Rebalancing - Portfolio Fixed Income Decisions

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There has been much discussion in the news recently about new highs in stock indices like the Dow Jones Industrial Average and the S&P 500. Markets, by nature, do fluctuate on a consistent basis and as such it is always important to be aware of one’s strategic allocation and rebalancing process. Normally rebalancing occurs between stocks and fixed income assets; this rebalancing is especially important when growth assets like stocks are at, or near, peaks. When unmonitored stocks can drift away from the desired target and expose an investor to additional and sometimes unknown risks. Behaviorally, in the moment, it is challenging to trim the “winners” and buy the perceived “losers”. Given this known flaw in human nature it is important to have a pre-determined plan in place so that when the moment arrives, we can confidently act combatting our innate biases. A well-built portfolio should have a disciplined rebalancing process in place; most commonly this consists of allowable tolerance ranges around an asset’s target percentage within a portfolio.

The fixed income portion of one’s portfolio may appear basic although it is vitally important when controlling the risk of a strategic allocation. Its role can vary according to an investor’s financial needs, concerns, and goals. For example, many investors look to fixed income for safety, income, and more stability in their portfolios. They must weigh these priorities against their concerns over future interest rates, inflation, government debt, and other factors that might affect fixed income returns.

Striking this balance can be a challenge in any market environment, but especially now, as low interest rates have sent many investors on a quest for higher-yield bonds, alternative investments, or pushing their equity allocation higher. Each of these changes can materially alter the overall risk of an investor’s portfolio—some of these changes may be challenging to see or understand.1

So, what’s an investor to do? How can you make prudent fixed income decisions while also addressing today’s low interest rates? Consider these principles:


Remember How Markets Work

The same core investment principles apply in any market environment. One key principle is that in a well-functioning capital market, securities prices reflect all available information. Today’s bond values reflect everything the market knows about current economic conditions, growth expectations, inflation, Fed monetary policy, and the like. So, according to this principle, the possibility of rising interest rates is already factored into fixed income prices.

This is one reason investors should view future interest rate movements as unpredictable. Even the market experts who have access to vast amounts of research have a hard time predicting the direction of interest rates.

Rather than trying to predict macroeconomic forces that are difficult to foresee, investors can look to the market to set prices and focus on the variables within their control.


Start with a Clearly Defined Goal

Fixed income choices should follow a broader investment strategy that defines the role of fixed income in a portfolio. The portfolio can then be customized to meet those specific goals while managing tradeoffs.

An investor who seeks to avoid losing market value might have a different fixed income allocation than someone who needs immediate income or is seeking higher returns. Investors with different objectives typically have different tradeoffs regarding risk, expected return, and costs.


Know What You Own

Strive for transparency in a portfolio. This means understanding an investment manager’s basic strategy and knowing how the instruments held in the portfolio might respond in different economic, market, and interest rate scenarios.

Unfortunately, investors who chase performance often make their investment decisions based on the past performance and perceived popularity of the strategy. For example, some of the mutual fund categories experiencing the heaviest inflows of cash in the industry are in asset groups that have recently experienced higher than average yields. Higher yields are typically accompanied by higher risks. But do investors know what risks their managers are taking to deliver those attractive yields?


Understand the Tradeoffs

When reaching for higher yield, investors should carefully consider the potential effects of their decisions on expected portfolio performance and risk. In the fixed income arena, investors have two primary ways to increase expected yield and returns on bonds. They can:

  • Extend the overall maturity of their bond portfolio (take more term risk).
  • Hold bonds of lower credit quality (take more credit risk).

These may be reasonable actions. But pursuing higher income means accepting more risk, as measured by interest rate movements, price volatility, or greater odds of losing value if the issuer defaults. Higher yield can also bring potentially higher volatility.


Pay Attention to Costs

Investors typically do not realize that investment-related costs determine a large part of a portfolio’s yield and return. In a low interest rate environment costs are important to fixed income securities. In fact, research has shown that a bond mutual fund’s expense helps explain much of its net performance—and funds with the highest expenses tended to have the lowest performance within their peer group.2



No one can perfectly predict the speed and magnitude of interest rate changes. Most investors are best served by building a fixed income strategy to complement their broader portfolio objectives, understanding the sources of risk, and paying attention to fees. Pursuing a defined strategy in a disciplined fashion has proven to be a successful way to approach investing. Rebalancing is a vital risk management tool which will assist you and reaching your goals while helping to control risk. Although selling the “winners” to buy the perceived “losers” does not feel great it is an important part of controlling risk.  If you don’t have one, I’d encourage you to determine a rebalancing strategy. If you’re interested in engaging with an investment advisor familiar with the goals and concerns of Physicians one of our trained UMAFS financial advisors would welcome the opportunity to review your portfolio and discuss these topics in further detail.    



This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale. UMAFS is an investment advisor registered with the Securities and Exchange Commission.

Investing risks include loss of principal and fluctuating value. Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, liquidity, prepayments, and other factors.


1. When interest rates rise, the value of an existing bond declines; when rates fall, existing bond values rise. The market adjusts a bond’s price to match the yield available on a new instrument. Investors who hold fixed income securities with longer maturities are exposed to the amplified effects of term risk. A long-term bond is more exposed to rate changes than a short-term instrument, and usually (but not always) offers a higher yield to compensate investors for the extra risk. Also, lower-coupon bonds are more affected by interest rate changes than higher-coupon bonds. For example, if rates move 1%, a bond that pays 3% will experience a greater gain or loss than one paying 5%.

2. The study examined monthly alpha and expense ratios for bond funds in the CRSP survivorship-bias-free mutual fund database from January 1992 to December 2011. Source: Dimensional Fund Advisors