In many ways, today’s fixed income is the new equity. Years ago, when you invested in a bond, you earned your 6 or 7 percent annually through maturity and that was that. Now, because of the persistent volatility in the market, investors and their advisors need to treat fixed income almost the same as an equity investment. In short, today’s fixed income brings with it the risks most often associated with equities.
So, investors need to be more opportunistic and more carefully manage their fixed income risk. A good place to start: Evaluate each of your fixed income investments individually and, when doing so, ask yourself: “Am I being sufficiently paid for the risk I am taking with this investment?” If the answer is no, you likely need to replace this investment with one that balances risk with reward. However, if the answer is yes, the next step is to view this investment from a more macro view and measure its contribution to your portfolio’s overall risk/reward balance. You may need to shift away from this investment, not necessarily entirely, but to some degree, to adjust the portfolio and bring down risk.
Of course, it is much easier to describe this process than it is to actually ask the risk/reward question and come up with an answer. Many factors contribute to any fixed income investment’s risk level: the marketplace, the health of a corporation or a municipality, the strength of a real estate market, to name a few, and of course what kind of investment it is. There is a big difference between the risks associated with preferred equity investments (quite high) and inflation-protected Treasury notes (moderate to low).
We have found our Rings of Risk® tool immensely helpful in managing fixed income risk/reward in our clients’ portfolios.
As advisors to high net worth clients, we deal with this conundrum nearly every business day. And we were determined to find a way, not to make the process easy, necessarily, but to simplify it. If we could do this, we reasoned, we would make it easier for clients to understand the risk-balancing moves we recommend. But more importantly, our recommendations would be more spot-on, focused towards reduced risk and increased income for our clients.
The result of our simplification efforts has become what we call the Rings of Risk®. To illustrate the concept, we created a color coded graphic which displays multiple fixed income investments available inside one of a series of concentric rings. The highest-risk investments are in the outer rings and are a deep red color. Progressing inward toward the center are lighter red rings displaying investments with less risk. These give way to less risky green rings and finally blue rings at the center, which display examples of the lowest-risk investments.
It is important to note that the position of each investment type in the graphic is based on real-time information and reflects recent performance, estimates for future income and current/upcoming market forces that may likely boost or lower that risk rating.*
We have found this new tool immensely helpful in managing fixed income risk/reward in our clients’ portfolios. And, since every client is different, as you might imagine, each has an individual version of the Rings of Risk®, which reflects his or her unique income goals, not to mention tolerance for risk. Yours, of course would look different from another’s. That said, there is no foolproof way to guarantee that any fixed-income investment’s reward outweighs its risk, but you can make an important first step by simply asking: “Does it?”
“Rings of Risk®” is a trademark of Strategic Financial Group, LLC. ®2016 Strategic Financial Group, LLC. All rights reserved. Advisory services offered through Strategic Financial Group, LLC, a Registered Investment Advisor. Investing involves risk. Investment return and principal value of an investment will fluctuate, and an investor’s shares, when redeemed, may be worth more or less than their original cost. Advisory Services offered through Strategic Financial Group, LLC (dba SFGI, LLC in Illinois), a Registered Investment Advisor.
This article was originally published in the June/July 2016 issue of Worth.