’t lend to people, and consequently the pressures to call in marginal borrowers is less.

Plus, also the pressure on those borrowers, in terms of those interest rates, are so low that they don’t have this squeeze of interest costs that’s driving them into bankruptcy, and they can refinance at much lower rates. So their chances of survival have actually improved because of the low interest rates.

But what investors really should be worrying about is volatility. We saw a lot of that last year, because what we have now is a market where fixed-income securities and equities are being treated the same. The market is ignoring the fact that a security that pays 6%, 7%, 8% yield shouldn’t be fluctuating the way one that pays no dividends should be.

As a result, there has been a lot of concern by investors, because they look at their statements every month and they think they’re losing money. But what investors need to keep in mind was that you are an income investor, you’re buying it for the return that it’s supposed to give you, and that doesn’t change just because of the ups and downs.

So consequently, the investor should see volatility as a buying opportunity and ignore the fluctuation and the valuation of the portfolio, because it does come back in a 0% to 2% interest-rate environment that we have today.

You know, with you holding securities that are paying you 5%, 6%, 7%, they’re going to come back, because there’s always going to be the demand for that kind of paper. So these short-term fluctuations in volatility are something that you need to discipline yourself to ignore.

Yes, because it seems like some investors are looking at that and saying, "Boy, I’m not making any money at all right now." And they are sort of fleeing to some of the riskier assets, like some of the mortgage rates, so that they might get a 19% or 20% yield on those things.

So are you saying, just hang loose and don’t worry about it right now, that eventually the yields will come back? And if you’re in it for total return, as you said, just be confident that things will sort of come back to normal at some point in time?

Yeah. In terms of that volatility, that’s true. But it is true that investors are going to have to go out on the risk scale, because the Fed has in effect said, if you want a risk-free investment, we’re only going to pay you 25 to 50 basis points…and if you can’t live on that, you have no other choice but to go out on the risk scale.

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