Investment Strategies

Investors use many strategies when investing in bonds. Read brief summaries describing some of the more common investment strategies used by fixed income investors.

Investors typically use investment strategies to either protect a portfolio from volatility or to enhance the returns generated by a portfolio. As with any investment strategy, the successful use of a particular strategy depends upon many factors including: an investor’s specific investing situation (objectives, tax bracket, etc.), economic and market factors and other factors too numerous to list fully in this discussion. While this discussion touches upon the more popular fixed income investment strategies, the information is provided solely to inform you of various fixed income investment strategies. Before using any investment strategy, individuals should consult with their tax or investment advisor.

Asset Allocation

Asset allocation is the distribution of investments among different types of assets including cash, stocks, fixed income securities (bonds, CDs, etc.) and tangible assets like real estate, metals and collectibles. Asset allocation affects both the risk and the return of a portfolio and is a central concept in personal financial planning and investment management. For example, for a young, single investor saving for retirement 35 years from now, a financial planner may suggest a portfolio heavy in high growth stocks offering the potential for capital appreciation. However, that same financial planner, for an investor near retirement, may suggest a portfolio heavy in municipal bonds for capital preservation and regular income.

Bond Ladder

A bond ladder is a strategy for managing fixed income investments such as municipal bonds, corporate bonds, U.S. Treasury notes and bonds and CDs. In the simplest terms, to build a ladder, investors divide their investable dollars evenly among bonds or CDs that mature at regular intervals (e.g., every six months, each year). For investors, the benefits of using a bond ladder may include:

  • Diversification
    Using a ladder allows an investor to invest in a variety of bonds thus lessening the risks associated with fixed income investing. The primary risks include: a bond issuer defaulting on principal and interest payments (credit risk) or the risk that your bonds mature in a low yield environment forcing you to either accept a lower yield or accept increased risk for a higher yield (reinvestment risk).
  • Higher Yield
    In a normal interest rate environment, intermediate and longer-term bonds offer higher returns than shorter maturities. An investor using a ladder strategy often enjoys short-term liquidity to meet various needs (e.g., college tuition for a child) while enjoying a slightly higher yield from the longer-term bonds within the ladder.
  • Liquidity
    With a ladder, bonds mature regularly, allowing an investor to reinvest the proceeds or take out cash as needed.
  • Flexibility
    Investors can design a bond ladder program to meet their financial needs. Laddering offers investors the opportunity to modify a fixed income portfolio as their needs and objectives change.

Barbell Portfolio

Like a bond ladder, a barbell portfolio is a portfolio of bonds with varying maturities. However, the maturities of the bonds are distributed like a barbell with most of the bonds having short-term and long-term maturities and fewer bonds having intermediate maturities. Investors are able to adjust their portfolio to emphasize short- or long-term bonds depending on the investor’s beliefs regarding the direction of interest rates.

Bond Swaps

A bond swap is the simultaneous sale of one bond issue and the purchase of another bond issue. Most investors use a bond swap to take advantage of a tax loss within their portfolio when they need to apply a capital loss against a capital gain. However, investors may also use bond swaps to improve portfolio quality, adjust maturity, or to seek higher yields.