Bond Market Normalization

For eight of the last thirteen years, the Federal Reserve held short-term interest rates near zero, causing a ripple effect through the other interest rate categories in our economy.?Savings rates, corporate bond rates, and mortgage rates were all well below historical averages.?The average mortgage rate over the last 30 years was 5.66% but had reached a low of 2.65% in 2021.??

This policy of zero interest rates also had an impact on the fixed income side of investment portfolios, negatively impacting the income one could reasonably expect to receive on bonds and savings instruments.?Bond prices generally move inversely to interest rates, so the low rates of income were masked by strong stock market performance and capital appreciation in balanced portfolios.?

What we have seen this year has been a drastic normalization of interest rate policy and since bond prices generally move inversely to those rates, a destruction of capital in fixed income securities the likes of which we have never seen.?In fact, through September, this has been the worst year in history for the bond market.

However, this normalization of prices and rates have uncovered opportunities to return to the traditional concept of “fixed” income, that is, utilizing bonds and savings instruments to generate current income in a more stable manner, and not relying on price appreciation (i.e. interest rate movements) to fund withdrawals, especially for folks in retirement.

Throughout the year, we have implemented individual portfolios of fixed income securities, that when held until maturity, reduces exposure to interest rate risk. ?This method allows the fixed income side of our portfolios to exhibit more stable return characteristics in comparison to portfolios of bond mutual funds and ETFs without defined maturities.

This strategy is not without risk, of course.?When mitigating interest rate risk in this way, you take on what is known as reinvestment risk, that is, the risk that when the current bond comes due, rates will then be lower, a risk of reinvesting at a lower rate in the future.?But for folks where portfolios are supporting income, those maturities can be structured in such a way that the proceeds are used to fund withdrawals, further mitigating the overall risk in the portfolio.

Disclosures

The market value of bonds fluctuates based on the current market conditions. If the bond is sold prior to maturity, the investor’s yield may differ from that of the advertised yield. If the bond is held until maturity, the bond will continue to pay the stated coupon rate as well as its face value upon maturity. However, the coupon rate and the repayment of the face value is still subject to default risk. Bonds face many types of risks, including but not limited to, liquidity risk, interest rate risk, inflation risk, credit or default risk, reinvestment risk, etc.

Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Investing involves risks, including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. Forecasts may not unfold as predicted.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. Investors should ensure that they obtain all available relevant information before making any investment.

All information is believed to be from reliable sources and accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. Independence Square Advisors makes no representation as to the content’s completeness or accuracy.

Securities offered through LPL Financial, member FINRA/SIPC FINRA.org SIPC.org.?Investment advice offered through Independence Square Holdings, a registered investment advisor. Independence Square Holdings and Independence Square Advisors are separate entities from LPL Financial.?