Retirees seeking a reliable source of income at an acceptable level of risk often will boost the bond portion of their portfolios. Because of today’s volatile stock market, many investors are revisiting their asset allocation strategy and adjusting their portfolios to include more fixed-income investments.

Bond risks
Bondholders face three significant risks: default risk, interest-rate risk, and reinvestment risk. Default risk is the chance that the issuer will lose the ability to make interest or principal repayments.
When interest rates rise, the bond values decline. If rates fall, values rise. And the longer the maturity of the bond, the more volatile the price will be. Because prices fluctuate, bondholders may reap some gain or incur a loss when a bond is sold prior to its maturity date. If a bond is held to maturity, the loss on paper won’t be realized.
Reinvestment risk refers to what investors may face after a bond reaches maturity. When a bondholder receives his or her original investment back, he or she must reinvest at prevailing interest rates. If rates have fallen since the original purchase, the investor must choose to accept less income or invest in another kind of security.

Managing risk with a bond ladder
One of the decisions that investors who are considering a bond purchase must grapple with is choosing a maturity date. Short-term bonds offer the most safety, but with their low yields may not provide a sufficient flow of income. Longer-term bonds offer more income, but the farther out an investor goes, the greater the risk that should the bond need to be cashed in prior to maturity, he or she will receive less than what was paid for the bond.
The solution for some investors is to establish a bond ladder. The investor decides how much he or she wants to invest in bonds and divides the amount equally, purchasing bonds with staggered maturities (each maturity date comprises a rung of the ladder).
If interest rates are trending upward right after an investor has purchased a bond, he or she knows that there will be money forthcoming in the near future to take advantage of the higher rates when one of the shorter-term bonds mature. Conversely, if interest rates are declining after the purchase, the investor has been able to lock in the higher rates for a portion of his or her portfolio.
In addition, an investor may have the flexibility to match or adjust the flow of income according to his or her needs. And the relative liquidity can be a buffer when unexpected expenses are incurred.
For maximum safety, investors may choose Treasury bonds. For shorter maturities the ladder’s rungs can be constructed with Treasury notes or bills or even CDs. Depending upon the investment strategy, ladders or rungs might consist of other securities, such as municipal or corporate bonds.

An example
Say that Investor wants to create a bond ladder with $100,000 in capital with a maximum ten-year maturity. He invests $20,000 each in Treasuries with maturities of two, four, six, eight and ten years. If Investor wishes to maintain the same average maturity for his ladder, every two years as a bond matures, it is replaced with a ten-year bond.
With this approach, Investor always has 20% of his or her bonds maturing in two years, with funds available to take advantage of higher-yielding bonds if interest rates increase or to use as a cash source should a need later arise.

Consider these points
Interest-rate risk is not eliminated with a bond ladder. Should a bond need to be sold prior to its maturity date, and interests rates are higher than at the time of its purchase, the bondholder receives less than what he or she paid for the bond. If there are callable bonds in the ladder, and they are called before maturity, interest payments cease, and the principal is returned to the investor as of the call date. Reinvesting the principal will mean accepting income payments that are consistent with the prevailing interest rates.
What’s more, because Treasury bonds are available only in limited maturities, an investor may have to use the secondary market and buy a bond at a premium. But at maturity an investor receives only the par value of the bond. (The loss may be deducible on his or her tax return.)
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Bond ladders, as with any investment strategy, are not for everyone. If you are considering increasing the allocation of bonds in your portfolio, we would be glad to evaluate your current holdings and discuss the pros and cons of a bond ladder in your particular circumstances.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

Company retirement plans, charitable organizations and other entities must define clearly, in writing, exactly how the contributions that they make are invested and managed. One of the ways that this goal is accomplished is by drawing up a document, often referred to as an Investment Policy Statement (IPS). For individual investors, too, an IPS can be a useful and valuable document.

The benefits of an IPS
An IPS brings structure to the process of investing. It also brings discipline by requiring the investor to put into words the strategy for the management of his or her investments— something that the investor may not have articulated formally previously. And, as time passes, it permits the investor to examine how this strategy is working and what changes, if
any, may be necessary.

An outline
There is no one right way to draft an IPS. But, although some of the organizational structure and language used in drafting the document can vary, there are several elements that are likely to appear in any IPS.
An overview. The opening section of the IPS usually provides an overall perspective on the investor and his or her current investment profile. It may include, for example, current assets, how much will be invested over a stated period of time, and one’s investment time horizon, tolerance for risk and target asset allocation. A statement of objectives. Here the investor’s goals are outlined, both for the short term and the long. This section may discuss how much of the investor’s assets will be dedicated toward meeting each individual goal, over what particular time period.
Investment philosophy. What is important to the individual from an investment
perspective? What does he or she believe about investing and the investment process? These are the kinds of questions that need to be answered to put an investor’s philosophy into words. This philosophy may be stated in generalities or be presented in depth—addressing such issues as risk, diversification, trading, taxes and other costs.
The selection of investments. This section is the core of the IPS. It is used to develop the investor’s asset allocation strategy—how investments will be distributed among the various asset classes. This discussion often focuses on such things as investment diversification, choice of nontraditional investments and ways to make the investor’s portfoliotax efficient.
Monitoring and review. An effective IPS also will set up the criteria for measuring the performance of investments. Monitoring will help tell the investor when a rebalancing of a portfolio may be necessary and, perhaps, what investments, if any, should be sold.

We’re here to help
Are you interested in establishing your own IPS? Putting it in writing is a good idea, but even if you don’t, you should at least try to have answers to the questions that arise in the process of developing an IPS.
We will be glad to provide you with guidance and assistance in developing your own document. We will consult with you in order to get a firm grasp on your needs as an investor as well as to examine your current portfolio. We will analyze the information that you give us. Develop a strategy. Implement it for you as well. Of course, we always will be available to discuss with you any aspect of your IPS, review it regularly and recommend any changes
that we believe will contribute to your success as an investor.

Please call upon us at any time. We look forward to hearing from you.
© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.