Where Investors Should Look for Safety and High Yield
May 27, 2018
“Investors seeking safe fixed-income investments that have a current yield greater than 3% need to consider this above all else: “Safe,” says Ken Waltzer, the managing director of KCS Wealth Advisory, “is a relative term.”
There are, as most fixed-income investors know already, two main risks in buying bonds:
The first is interest rate risk, which is the risk that the bond price will fall in value when interest rates rise. This can be quantified with “duration,” says Waltzer. Duration provides a time-weighted measure of a security’s cash flow in terms of payback.
The second is credit risk, which is the risk that the issuer will default in principal or interest payments. “U.S. Treasuries, by definition, have zero credit risk,” says Waltzer. “Ten-year Treasuries do, however, have significant interest rate risk, with a duration of about 8. This means that a 1% rise in yields will cause the bond’s price to fall by 8%.”
Currently, the 10-year Treasury is yielding 3.07%. And, in order to get a higher yield, Waltzer says you need to incur either interest rate risk or credit risk.
“At the current stage of the economic cycle, we believe that the safer course is to take some credit risk and minimize interest rate risk,” he says. “This implies bonds that are of shorter (lesser) duration but do have some default risk during a recession, which we think is still a ways off.””
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