SOURCE: Creekside Partners

June 26, 2013 14:29 ET

Aligning Your Bond Maturities Is a Key Component in Successful Fixed Income Investing

LAFAYETTE, CA--(Marketwired - Jun 26, 2013) - There's a belief in the investment community that the Federal Reserve cannot keep buying Treasuries and mortgage bonds forever. And if the Fed slows down its buying, "the invisible hand of the market will drive interest rates up."

"We have already seen this happen in some respects with interest rates on the benchmark 10-year Treasury bond, which have gone from 1.70 percent to 2.20 percent since April," said Rick Ashburn, Chief Investment Officer at Creekside Partners (www.creeksidepartners.com).

"While the causes of this move are many, the dominant story line seems to be investors' awareness that the Fed cannot keep buying $85 billion of Treasuries and mortgage bonds forever. And if the Fed slows down its buying, the invisible hand of the market will tend to drive rates up."

Ashburn added that it is "common" to view the bond market in terms of interest rates. "But on our brokerage statements, the bonds we own, including via mutual funds, are given a dollar price. This dollar price can reflect a decline in what you originally paid for the bond, especially if the interest rate for such bonds has been climbing.

"But did we really lose money?" Ashburn asks. "Bonds always climb back up in price. And they do so predictably, and finish doing so on a date certain. Those 10-year Treasury bonds that fell from $100,000 to $96,000 in value will, with absolute certainty, be worth $100,000 again no later than the day they mature. That's why bonds are called 'fixed income.'"

Ashburn noted that "you can only lose money in bonds for two reasons. The first is credit quality and, if you're careful, you can largely eliminate this risk. The second reason is that you bought a bond with the wrong maturity for your needs.

"If you have a 3-year investment horizon and you bought a 10-year Treasury, you are taking the risk that you lose money when you sell the bond after 3 years," said Ashburn. "You might have bought the longer bond because its yield was higher than that available on a 3-year bond. People do it all the time, and it is tempting to do so. But, nonetheless, the risk can be avoided by 'duration matching' the bond to your investment horizon. Absent a specific shorter directive from clients about cash requirements, we set the investment horizon for most private investors at about 5-7 years. That is long enough to commit money to a meaningful strategy, and short enough to allow for changes to the clients' (and the market's) situation."

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