Investment

If you are investing in bonds for income, you most likely want to minimize any risk of loss to your portfolio. Since no investment is entirely risk free, you need to understand where the risks with bonds lie. One risk is the possibility that the issuer won’t pay the interest or repay the principal at maturity. There’s also reinvestment risk, or the risk that your bonds will mature while interest rates are falling. When that happens and you buy new bonds with a lower interest rate, you reduce the income stream that you are depending on.

Laddering is a strategy that minimizes the risk of being locked in at a single interest rate and provides added liquidity to your portfolio. It involves buying a series of bonds (perhaps from different issuers) with a range of maturities. The staggered maturities of the “laddered” bonds can reduce the likelihood of you dealing with reinvestment shock if interest rates happen to be lower when some of your bonds mature. Creating a laddered portfolio can help even out volatility in your income stream while allowing you to estimate how much your portfolio will yield from year to year.

Another benefit of a diverse,* laddered portfolio of bonds is that it can reduce your exposure to default risk. The default of one issuer in a portfolio that holds bonds from multiple issuers is less damaging than it would be in a portfolio concentrated in bonds from just one or two issuers.

The Mechanics of Laddering

As an example, assume that you divide up your portfolio by buying equal dollar amounts of bonds with two-, four-, six-, eight-, and 10-year maturities. So, the average maturity in your portfolio is six years. As each bond matures, you replace that bond with one equal to the longest maturity in your portfolio. For example, when your two-year bond matures, replace it with a 10-year bond. The 10-year bond you initially purchased now has eight years until it matures. And the eight-year bond has six years to maturity and so on. Despite these changes, the average weighted maturity of your portfolio does not change — it remains at six years.

When interest rates fall, your laddered portfolio protects you since the longer maturity bonds at the top of the ladder are still paying above-market rates. And when interest rates start climbing, you reinvest maturing bonds at the bottom of the ladder in higher yielding, longer maturity bonds.

You can also use laddering as a strategy if you are investing in certificates of deposit (CDs) for income. The principle is the same except you are buying bank-issued CDs instead of bonds.

As an income investor, ensuring a steady, predictable stream of income is critically important. Your investment professional can help you determine if laddering bonds or CDs is a smart strategy for achieving your goals.

For more information on Laddering, call Vista Tax Relief at 480-916-2862 today!

Many mutual funds* and exchanged-traded funds (ETFs) buy stock in companies that represent a broad range of industries and economic sectors. However, some stock funds take a less diversified, more high-risk approach, investing only in companies active in a specific sector of the economy, such as utilities, health care, or information technology.

Background

There are 11 market sectors that have been identified under the Global Industry Classification Standard, a classification system developed by MSCI and S&P Dow Jones Indices to categorize companies traded on public exchanges. This system is recognized by the wider financial and investment community.

The 11 sectors are:

• Energy
• Materials
• Industrials
• Consumer Discretionary
• Consumer Staples
• Health Care
• Financials
• Information Technology
• Communication Services
• Utilities
• Real Estate

Within these 11 sectors, there are 24 industry groups, 69 industries, and 158 sub-industries. Typically, a sector fund will only buy stock in companies that operate in one of these sectors or in a subsector.

Pluses of Investing in Sector Funds

Sector funds allow investors to invest in specific market sectors that may outperform the overall market. Investors can use these funds to try to capitalize on emerging developments and advances in various sectors of the economy.

Sector funds may also be used by investors who are attempting to take advantage of business cycles. Cyclical stocks are sensitive to the health of the economy and their prices tend to move up during periods of strong economic growth. Cyclical companies make goods and provide services that are in high demand by consumers when the economy is strong, such as autos and electronic goods. Defensive stocks are stocks in companies that produce goods and services that consumers keep buying even during a weakening economy. Because the demand for utilities, food, and other staples remains fairly constant through all economic phases, the stock prices of companies in this sector typically do not fluctuate too much during economic highs and lows.

Be Aware of the Risks

Sector funds involve risks associated with a portfolio that concentrates its investments in one sector and can experience extreme volatility. There is a higher risk of loss and investors should expect higher expenses and costs buying sector funds than they would buying an index fund.

In general, sector funds may be appropriate for experienced, informed investors who can handle a high level of investment risk and have a long-term investing horizon. Before investing in sector funds, it may be advisable to own a portfolio of broadly diversified funds.**

As always, be sure to consult with a financial professional before investing, especially in assets that are complex and may present a higher than average investment risk.

*You should consider the fund’s investment objectives, charges, expenses, and risks carefully before you invest. The fund’s prospectus, which can be obtained from your financial representative, contains this and other information about the fund. Read the prospectus carefully before you invest or send money. Shares, when redeemed, may be worth more or less than their original cost.

**Diversification does not ensure a profit or protect against loss in a declining market.

For more information on Sector Funds, call Vista Tax Relief at 480-916-2862 today!