Balancing risk and reward Looking for yield without too much risk

An important consideration when investing in bonds and fixed income securities is that there are two typical kinds of risk. Credit risk is the possibility that you won’t get your principle paid back. Interest rate risk is the opportunity cost that interest rates move higher while you are invested in a lower yielding instrument.

When dealing with credit risk, you normally receive a higher interest rate to compensate for the higher probability of not getting your investment back. Credit risk can be avoided by buying treasury bonds and bills. Of course the yields of today’s government securities are not very exciting.

Interest rate risk is buying a bond or CD with a set rate and having yields subsequently move higher. For example, buying a CD paying a 4% interest rate and then having the same maturity move to 4.5% while you are receiving 4%.

Interest rates are expected to move higher over the next several years. If that happens (its far from certain), investing in safer things like CD’s and bonds will be tricky. It will re-introduce interest rate risk to the market for the first time in 35 years (Interest rates have been falling since 1982).

As a way to educate investors, we have constructed some options to consider. Please know that this is not a comprehensive list and there are many more options available. These are used to illustrate the state of the market. Further this is not a recommendation as they may or may not be appropriate.

The table includes the yield, the duration, and the 3-year range for the price. Duration, for those who are not familiar with the term, is the time-weighted average of the security’s cash flows. The higher the number the greater the sensitivity to changes in interest rates. In other words, high duration bonds will go down in price more than low duration bonds given the same interest rate move.

The 3-year price range is provided to offer a sense of price volatility. Bond prices move inversely to the move in interest rates.

This table emphasizes price stability or low interest rate risk. We try to help readers understand what yields are available for the lowest interest rate risk. Some of these examples do not have credit risk (CD’s and TIPS) but some others do.

Yield Duration 3 year price Variance from mid-pt.

CD’s 1% 6 months

Franklin 2.12% 1.4 years $100.14 – 1.57%
Liberty Short $97.04
Duration US
Govt ETF

Fidelity Adv 1.63% 2.6 years $11.62 – 1.18%
Ltd. Term $11.35
Bond Fd

Lord Abbett 2.05% 2 years $4.56 – 3.28%
Short Duration $4.27
Income Fund

Putnam 6.03% 1.1 years $8.05 – 11.42%
Diversified $6.40
Income Fund

Vangurad Short -0.25% 2.8 years $52.12 – 4.31%
Term TIP ETF $47.81

Nuveen NY 3.89% 7.3 years $14.89 – 7.16%
Tax Freed $12.90

DoubleLine 0.62% 0.2 years $10.02 – 0.10%
Ultra Short $10.00
Bong Fund

For more information or questions, please contact me.

Jeffrey J. Kerr, CFA

Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13905