Tommi Harris, Financial Advisor
Here’s why they are worth considering.
There are two ways you may make money investing in bonds: appreciate in value over time and systematic interest payments. Lately, investors are forgetting about the latter.
Imagine stepping on board a large boat on a warm summer’s day, you realize it is both calming and exhilarating to be out in the open water for an extended period of time. However, the desire to cool off in the deep water becomes too irresistible, and you find yourself jumping into the water. The water wraps you up in a refreshing embrace, and you are lost in the moment. Soon after, you begin to notice that your boat is starting to drift away from you, and you find yourself stranded in the middle of the deep water. You realize you have to swim back to the boat with all your might, hoping you can reach it. Your heart begins to race, and soon you find yourself struggling to keep your head above the water. You wish you had decided to swim in shallower waters or had a more stable anchor to prevent the boat from drifting away. Ever feel this way when it comes to investing? When markets are good, it can be exhilarating, but when markets turn downward, you may wish you had a stable anchor to hold your portfolio in place.
With the aggressive Federal Reserve rate hike cycle over the past year and a half, bonds and cash have become more common topics within investment-related conversations. Here is what to consider when reviewing your own portfolio and the speed at which your investments are driving.
Diversified bonds as a segment of one’s portfolio may provide a stable anchor. Over a full market cycle, providing some diversification from other asset classes or segments during a heightened period of stock market volatility. Bonds are essentially loans made by the government, municipalities, or corporations, and when you invest in them, you become a creditor.
Three things that may be advantageous are…
- Income stream: Bonds offer regular interest payments creating a consistent income stream even in uncertain times and when the bond itself has depreciated. Consider it like an investment property. You purchase the house with the hopes the real estate market will appreciate over a long time period. Every once in a while the house may depreciate in value; just like a bond, its price may fluctuate. The second way you hope to make money when buying a house as a rental property is through a tenant paying rent each month; this is similar to a bond, by receiving systematic interest payments.
- Capital Preservation: Bonds are generally less volatile than stocks over a long period of time, such as in 2022, which was during an extreme period of interest rate hikes.
- Diversification: Including bonds in your portfolio diversifies risk, especially if the bond itself has a negative correlation to the stock segment or other asset classes within the portfolio.
High-yielding money market accounts and the temptation of liquidity. Money market accounts offer liquidity and higher interest rates compared to traditional savings accounts. They are often seen as a safe haven. When allocating the right amount of someone’s overall net worth to a money market account, a high-interest rate environment may be advantageous. However, any more than what is needed in ultra-short liquid accounts may not be the ideal choice for wealth building or preservation.
Here’s why you don’t want to over-allocate your net worth or liquid money into a high-yielding money market account.
- Limited growth potential: Money market accounts provide liquidity. While we can all agree it is important to have funds in a liquid account, they offer limited growth potential compared to bonds, which typically yield higher returns than cash over time.
- Inflation erosion: When interest rates rise, even a high-yielding savings account will have a hard time keeping pace with inflation. Also, the real purchasing power of money market funds can diminish over time.
- Opportunity cost: Opting for money market accounts alone may result in missed opportunities for long-term wealth generation.
When aiming to maximize wealth, there are various options worth exploring, including diversified bonds, money market accounts, or CDs. Although diversified bonds can yield higher returns over time, they also entail some degree of risk. Conversely, money market accounts and CDs typically offer lower returns but are considered to be safer choices. Ultimately, the optimal selection for you will depend on your unique financial objectives, risk tolerance, and investment timeline. It is worth seeking advice from a Verde financial advisor to determine the most suitable investment strategy.
Remember the key to successful wealth management lies in striking the right balance between safety and growth. Speak with your Verde advisor to tailor a strategy that aligns with your unique financial goals and risk appetite.