With 2016 about to close let’s take a look at what lies ahead for 2017 and try and determine what are the best fixed income investments. This is where we are going to park at least 40% of our portfolio and then break that portion down and look for those investment vehicles that will provide us with the lowest risk out there. You will never eliminate risk completely, that’s impossible. What you can do is provide a cushion for your overall portfolio when the world goes nuts as it is right now at the end of 2016.
Right now everyone is giddy as the markets are ‘melting up’ with some forecasters calling for Dow 20,000 by year end. This is no time to start dumping your bonds and go into the stock market 100%. Resist the urge of making quick money just because the market is rising. This is the time to proceed with caution and stick with your plan of putting 40% of your money into safe stuff.
If you went and asked any professional money manager out there they would do the same. The reason we’re doing this on our own is to keep more of the money we saved so we want to invest it in safer stuff so we can sleep at night. I would also add that we don’t want to place any of the money that we’ve put aside for retirement at risk. Just never do that. That’s why the 40% allocation is appropriate. Let’s emulate what the pros would do and be smart about this stuff.
What is Fixed Income?
Fixed Income is basically any investment that is NOT equity. It pays you monthly or quarterly on a fixed schedule. It is an obligation on the borrower and or issuer to make those payments even if they vary or are changed.
A common type of this is a BOND. Others include CSBs (Canada Savings Bonds) and GICs (Guaranteed Investment Certificates). You can buy these at ant financial institution.
Some investors me included also classify ‘preferred shares’ as fixed income in my 40% allocation. Some people do not but for 2017 I think it’s prudent to help squeeze out some extra yield for asset allocation purposes. You can make the case for leaving this out but I’m showing you where I will be invested for 2017. You can determine for yourself whether this makes sense for you in your situation.
This is a certificate issued to you that proves there is a debt obligation from the issuer. Could be a bank a company etc.. It is called negotiable because the ownership of the certificate can be transferred in the secondary market. It is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals (semi annual, annual, sometimes monthly).
In Canada, bonds are issued by the Feds, the provinces, municipalities (Munis), agencies and corporations. These descriptions may apply to one or more of these bond types.
- Conventional Bonds
- High Yield Bonds
- Real Return Bonds
- Savings Bonds
Investopedia defines a term deposit as: “A deposit held at a financial institution that has a fixed term. These are generally short-term with maturities ranging anywhere from a month to a few years. When a term deposit is purchased, the lender (the customer) understands that the money can only be withdrawn after the term has ended or by giving a predetermined number of days notice”. Also called CDs (Certificates of Deposit) in the U.S.
There is some terminology in this asset class that is good to know for a better understanding of fixed income.
- Issuer – the entity could be the gov’t or a company who borrows money (issues the bond) and pays out the interest.
- Principal – known as the maturity value, face value, or par value is the amount that the issuer borrows which must be repaid to the lender.
- Coupon – is the interest that the issuer must pay on the bond.
- Maturity Date – is the end of the bond. The issuer must return the principal on that date.
- Issue – another term for the bond itself.
- Indenture – is the contract that states all of the terms of the bond.
Here is a calculator for you to determine what your bonds will pay you Moneychimp Calculator
Pricing and yields
Canadian newspapers and websites carry sections listing current pricing and yields of various benchmark bonds. These prices are typically wholesale prices (and therefore yields) and therefore are not available to the retail investor who is buying bonds.
The Purchaser of the bond is obligated to pay the seller the interest due on the bond at the settlement date. Canadian conventions on calculating accrued interest are generally as follows:
For money market instruments with less than one year to maturity, an actual 365 day count is used. This what the Americans use also.
For most bonds or GICs an actual 365 day count is used. This differs from the American practice, which is the actual for terms longer than one year.
My Fixed Income Holdings
In some of the family portfolios I manage this is where I’m putting my 40% allocation:
20% in a preferred ETF. I like CPD (ishares product) and ZPR (BMO product). You can google the symbol for a lot more information provided to you for free on the company websites.
I don’t buy individual preferred shares as I find it much easier to buy the ETF, giving me broad exposure to this asset class. I will be adding to my holdings as I rebalance my portfolio going into the New year. Right now these products are cheap to buy so now is the time.
I am also going to allocate 10% to XQB for exposure to government and corporate bonds and a 5% holding in XHY (ishares) for exposure to the high yield market.
I will always carry a 5% weighting in cash through a high interest savings account like offered through Purpose Investments (PSA)
This brings us to our 40%. I then make sure I rebalance at the start of every year. It’s just a practice I find easy to follow. You can pick and choose what company specific ETFs you want to hold, I chose these for simplicity and low cost. I receive no compensation for mentioning any of these companies in this article.
ZPR – 20%
XQB – 10%
XHY – 5%
PSA – 5%
Nobody knows what’s going to happen in the future so this is what I’m doing for 2017. While stock markets are frothy they may come down so best be prepared for it. Just like nobody predicted a Trump victory in 2016, so it’s best to protect yourself now and get ready.
This website expresses my own opinion on various subjects including those relating to economics, finance, and investing. I’m not a financial advisor, broker or securities dealer and you should always seek qualified advice pertaining to your own unique situation before investing your money. Any opinions, news, research, analyses, prices, or other information contained on this website is provided as general market commentary, and does not constitute investment advice.
What will you do with your fixed income holdings for 2017? Got any questions or comments? I would love to here from you in the comments below.
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