Mark Peters discusses the role fixed income can play in a retirement planning portfolio
The recent market turmoil has undoubtedly had an impact on investor confidence, but for those chasing their dream retirement, now is not the time to run for cover and try to simply weather the storm. Nervous though they may be about investing, the need for positive action has never been so important and advice at this point is critical, if retirement plans are to be achieved.
Despite recent market turbulence, most investors recognise that equities hold the key to longer term performance and ultimately growth within their retirement portfolios. However, not all are prepared to act. Equally, far too many seem to simply adopt an ‘all or nothing’ approach when it comes to equities, leading to the inevitable vicious circle that follows. They hold money on deposit until shares have shown positive growth for a number of years; then move heavily into equities only to incur losses that then see them retreat to the security of deposits again.
Holding only equities within an investment portfolio, as I’ve touched on above, can be a very high-risk strategy, and one that is likely to be accompanied by considerable volatility within an individual’s own investment portfolio. The secret is diversification across different asset classes in the bid to create a portfolio that has the potential to deliver consistent returns.
Diversifying a portfolio normally means spreading the investment across a range of different assets classes, from equities, property and fixed interest. In terms of volatility, relative to equities, fixed interest investments can be described as positively boring. Yet it has been proven that it has a key role to play within a client’s investment portfolio, providing additional stability during times of stock market uncertainty. Fixed interest investments, such as gilts (Government debt) and corporate bonds (i.e. corporate debt) are an important element that often feature in portfolios, increasingly so for lower risk clients.
As with other asset classes, there are different types of fixed interest investments, such as Government gilts, corporate bonds and high-yield bonds. Each has very different characteristics and often perform very differently to each other.
Spectre of deflation
Gilts for instance benefited from the Bank of England’s quantitative easing programme in 2009, which meant prices were generally stable. However, with quantitative easing likely to fall off in 2010 we may not see this level of performance continuing. That said, for many investors, gilts will remain attractive from a security perspective or if the spectre of deflation should ever loom large over the UK economy.
Corporate bonds also performed well in 2009 with the Sterling Iboxx Corporate Bond index showing a return of some 15%. However, it would be a mistake to assume that these levels will be achieved in 2010. Inflation is perhaps the biggest risk currently. As inflation increases, we’re likely to see interest rates follow suit to counteract it. Rising interest rates have always been bad news for fixed interest investments, as the capital values offered by both gilts and corporate bonds usually fall as interest rates rise. A key consideration is very much a political one – do you believe the UK economy can withstand a rise in interest rates at a time of high unemployment?
One thing to be aware of is that corporate bonds do not provide the same level of protection as gilts during uncertain economic periods and while they may perform better when markets are stable, history shows that over the longer term it is actually the equity component in the client’s portfolio that will contribute most to any growth. All of this reinforces the need for diversification (and advice), both within an individual asset class (i.e. fixed interest) as well as within a client’s wider portfolio.
What needs to be at the core of any advice process is that investors should try to hold a wide range of asset classes within their investment portfolios, whatever the ultimate financial goal.
Remember, it is the choices we made in the past that have helped shape who we are today. However, it is the choices we make (or don’t make) today that will help decide who we can become tomorrow.
Mark Peters is investment proposition manager at Zurich
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